Thoughts on receiving both EIDL and PPP loans

Become a Patron!Last week I wrote about my successful Economic Injury Disaster Loan experience, and mentioned in passing "the programs [EIDL and PPP] are very different, and while not technically mutually exclusive (you can take out loans from both programs, under certain conditions), most businesses will only take advantage of only one or the other."Overall I thought it was a good and useful post, but that sentence kept coming back to bug me, since if I read it on anyone else's blog, or in a newspaper's "Business" section, I would immediately ask, "under what conditions?" In other words, who can and who should take out loans through both EIDL and PPP?So, in this post I'll ease my conscience by exploring that precise question.

EIDL and PPP loans cannot be spent on "the same" expenses

Let me say up front, from a business perspective, this rule makes no sense. Money is, famously, fungible, so there's no meaningful sense in which any individual loan is being "spent" on any individual expense. What this rule seems to mean is simply that you cannot borrow more money combined through the two programs than your actual expenses: if you have $100,000 in expenses, you cannot borrow $75,000 from EIDL and $75,000 from PPP because that would mean $50,000 was spent on the "same" expense.In practice, since PPP loans are forgivable when 75% of your loan is spent on payroll, you should "allocate" your PPP loan to payroll, rent, mortgage, and utility payments, then "allocate" your EIDL loan to any remaining eligible expenses up to your total expenses. Since this is all an accounting fiction, all I can recommend is to keep your receipts!

Remember: EIDL advances reduce PPP loan forgiveness

The amount of your PPP loan forgiveness eligibility is reduced by the amount of your EIDL advance. EIDL loans have 30-year terms, but any non-forgiven PPP balance is due in just 2 years, so you should set aside or plan to save up the amount of your advance to begin repaying your PPP loan 6 months after disbursement and complete repayment in 2 years.In practice since EIDL advances are capped at $10,000 this shouldn't be a huge obstacle for a firm big enough to be interested in pursuing both loan types.

Who should pursue both EIDL and PPP loans?

Hopefully at this point the picture is a little clearer: a firm might consider taking out both types of loans if they have both high ongoing operating expenses and high payroll expenses. By "allocating" their PPP loan to payroll and other eligible expenses, they receive two free months of payroll and (at least) discounted rent and utilities, which is especially nice if the firm is able to stay open and continue bringing in revenue.The EIDL loan can then be "allocated" to operating expenses (although not "expansion of facilities or acquisition of fixed assets" or "repair or replacement of physical damages"). The EIDL loan does have to be repaid, but on very favorable terms: 30 years at a fixed 3.75% APR, with no origination fees or prepayment penalties and a one year delay before the first payment is due.

Why I won't be pursuing the PPP option

While researching this post I contemplated the possibility of taking out a PPP loan, but in my case ended up convinced that it would make no sense. Although I do have ongoing operating expenses I could "allocate" my EIDL loan to, after reducing the maximum PPP loan I'd be eligible for (multiply the previous year's payroll by 2.5, then divide the result by 12) by the amount of my EIDL advance, I'd only be eligible for a few hundred dollars in loan forgiveness!And that's assuming I could find a lender willing to handle a PPP loan as small as mine would end up being.

Conclusion

Are any readers pursuing separate EIDL and PPP loans? How have you found the experience so far? Has your PPP lender tried to convince you to convert your EIDL loan to PPP? Sound off in the comments.Become a Patron!

My successful Economic Injury Disaster Loan story

Become a Patron!I've been looking forward to this post for over a month, so I'm glad to finally be able to write up the complete story of my Economic Injury Disaster Loan. I know a lot of people are at different stages of the process, so hopefully this will be a useful guide for what to expect, particularly if Congress ends up appropriating additional money for the program in a future disaster relief bill.

The timeline

Obviously this is the issue people are most concerned about: how long should you expect to wait between submitting an application and reaching the end of the loan disbursement process?Here was my experience:

• March 29, 2020: I submitted my initial application within a few hours of the EIDL portal going live. The application was extremely simple, essentially asking for your business structure, number of employees, and your income in either the previous year or previous quarter, which was easy enough to pull up from my records. They warn it can take 2.5 hours to complete but I'd be shocked if it took me 10 minutes.
• April 13: received e-mail from the Small Business Administration confirming that the EIDL "advance" grant would be limited to $1,000 per employee. This had been left ambiguous in both the underlying legislation and on the EIDL application, with both saying only that the advance would be "up to $10,000."
• April 15: received $1,000 advance by direct deposit.
• May 8: received an e-mail invitation to create an account at covidrelief1.sba.gov, created the account and confirmed my identity.
• May 9: received approval and e-mail invitation to complete my loan documents.
• May 11: completed my loan documents.
• May 12: received my loan proceeds by direct deposit.

The mystery of the EIDL "advance" — solved!

All things considered, this was an extremely simple and painless process, although obviously it would have been nice if the money had gone out a little quicker. The one source of universal confusion about the EIDL program relates to the co-called "advance," in my case the $1,000 I received on April 15.In ordinary life, if someone gives you an advance on a loan, the amount of the advance is part of the loan. Sometimes it's the entirety of the loan, as in the case of a "paycheck advance loans," for instance.It was widely known and reported that the EIDL advance doesn't have to be repaid if you aren't ultimately approved for a loan. The obvious question was, would an EIDL advance have to be repaid if you are ultimately approved for a loan?In my case, I received a $1,000 advance and was approved for a $3,000 loan. What I wanted to know was, if I accepted the loan, would I only receive an additional $2,000, having already received $1,000 of my $3,000 loan? In that case, I'd turn down the loan, since there's no reason to elect to repay $1,000 that would otherwise be free and clear.To get a definite answer, I called the Small Business Administration, where someone immediately answered the phone (on a Saturday afternoon, no less) and assured me that the EIDL "advance" has nothing to do with the loan: it's free money. I'd receive the full $3,000 loan, and only have to repay the $3,000 loan. That was reassuring, but I wasn't completely convinced, given how new the program is. Ultimately, to get a definite answer, I'd have to complete the loan documents.Fortunately, the agent was right, and the full $3,000 loan was deposited this morning.

