Happy Tax Day!

James Otis once said that “Taxation without representation is tyranny.” I say that even with adequate representation, having to fill out a bunch of complex forms every year and abide by confusing tax rules is tyranny as well.

In this article, I want to share some of the lessons learned (or further reinforce) during this hectic tax season. The two main themes that surfaced were:

1. Filing returns that are error-free and efficient (“no money left on the table”) can be quite challenging.


2. There are infinite ways to overpay the government (or worse, underpay and be at risk of an audit).

As many of you know, we work alongside our clients’ accountants (or TurboTax) to ensure that tax returns are done accurately and efficiently. The last few weeks have been intense for my team since we probably do as much work as the actual tax preparers themselves. Below are 10 lessons we took away.

1. Extend, baby, extend

I’ll never fully understand how sensitive taxpayers can get about filing an extension. Some strongly believe that extending is somehow shameful or disgraceful. We disagree. Extending is a very common activity and highly advised in a situation when the taxpayer doesn’t have all the data (even if the data doesn’t change the overall tax liability). Some of our partner accountants have said that extending may even reduce the risk of an audit. Hard to prove that point, but it makes sense that the IRS would assume a higher degree of accuracy with extended returns—or perhaps that its operations might be designed to monitor those returns that come in first. Also, there continues to be some confusion on what exactly it means to “extend”—it is an extension to file, not an extension to pay. If there is a balance due after the deadline, interest and penalties will accrue monthly on that amount. There’s no patriotism in giving the government more than they deserve.

2. AMT is stupid, stupid, stupid

AMT is a different way of calculating one’s tax liability, and it in my opinion has lost its relevance. Hopefully Trump can at least get rid of this idiotic system that mainly punishes the middle class. In our experience, taxpayers who have incomes under $150K or over $600K will generally avoid AMT, so neither the poor nor the “evil” rich gets hit with AMT.

3. Few ways to get things right, infinite ways to screw things up

In our due diligence, we found errors even when a Top 5 accounting firm was responsible for preparing the return. Like in the investment management world, brand name is pretty worthless when it comes to tax prep. The thing that really matters is who’s behind the work—how much experience that person has and how much time they have devoted to the return. The latter is usually the issue—tax preparation is mainly a volume game that does not pay much for triple-checking for errors and inefficiencies. I wish I could say there is a pattern in the deficiencies we found, but it really was all over the place, from not adjusting the basis of stock grants (e.g., NSOs, RSUs, ISOs), to forgetting to put in rental depreciation expense, to including California municipal bond interest as taxable income.

4. Taxes will always be complex (and a pain in the a#$)

I am a hobbyist computer programmer and many of my clients are software engineers who work in Silicon Valley. When your computer code has an error, it’s common to simply research the answer on sites like Stack Overflow or GitHub. The do-it-yourself approach to software development, education, and other areas of life is great! But in the world of taxes, it can be disastrous. In an effort to save a couple hundred dollars many folks go at it themselves or hire inexpensive preparers. (My favorite quote: “I used a lady in Chinatown that charged me $150.”) Unfortunately, our politicians have made the tax code extremely complex with a lot of “gray” in the interpretation of certain rules. I can’t see this ever changing, as there are too many interests at stake. We should accept the fact that taxes will always be hard and difficult to fully understand. It is very easy to make up the extra cost of hiring good people.

5. No taxation without representation?

Working with many international clients and nonresident taxpayers, I’ve grown to appreciate how challenging it can be to navigate the complexities of the tax code as a foreigner. Even worse, these taxpayers often have to abide by a different set of rules if they have to file a 1040NR. (We Americans use the good old 1040.) In our limited sample, nonresident taxpayers also seem to get disproportionally singled out for things like disallowing the MBA Expense deduction. I guess if you can’t vote and you are here as a guest, you are less likely to make a fuss when the IRS sends you a notice.

6. Worldwide income, foreign assets

U.S. citizens have the great pleasure of paying taxes on worldwide income. Forever. Under certain circumstances, one needs to disclose foreign accounts and holdings in foreign corporations. This is when things get interesting, since the rules around foreign disclosures are even more esoteric compared to the general tax code. We’ve witnessed plenty of cases where foreign income and foreign holdings were reported incorrectly. Some of our clients have had to pay heavy fines. The IRS is getting more stringent on these issues even if your foreign assets pale in comparison to those of El Chapo Guzmán.

7. Sitting ducks

High-income taxpayers who earn only W2 income and reside in states like California or New York are what we call “sitting ducks.” The marginal tax rates on ordinary income will likely exceed 50% all in, and there is not much that can be done to escape the wrath of the IRS under these circumstances. If the income is high enough these taxpayers will at least avoid AMT. Oh yeah….AMT is still stupid.

8. Trump’s favorite asset class

I am still amazed at how much benefit real estate investors get relative to other type of investors. For example, if you buy a residential rental property you are allowed to depreciate the building value divided by 27.5 years. This offsets rental income and often enables the investor to avoid taxes on the income for a few years. Before you get too angry, this “loophole” is readily available to anyone who invests in real estate, not just billionaires. No such deduction exists if you buy Apple stock or invest in a startup and I doubt Mr. Trump will change the rules.

9. The side business

One of the best ways to maximize tax efficiency is to be a business owner, even if it’s just a part-time activity (e.g., consulting, startup advising). Unlike the W-2 employee discussed earlier, the entrepreneur has a lot more levers to pull, including writing off home office, travel, meals and entertainment, and other “ordinary and necessary” business expenses. Working virtually and on-demand is much more accepted these days and can be a great tax strategy tool. “Starting a company” can be as simple as getting a small paid side job and letting others know that you are in business.

10. Accountants are not financial advisors; financial advisors are not accountants

One cannot separate taxes from investments. At the end of the day, the best measure for any investment program is the after-tax, after-fee return per unit of risk. Most accountants we’ve worked with are fairly conservative and perhaps don’t have the best incentive system. Many advisors we know couldn’t explain how AMT works or build scenario models on exercising incentive stock options (but many could tell you about expensive wines and grape varietals). It’s important to have a “Compliance Team” to keep you from breaking the tax laws and having to pay penalties and interest (or go to jail) for being too aggressive with your deductions. Equally important is to have a “Tax Strategy Team” to keep you paying the least possible amount (legally and ethically), and provide checks and balances to the tax preparer or tax software program.

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