EIDL and Paycheck Protection Program loan interaction

If you're happy with the terms of your EIDL loan, that's all you need to know: a 30-year, unsecured loan at 3.75% APR, with no origination fees and no prepayment penalty sounds pretty good to me!Larger business, and those with more employees, do have another option to consider: converting an EIDL loan to a 2-year Paycheck Protection Program loan.Why would anyone convert a 30-year loan into a 2-year loan? The reason is that unlike EIDL loans, your PPP loan balance is forgivable if the money is spent on eligible expenses, principally maintaining your pre-crisis payroll (hence the "Paycheck" in "Paycheck Protection Program").Here's where it gets tricky: if and only if you pursue a PPP loan after receiving an EIDL advance, then the amount of the EIDL advance reduces the forgivable amount of your PPP loan. An employer that received a full $10,000 EIDL advance, then decided to switch over to PPP and borrowed an additional $30,000, would only be eligible for $20,000 in PPP loan forgiveness. On the one hand, you can see the logic here: the employer didn't "really" borrow $30,000, they only borrowed $20,000: the extra $10,000 can be repaid from their EIDL advance. On the other hand, this design choice leaves employers with a complex decision between the two programs.Let's illustrate this with some numbers:

• Company 1 receives a $10,000 EIDL advance and a $30,000 EIDL loan from the Small Business Administration. The $30,000 loan has to be repaid over 30 years, with the first payment deferred for 1 year. The money can be spent to "meet financial obligations and operating expenses that could have been met had the disaster not occurred."
• Company 2 receives a $10,000 EIDL advance, then decides to proceed with a PPP loan application and receives a $30,000 PPP loan from a private lender. Within 8 weeks of receiving the loan, Company 2 spends at least 75% of their loan on maintaining their number of staff and level of payroll, and the rest on mortgage interest, rent, and utilities payments. Company 2 then requests loan forgiveness from their private lender, and receives $20,000 in loan forgiveness: the amount of their PPP loan, reduced by the amount of their EIDL advance, which they can use to repay the remaining $10,000 loan, or to meet other expenses.

Deciding between the programs: easy cases and hard cases

A lot of people are struggling to decide between EIDL and PPP loans, and rightly so: the programs are very different, and while not technically mutually exclusive (you can take out loans from both programs, under certain conditions), most businesses will only take advantage of only one or the other. That being said, let's get the easy cases out of the way:

• PPP: labor-intensive business that remain open. Consider a dog-walking service that pays out virtually 100% of its expenses for labor, and continues to see similar demand during the pandemic; PPP loan forgiveness makes 8 weeks of payroll the government's problem, and turns the firm's entire revenue into pure profit. You can also include here less labor-intensive businesses that nonetheless have a lot of payroll expenses, like independent grocery stores and co-ops, local gas stations and convenience stores, liquor stores and takeout pizza parlors. Labor may not be the biggest cost center for these business, but it's a large expense that can be wiped away with a PPP loan, giving the business temporarily expanded profit margins.
• EIDL: capital-intensive, low-margin businesses. Obviously the biggest problem with PPP loans is that the forgivable amount is contingent on your pre-crisis payroll. If you don't plan on pursuing PPP loan forgiveness, then the program simply offers a low-interest, short-term loan. Most low-margin, part-time, and hobbyist sole proprietors will be better off with an EIDL loan, with its free advance, low interest, and long repayment period.

If the world were composed of only easy cases, our work here would be done. Unfortunately, most businesses don't fall into those two buckets. Consider a harder case:

• Closed businesses that rely on specialized labor. An example here is something like a high-end sushi restaurant that has recruited or trained skilled sushi chefs, but relies entirely on customers dining in, and has closed for the duration of the crisis. Taking out a PPP loan allows this business to maintain its payroll for free, but only if ongoing mortgage, rent, and utility payments represent less than 25% of their total expenses. If those expenses exceed 25%, the loan will be ineligible for forgiveness, or the investors will have to pay them from other sources, like savings or new capital. The less certain they are of reopening, the less willing they should be to do so, and the more attractive an EIDL loan becomes.

Conclusion: these are business loans, not worker loans

Since these loan programs received an enormous amount of the money made available in our pandemic recovery laws so far, they've naturally received a lot of attention from the media, which have unfortunately tended to treat them as designed, in different ways, for the benefit of employees.This is a mistake, because neither of these programs is designed to benefit workers in any way: workers simply don't get a say in which program their employer participates in. On the contrary, an employer's decision to pursue one program or the other can materially harm the worker's interests: a low-wage employer who chooses to maintain payroll makes their employees ineligible for expanded unemployment insurance!Here's a simple rule of thumb I like to keep in mind: the working class is not the beneficiary of systems that are not designed and led by the working class. Or even more concisely: "nothing about us, without us."Become a Patron!

Personal finance during the plague: self-employment (2)

Become a Patron!Earlier this month I wrote about some of the advantages of replacing work lost to the coronavirus pandemic with self-employment. I want to continue that discussion today with some questions to ask before and as you get your self-employment up and running.

Is your self-employment a business or a job?

This question confuses people in the United States due to the unfortunate terminology used by our tax code: technically all self-employment income is reported as business income, whether on Schedule C or on the K-1 issued by an S corporation. A surprising number of people are even tricked by this sophistry into believing they own and operate a small business when they deliver groceries or walk dogs, just because their income happens to be reported on a 1099 instead of a W-2.I prefer a simpler distinction: will there be any residual value left if you personally stop working? If so, you may have a business. If not, you definitely have a job.Take two simple examples from the world of reselling, or retail arbitrage. In the first case, a reseller drives around the region buying up bleach wipes and hand sanitizer, then lists it for sale on Amazon. In the second case, a reseller buys a warehouse in a state without sales tax, hires employees, and trains them to find good resale opportunities.From a tax perspective, the two cases are very similar, if not identical. But in the first case, as soon as the reseller stops reselling, the company is immediately worthless, while in the second case, the business retains assets that can be sold on to a buyer (for example, if the reseller's employees wanted to buy out the founder and run it themselves).Likewise, renting out a second bedroom on AirBNB is a job: part housekeeping, part marketing, part photography, part hospitality. As soon as you delist the bedroom, your job disappears.On the other hand, buying a bunch of condos and renting them out on AirBNB is a business: even if the units are delisted, the business retains assets that can be held for some other purpose, or sold on to another buyer.Of course there are some situations which fall somewhere in the middle: if you buy a new car, drive for Uber for a year, then stop driving, you technically have an asset (a year-old car) that can be sold to another driver.The point is not to make a hard-and-fast distinction, but to help guide your decision-making. If all you want is a job, then you can worry less about things like incorporation, insurance, and payroll. If you're building a business — something that you think you will or may sell on to a buyer in the future, then you're going to need to focus earlier on things like business processes, company policies, titling of company assets, etc.I've only ever been self-employed in jobs, rather than businesses. When I lived in a two-bedroom apartment by myself, I rented out the second bedroom. Then my lease ended and I moved; my job ended. I track my self-employment income and meticulously report it (as I recommend everyone does), but if I decided to stop blogging, my business assets consist in their entirety of an internet domain and the copyright on an out-of-date book. In other words, it's a job.If you decide to build a business instead, then think about what kind of assets you can build or invest in that will retain their value under a new owner:

• Real estate. If you want to build a hospitality empire, it's better to own real estate rather than sublet year-to-year leases, and if you want to build a reselling empire, it's better to own a warehouse than use your garage.
• Intellectual property and trade secrets. Of course you can file for patents and copyrights, but also consider other kids of intellectual property, like business practices, algorithms, and other trade secrets. 
• Client information. This is extremely common in the case of medical practices, lawyers, and financial advisers, where often the only thing that makes them businesses instead of jobs is their client list, since if the firm is sold many clients may stay with the practice even under new management.
• Equipment. There's a small chain of middle eastern restaurants in Cambridge, Massachusetts, called Clover, which has no distinguishing characteristic (the food isn't even that good, although it's good for Cambridge) except that they imported authentic Israeli pita ovens to bake their bread in. It's those ovens that give Clover value above and beyond the fact they occupy extremely valuable commercial real estate in one of the world's wealthiest cities.

Capital structure: borrow or sell?

Another reason the distinction between a job and a business matters is that it can help you decide how you want to finance your self-employment: by borrowing your startup costs, or by selling a share of the business's value. Alternately, this is the difference between self-financing or raising capital from outside investors.I say these are alternate ways of expressing the same idea because even if you don't need to actually borrow money, and are instead able to finance your self-employment entirely from savings, you should properly account for that drawdown in savings as a loan from yourself to yourself — you should only "loan" money to yourself if you expect your self-employment to have a higher return than your savings!If you are creating a job, then self-financing or borrowing money might be more appealing, since a lower percentage of your annual income will go to paying down the debt.If you are creating a business, then selling a share of the business's future value to outside investors may be a better option, especially if it allows the business's potential final value to rise faster.Finally, this introduces the question of risk. Different industries have acquired different norms for capital structure, partly due to nuances in the tax code, and partly due to real or perceived risks. For example, residential real estate has historically been viewed as a relatively safe business model, which increases the willingness of lenders to lend and decreases the appeal of selling shares (setting aside commercial property conglomerates like REIT's). After all, the more certain you are in the outcome of your investment, the less willing you should be to split the proceeds with outsiders.Conversely, new restaurants have historically had very high failure rates, which decreases the willingness of lenders to provide cash they're unlikely to see repaid, and leads outside investors to demand a relatively high stake in future earnings (this is why top restaurants are invariably owned by LLC's ending in "Group." Celebrity chef José Andrés is the face of the Think Food Group, for instance; it's a group of investors, not a group of restaurants).Your own decision whether to self-finance, borrow, or raise outside capital should certainly be informed by these norms, but not determined by them. There's an unfortunate tendency to believe that the only reason anyone should consider becoming self-employed is to become fabulously wealthy.But this isn't a law of nature or economics; if Danny Meyer wanted, he could have kept selling burgers and shakes out of a cart in Central Park. This isn't a criticism of Danny Meyer or the Shake Shack empire, it's merely to point out that how you decide to build and grow your job, or your business, is a choice, and there's no rule that says you have to make the decisions that leave you with the highest net worth on your deathbed.Become a Patron!

Personal finance during the plague: self-employment (1)

Become a Patron!I've been self-employed for a long time now, and loyal readers know I'm a relentless advocate for self-employment. As I never tire of saying, not everyone should be self-employed because not everyone wants to be self-employed, but a lot more people should be self-employed than currently are. Since I'm writing this series on personal finance during the plague, I want to take the opportunity to recapitulate some of my typical arguments, and make a few more, in the context of the present crisis.

Your job is gone and it's not coming back for a long, long time

The speed and scale of job loss in the last month has been staggering, with no historical precedent I'm aware of. Even during the Great Recession professors continued to teach, civil servants continued issuing marriage licenses, librarians continued filing books (or in my case, archiving Civil War-era sheet music), restaurants kept preparing meals, and bartenders kept mixing cocktails. Last month, all those jobs disappeared.Of course, jobs are lost all the time, and most people who lose a job find a new one relatively quickly. Even in a city with a thriving restaurant scene, some restaurants are always closing and their employees lose their jobs. The difference is that most of those employees, most of the time, are usually able to find relatively similar work relatively quickly. Even in industries that have steadily shrunk their overall employment over time, like manufacturing, most laid off employees will find new work fairly quickly, while others who are already near retirement may choose to accelerate their plans and retire at age 62 instead of 65 or 70.When today's emergency restrictions are lifted, the situation will be totally different. Some furloughed employees will be able to return to work relatively quickly, while a huge amount of economic activity will be permanently displaced. Do not confuse this for pessimism; my preference would be for an enormous amount of economic activity to permanently disappear. Of course there will still be work for the best fine dining chefs, the best servers, the best sommeliers, the best mixologists, and the best hosts (or at least the ones with the best connections). But statistically, that's just not very likely to be you.In other words, waiting for "your" job to come back is a fool's errand, and just puts off making the decision about what you will do next.

But unemployment benefits have been extended and expanded!

Time for the good news: if your work history makes you eligible for unemployment benefits, you'll receive a $600 weekly bonus payment (as soon as your state gets its act together) until July 31, and are eligible to receive your standard unemployment insurance benefit for 39, rather than the usual 26 weeks. If the crisis persists, I suspect the federal top-up payment will be extended as well, although that's just speculation at this point.Additionally, the weekly work search requirements to continue receiving unemployment insurance have been suspended in most, if not all states.In other words, you've got between 4 (with federal top-up) and 9 (excluding the top-up) months to figure out what to do next. My suggestion is: self-employment.

Self-employment lets you earn income without threatening your benefits

Here it's important to understand a few different moving pieces of the US welfare state.First, health insurance. There are essentially three ways people below age 65 can receive health insurance: employer-sponsored insurance, subsidized ACA exchange plans, and Medicaid. The most important thing to keep in mind is that if your employer offers health insurance meeting certain minimum requirements, you are categorically ineligible for ACA exchange subsidies and Medicaid. That means every time you move between employers that offer health insurance, your income can fluctuate much more wildly than the difference in your pay: earning $60,000 per year at a company that covers the full cost of health insurance and earning $60,000 per year at a company that requires you to pay $1,000 per month for a plan with a $13,500 out-of-pocket maximum is the difference between earning $60,000 per year and earning $34,500 per year in take-home pay. This is the primary reason people overestimate the difficulty of becoming self-employed in the United States: they want to match their self-employment income to their employment income, without taking into account that their employment income was actually much, much lower than the number printed on their paystub.Second, the Supplemental Nutrition Assistance Program, which old people still call "food stamps" for the same reason they call the Czech Republic "Czechoslovakia." SNAP benefits are based on monthly income, starting at about $194 per month in benefits for single adults, and decreasing as monthly income increases. This functions as a base income of $2,328 for unemployed single adults, and is the most important remaining anti-poverty measure in the US toolkit. But SNAP benefits come with an important restriction: while those working 20 or more hours per week are eligible for indefinite SNAP benefits, you're only eligible for 3 months of benefits every 3 years while working less than 20 hours per week. That means it's essential, in order to continue to qualify for SNAP benefits, to work for 20 hours per week or more. For this purpose, hours spent on self-employment count as hours worked. Here, the so-called "gig economy" is illuminating. I'm on the record that the idea of classifying Uber drivers or delivery personnel as "independent contractors" is an absurd violation of federal law, and I'm glad that states have ever-so-tentatively started to crack down on the practice. But when it comes to SNAP benefits, the gig economy is your friend, since every hour you spend on self-employment is an hour worked, whether or not you're being paid for it. You don't need to be logged into any app in order to be working, if you're working for yourself. When you're washing your car, you're working. When you're getting gas, you're working. When you're on private forums encouraging drivers to organize for better pay, you're working. This makes it easy to trigger the weekly work requirements of programs like SNAP. I cannot stress enough, this is not fraud: this is the gig economy. If your boss says you're self-employed, you better act like you're self-employed.

You're gonna like the way your taxes look

The final piece of the self-employment puzzle is benefits administered through the tax code. The most important of these are the Earned Income Credit, the Retirement Savings Contribution Credit, and contributions to individual 401(k) plans.The Earned Income Credit famously phases in along with income, plateaus, then phases out as income rises past a certain point. Importantly, self-employment income counts as earned income. That means if your income year-to-date is below the phase-out point, and especially if it's below the plateau point, you don't suffer any penalty by earning additional income, and may actually increase the amount of your refundable credit (depending on how much you earned so far in 2020).The Retirement Savings Contribution Credit is not refundable, but can be used to offset any tax owed, including the repayment of ACA subsidies. For low-income self-employed people, this is a brilliant strategy, since it turns Roth IRA contributions into turbo-charged traditional IRA contributions: the Roth IRA permanently shields your contribution from dividend, capital gains, and income taxes, and also generates a credit to offset ordinary income taxes.Finally, self-employment gives you access to individual 401(k) accounts, which allow you shield the usual $19,500 in annual income from taxes, while also making "employer" contributions much more generous than any employer you've ever had.

Conclusion

Self-employment is a vast subject, and self-employment during the plague is self-employment on steroids, so I'm going to leave it here for now. There is, of course, much much more to come on this subject.Become a Patron!

What you need to know about the idiotic "QBI deduction reduction" rule

Become a Patron!In the frenzy to pass the Smash-and-Grab Tax Act of 2017, a faction of Republican senators who, totally coincidentally, are the owners of passthrough businesses, insisted on including a special treat: in addition to tax cuts on the profits of C corporations, and cuts to the personal income tax rates they pay on their passthrough income, they demanded that their taxes be reduced again by what's known as the "qualified business income deduction."Like all deductions, the benefits of the QBI deduction flow overwhelmingly to the highest-income taxpayers, since it lowers the marginal tax rate of the lowest-income business owners from 10% to 8%, and of the highest-income business owners eligible for the full deduction from 24% to 19.2%, a benefit 2.4 times larger.For folks with simple tax situations, calculating the deduction is complicated, but no more or less so than optimizing any other combination of deductions and credits. However, the new deduction created one issue that causes an enormous amount of confusion: the QBI deduction reduction.

What is the QBI deduction reduction?

The 20% QBI deduction is applied, as the name implies, to a figure called "qualified business income," which for simple passthrough businesses is simply net profit minus half the self-employment tax. For the 2019 tax year, you multiple that number by 20% and write it down on line 10 of Form 1040, right below the standard deduction, before arriving at your final taxable income. In other words, a dollar earned by a business which is reported on form 1040 doesn't increase your taxable income by $1, it increases it by just $0.80 (after deducting half the self-employment tax).This creates a problem, however, since deductible contributions to SEP IRA's and individual 401(k) accounts are reported as adjustments to income on Part II of Schedule 1, but do not reduce the amount of business income reported on Part I of Schedule 1.If nothing were done, this would allow the owners of passthrough entities to deduct the same income twice: in the 24% tax bracket, a $19,500 solo 401(k) contribution would reduce the owner's tax by $4,680, and then the QBI deduction applied to the same income would reduce it by another $936. This would create an additional, unintended tax subsidy for deductible retirement contributions; in some cases it would even allow the QBI deduction to be used to offset earned income!For that reason, the QBI deduction reduction was introduced: qualified business income is reduced by both half the self-employment tax and by the amount of any deductible contributions made to SEP IRA's and individual 401(k)'s. The owners of passthrough entities thus have to choose: on a given dollar of income, you can either make a fully deductible retirement plan contribution (to be taxed on withdrawal), or a 20% tax cut, but not both.This is sometimes confusingly referred to as making pre-tax retirement contributions only "partially" deductible, but this is incorrect, as the above should make clear: pre-tax retirement contributions are fully deductible at the rate they would otherwise be taxed at. The reason you "only" receive a 19.2% deduction for pre-tax retirement contributions when your income puts you in the 24% tax bracket is that 19.2% is the applicable tax rate, after the application of the 20% QBI. This is a full deduction, at the applicable tax rate.

What's the problem

This is, obviously, a pain in the ass, but any reputable tax software is capable of making the necessary calculations. It does, however, raise two extremely important issues to be aware of.The first issue is the decision between making deductible, pre-tax contributions to retirement plans or Roth, after-tax contributions. That's because Roth contributions do not reduce QBI or the QBI deduction in the way pre-tax contributions do. One way to approach the decision between pre-tax and after-tax contributions is to select a "pivot" point: if your income puts you in the 24% tax bracket, you might decide to make deductible contributions down to the 22% bracket, and Roth contributions after that.But if a 22% tax rate is your pivot point, and the QBI deduction means you're actually paying 19.2%, then 100% of your contributions should go to Roth accounts! Your marginal tax rate is already lower than the point at which you prefer to save taxes today and pay them later.The second issue is the allocation decision between individual retirement accounts and small business retirement accounts, since contributions to traditional IRA's are fully deductible and do not reduce QBI. Before the introduction of the QBI deduction, a business owner could be essentially indifferent between traditional and Roth IRA and solo 401(k) contributions. All traditional contributions were fully deductible, and all Roth contributions were taxable, at the applicable rates.With the QBI deduction reduction in place, these allocation decisions became extremely important, since a $6,000 traditional IRA contribution reduces taxable income by the full amount, while a $6,000 solo 401(k) contribution reduces it by just $4,800. If your IRA contributions have been on autopilot, it's time to turn it off: deductible contributions should always go first into IRA's, and only then should you decide how to split solo 401(k) contributions between pre-tax and Roth accounts.

Conclusion

As tax time gears up, wrangling with these issues has also been an opportunity for reflection, since I have both earned income and self-employment income that put me squarely into the 12% income tax bracket. The advice I would offer a stranger in my position would be to maximize Roth contributions to both their IRA and solo 401(k), paying 12% and 9.6% marginal rates now, and saving them on the presumably much larger balances they'd withdraw 30, 40, or 50 years from now.The problem, of course, is that I'm in the 12% income tax bracket because I'm poor, and this is indeed the entire problem with a retirement system that requires people to make carefully calculated bets each and every year. A $6,000 traditional IRA contribution is worth $720 to me, a $6,000 traditional 401(k) contribution worth $576 more. Do I want an embedded tax asset that I'll redeem decades in the future, or do I want $1,296? Go ahead and guess.It's become fashionable to describe Americans as being "financially illiterate," but I hope someday we get around to acknowledging that the text we're constantly being exhorted to read should never have been written in the first place.Become a Patron!

How to think about the Spousal IRA deduction gap

Become a Patron!With the end of the year in sight and tax season around the corner, I've been brushing up on the rules for IRA contributions and deductions. Remember IRA contributions can be made for the 2019 contribution year until April 15, 2020. Most large IRA custodians make it easy to designate your contribution for the appropriate year, but if you use an independent broker and make a 2019 contribution next year, make sure they record the contribution properly or you might get an angry letter from the IRS for exceeding your contribution limit in 2020. Today I got to thinking about how and when spousal IRA's can be maximized, particularly when you fall into what I call the "spousal IRA deduction gap."

How spousal IRA's (are supposed to) work

Technically an IRA should only be referred to as "spousal" if one spouse in a married-filing-jointly couple has earned income in excess of the individual contribution limit and the other has earned income less than the individual contribution limit. In this case, contributions can be made to an IRA in the non-earning spouse's name, based on the excess earnings of the earning spouse.That's a complicated way of saying that if the total earnings of a married-filing-jointly couple are at least $12,000 (in 2019), then each spouse's IRA is eligible for the maximum $6,000 contribution, regardless of the distribution of the earnings between the spouses. If the couple's total earnings are less than $12,000, then the amount of earnings can be split arbitrarily; there's no requirement to "fill up" the earning spouse's IRA before contributing to the spousal IRA.I don't know what the original rationale was for this scheme, but it functions as a kind of "breadwinner bonus:" if a worker marries a non-worker, they get to use the non-worker's IRA deduction, a kind of annual tax stipend for bourgeois family values.Of course, most low-income people don't contribute to IRA's, and most married couples consist of two earners, so this intended use case is negligible in the real world. There's one nuance to the spousal IRA rules, however, that has a very real impact: the spousal IRA deduction gap.

Why does the spousal IRA deduction gap occur?

The spousal IRA deduction gap arises because while total contributions for married-filing-jointly couples are limited to the greater of the couple's joint earnings or the annual per-spouse contribution limit, the deductibility of contributions is determined based on the combination of the couple's joint modified adjusted gross income (adjusted gross income after adding back in certain deductions) and each spouse's workplace retirement plan coverage.This is spelled out on page 13 of IRS publication 590-A. Table 1-2 shows that a married-filing-jointly spouse covered by a workplace retirement plan can deduct a traditional IRA contribution if their MAGI is $101,000 or less. Table 1-3 shows that a married-filing-jointly spouse whose spouse is covered by a workplace retirement plan can deduct a traditional IRA contribution if their MAGI is $189,000 or less.That creates an $88,000 gap, where contributions to the non-covered spouse's IRA is still fully deductible, whether or not they have any earnings.

Maximizing the value of the spousal IRA deduction gap

Ideally you'll be maximizing your traditional, Roth, or backdoor Roth IRA contributions each year, but obviously not everyone can, and not everyone who can, will. The spousal IRA deduction gap means that for couples that fall into the gap and aren't able or willing to maximize contributions to both spouse's IRA's, it may be more tax-advantageous to fill up the non-covered spouse's IRA before making contributions to the covered spouse's Roth IRA.

Planning around the spousal IRA deduction gap

Everything above has discussed the deductible IRA rules on the assumption that a couple is already married. However, there's a second payout tucked in Table 1-2: the increased MAGI limit for covered employees when they get married.A single filer covered by a workplace retirement plan with a MAGI of $73,000 is ineligible for any traditional IRA deduction, while a married-filing-jointly filer is eligible for a full deduction up to $101,000 in MAGI.That means the same filer, upon marriage to a non-covered person earning $28,000 or less, will see their taxes fall by $4,987, from $9,235 to $4,248, assuming a maximum traditional IRA contribution of $6,000 (the spouse's taxes, if any, will also fall due to the expanded married-filing-jointly tax brackets, so the total taxes paid by the couple will fall by more than either individual's under most circumstances).Most high-income workers are covered by one or more workplace retirement plans, and those plans are almost always more generous than the IRA deduction. The $19,000 employee 401(k) and 403(b) contribution limit, for example, is so much higher than the maximum IRA contribution that it wouldn't usually make sense financially to choose, between two other-wise identical jobs, the one without a retirement plan purely to maintain eligibility for the IRA deduction.However, few jobs are identical! There's naturally some breakeven point where an increased salary more than makes up for the lack of a workplace retirement plan; that exercise is left to the reader. Furthermore, people are motivated by more than money: a dream job that leaves you eligible for the IRA deduction might, in total, be more attractive than endless drudgery with a nice retirement package.The final important planning situation arises in the case of self-employment. It's tempting to open an individual 401(k) account soon after starting a small business, since they cost virtually nothing to set up and administer, and allow you to manage your taxes through deductible employer and employee contributions, and Roth employee contributions. That's good advice, but in some cases you might consider waiting until you're generating more (or any) income from the business: if you and your spouse are currently not covered by workplace retirement plans, and if you plan to continue working at a non-covered job while you work on your small business.That's because opening an individual 401(k) may trigger the MAGI limits on your joint income, completing eliminating the traditional IRA deduction if your MAGI exceeds $189,000 or thrusting you into the spousal IRA deduction gap. Of course, if you know your MAGI will remain below $101,000, then there's no harm done, since contributions to both spouse's IRA's will remain fully deductible.The same logic applies once a small business has stopped generating income. While closing a 401(k) may seem like too much trouble, keeping it open may cause you to be considered "covered" and limit your IRA deduction. In that case, once you know you won't be making any further contributions, you may be better off simply rolling the balance into traditional and Roth IRA accounts.These corner cases can become extremely complex very quickly; only a fee-only, fiduciary financial advisor can provide advice tailored to your situation.Become a Patron!

California's AB 5 is about benefits, not wages or unions

Become a Patron!I've been following with interest the development and passage of AB 5, California's attempt to end the misclassification of employees, especially at app-based and platform companies including household names like Uber and Lyft.What I found is that there's a high degree of confusion surrounding the need for the bill, whom it will affect and how, and why the implicated companies have been so strongly opposed to it.The key to understanding the issue is that it's not about wages or unions; it's about benefits.

Uber isn't afraid of a union

One common idea people have about the employee classification debate is that it has "something to do with unions." And indeed, it does have something to do with unions! Union leaders in California have spearheaded the drive to end misclassification of platform employees, and the final passage of AB 5 will be a triumphant display of their ability to turn out activists and corral legislators.But it doesn't have anything to do with forming unions. The reason is simple: it's virtually impossible to form a union in the United States, and the distributed nature of platform employees is guaranteed to make it impossible in fact.That's because US labor law is based on the organization of similar workers in specific workplaces. In the mid-20th century that might be all the assembly line workers in a particular GM plant (but not the bookkeepers at the same plant), or all the electricians on a particular construction site (but not the plumbers).The recognition of workers as employees of platform companies will give them the theoretical right to collectively bargain — but only after their bargaining unit has been recognized, and Uber has unlimited tools at its disposal to make that process as onerous as possible:

• First, it will certainly insist that employees who provide rides belong in a different bargaining unit than employees who deliver food, who are different from the employees who repair scooters, who are different from the employees who charge scooters.
• Second, it will certainly insist that the relevant "workplace" is a single city, at the very largest. If you've ever taken a look at a map of "the San Francisco Bay Area" you quickly realize it's not one city, but dozens. Uber will insist its employees organize separately in each city.
• Next, they'll insist that workers will only be included in a bargaining unit if they work at least 20, or perhaps more, hours per week in that workplace, and they'll almost certainly insist that the only hours that count "in the workplace" are hours spent picking up in the relevant workplace. If you drive a passenger from San Francisco to Oakland, and another passenger back, only the outbound ride will count towards your membership in the bargaining unit.

Note that I came up with these obstacles in 10 minutes. Uber will employ the best union-busting law firms in the country to come up with many, many, many more obstacles.It is, of course, possible that there are cities where particularly industrious union organizers will meet all these tests. Unified metropolitan areas (without multiple divisions into separate municipalities) like Detroit would be good candidates.But I want to be very clear: there is no chance more than a trifling number of Uber drivers will ever belong to a collective bargaining unit, and I'd be extremely surprised if the number is ever more than 0, if for no other reason that if a union is ever formed, Uber always has the option to simply leave the market, which is entirely legal under our labor laws (there are a few trivial exceptions but, obviously, Uber will get around them).

Uber isn't afraid of higher wages

Another thing people are understandably bewildered by is that, where Uber drivers have been able to organize into local advocacy groups, Uber has not hesitated to meet with them and has made all sorts of concessions. In August Uber and Lyft even offered drivers in California a $21-per-hour minimum just-don't-call-it-a-wage, far above California's state $12 minimum wage, if they would oppose AB 5.If you thought AB 5 was primarily about wages, this would be extremely confusing behavior. Why would a company offer its workers a wage higher than the minimum wage in order to prevent them from being subject to the minimum wage?

It's all about the benefits

It shouldn't be much of a surprise at this point, since it's right there in the headline, but the reason these so-called "platform" companies oppose properly classifying their employees is that US labor law, for all its shortcomings compared to the rest of the developed world, does offer one nearly-airtight protection: non-discrimination in the provision of tax-deductible employee benefits.In short, this means that with a few exceptions, for an employee benefit to be tax-deductible, it has to be provided on more-or-less equal terms to more-or-less all full-time employees. And the problem with running a hot startup tech company is that if you want to attract talent, you need to offer pretty generous benefits, among the most important of which is health insurance.Under their current "fissured workplace" model, platform companies are able to provide tax-deductible health insurance exclusively to their white collar workforce. Let us very delicately and preliminarily guess that workforce is, on average, younger, healthier, and more educated than their driver and delivery employees.Of course, their driver and delivery employees mostly don't go uninsured. Thanks to the Affordable Care Act, in California the uninsured rate was just 7.2% in 2018. How did California achieve this? Through massive federal expenditures, of course: to expand Medicaid to cover those below 135% of the federal poverty line, and through refundable federal tax credits to cover the cost of insurance purchased through California's ACA exchange.So you can see, it's irrelevant whether Uber does or doesn't "care" whether its driver employees have health insurance or not: rather, it's that Uber wants to offer a generous employer-based health insurance plan to attract the white-collar employees it believes it needs to succeed, while federally-financed ACA exchange plans are "good enough" for its drivers.The misclassification of employees as independent contractors, in other words, is targeted directly at the only real legal protection American workers have: the principle of non-discrimination. You don't have to offer generous health insurance or retirement benefits, but if you do, you have to offer them to all your employees on equal terms — and Uber doesn't want to.

Conclusion: who is flexibility for?

There's a final point I want to make that's somewhat abstracted away from the nitty-gritty of labor and employment law. In all these debates over misclassification the platform company lobbyists and PR goons are always quick to point out that "drivers have the flexibility of deciding when to work." And of course, in a hyper-literal sense this is factually true. Uber cannot force drivers to open their phones and log into the app, so drivers have a choice of whether and when to do so.But while drivers may have control over selecting the hours they're logged into the app, they don't have any control over user demand for rides, or the process of pricing and assigning those rides, and so they don't have any control over the amount they're paid. In this way, they resemble nothing so much as an Applebee's waitress told to clock out and wait in her car outside when business is slow, then clock back in for the dinner rush.Platform companies rely on "flexibility" in order to spin up the availability of workers during periods of high demand. If they couldn't do so, wait times would stretch out of control and users would migrate to other services (or, God forbid, traditional taxis and delivery services). In other words, companies get paid for their worker's flexibility; they rely on it for their very survival, such as it is.But worker's don't get a symmetrical payoff. If a driver's "flexibility" doesn't match up with the company's needs, the driver just doesn't get paid. Again, this isn't unusual across the employment landscape: if you're only available to work at a grocery store between midnight and 5 am, and the grocery store closes at 10 pm and opens at 8 am, you're not going to get hired. Your availability doesn't match up with the store's hours!The platform companies, on the other hand, would appreciate it if you stood outside the grocery store anyway, on the off chance that today is the day they decide to open at midnight instead. There's nothing wrong with asking people to show up even when they're not needed and there's nothing for them to do. But we already have a perfectly good word for those people: employees. And unlike independent contractors, employees still have a few rights left.No wonder Uber is scared.Become a Patron!

Why workers should fight for entrepreneurs and entrepreneurship, too

Become a Patron!Even though this blog is committed to promoting entrepreneurship, I often say I don't think everyone should become an entrepreneur, for the fundamental reason that not everyone wants to become an entrepreneur. Plenty of people want to go to work, do their job as well as they can (or as badly as they can get away with), and get paid a predictable amount on a predictable schedule.But the flip side of that is plenty of people do want to become entrepreneurs, but don't because of the unfathomable complexity of our system (which I obviously strive to make as fathomable as possible).I compare entrepreneurship to the decision whether to live in a city, a suburb, or a rural area. It's true that living in a city is much more environmentally sustainable than living in a suburb or rural area, due largely to shorter driving distances, increased access to public transit, and the higher heating/cooling efficiency of multifamily structures compared to single-family homes. But I don't think everyone should live in a city because not everyone wants to live in a city. My view is simply that since more people want to live in cities than can currently afford to, and given the environmental benefits, we should strive to make city living more easily accessible.In the same way rural residents benefit from the lower greenhouse gas emissions of city residents, what's often missing in this conversation are the ways workers benefit from entrepreneurship — even workers who do not themselves become entrepreneurs.

The most important job an entrepreneur creates is their own

The idea of a "labor market" is a metaphor strained so hard you can see it coming apart at the seams. Virtually no one shows up to the "labor market" each day and puts out labor offers which are matched by labor bids from employers until the "market" clears. There are exceptions, of course: in certain neighborhoods in certain cities in certain parts of the country, I'm told, you really can drive up to the Home Depot parking lot and bargain one-on-one with day laborers for exactly one day's work.But that's a curio: most laborers are not day laborers, and most "day" laborers are not actually employed by the day (it takes a couple days to replace a roof).Still, the "labor market" is a metaphor that's stuck around for a reason: you can see with the naked eye the fact that when firms are profitable, growing, and in need of additional workers, they become more desperate to hire, and when they're unprofitable, shrinking, and laying off workers, they only replace absolutely essential personnel. If you squint at this observation just right, it kind of looks like a "labor market."But if you take the metaphor of a "labor market" even half-seriously, then it has an extremely important implication: when entrepreneurship removes a worker ("supply") from the labor market, it increases the market price of all the labor remaining in the market. And, importantly, this is true regardless of the success or failure of the enterprise.

Eliminating barriers to entrepreneurship is pro-worker

Operating a profitable business is hard, but lots of things are hard, so that doesn't bother me much. What concerns me are barriers to entrepreneurship. To give some obvious examples:

• the lack of a universal national health insurance scheme means employees, who pay workplace health insurance premiums, have to decide whether to go uninsured, switch to a public health insurance program, or buy insurance on an ACA exchange when starting a business. What is easy and simple for an employee requires a sprawling spreadsheet for an entrepreneur.
• the different rules for workplace-based savings schemes like HSA's and 401(k)'s mean workers have to weigh the loss of one set of tax benefits against the benefits of gaining another.
• special treatment for business distributions compared to wages means that workers have to calculate whether a lower pre-tax business income may actually increase their take-home pay.

While these specific concerns are obviously tailored to problems in the United States, I want to make clear that the United States has an unusually good environment for entrepreneurs and entrepreneurship. In the United States, it is still possible to become an entrepreneur. These problems are even more significant in countries where the administrative burden simply puts entrepreneurship out of the question.

The problem is complexity, and it will run out of control if we let it

This is, obviously, at its core a political problem. But it is not a partisan problem. Republicans, famously, want to weaken the position of workers by making them increasingly reliant on their (stingy) workplace benefits. Democrats, famously, want to strengthen the position of workers by making them increasingly reliant on their (generous) workplace benefits. But the problem in both cases is the workplace as the locus of the welfare state.Barack Obama was not a perfect president and the Affordable Care Act is not a perfect law, but since its pro-worker provisions affected so many more people, its pro-entrepreneur provisions have gone less noticed: Medicaid expansion was explicitly supposed to be a form of health insurance for new entrepreneurs; premium subsidies provide affordable health insurance for more profitable businesses; guaranteed issue and community rating provide health insurance for successful businesses.The sabotage of this system by Republican officeholders is an urgent crisis, but we need to be realistic about the problems in the system itself: it relies, first and foremost, on workplace benefits, and as long as it does so, it is an obstacle to entrepreneurship, and so is definitionally anti-worker, no matter how generous the benefits are.

Conclusion: workplace-based policies are a guarantee of stagnation and decline

Back in April I wrote about a little-known giveaway included in the Smash-And-Grab Tax Act of 2017: the paid family and medical leave credit. Under that law, employers who provide their workers with paid family and medical leave (by the end of 2019) receive a rebate of a portion of their after-tax wage cost in the form of a refundable business tax credit.But entrepreneurs don't, and you see this tendency across the board: every policy that promotes employment has an equal and opposite effect on the appeal of entrepreneurship. The more money the government spends subsidizing workers, the less appeal there is in entrepreneurship, and the higher the supply of labor, depressing any hypothetical benefits that might flow down to workers themselves.Before we succumb to the stagnation of other developed countries that have gone all-in on workplace-based policies, we need to start asking some simple questions:

• is a benefit universal, or is it means-tested?
• is a benefit universal, or is it employer-based?
• is a benefit universal, or is it location-based?
• is a benefit universal, or is it family-based?

Today the United States has an underdeveloped system of means-tested, employer-based, location-based, family-based policies. If we're going to expand that system as much as we need to, we also need to expand it in a way that is universal and leaves room for entrepreneurs to exit the labor market and workers to demand higher wages.Become a Patron!

Means-testing and Appalachian roots

In October, 2017, the Washington Post published a very strange series of articles about the recipients of disability benefits in the United States. The entire series is worth reading for various reasons, but I want to direct your attention to one particular entry: After the check is gone.The principal character in the article, Donna Jean Dempsey, collects aluminum cans and hunts for wild roots towards the end of each month when her disability and SNAP benefits run out. The article refers to this as "the underground American economy, where researchers know some people receiving disability benefits are forced to work illegally."This is flatly false, and it's repugnant, but it's not surprising. The problem is not a dumb Washington Post reporter. The problem is an economy-wide revulsion towards self-employment.

"To work illegally" is a nonsense phrase

In the United States, our laws rest uneasily alongside our intuitions. Most people, most of their lives, work for large employers who mostly run competent "human resources" departments that mostly follow the law.That creates the enormously convenient presumption that whatever your employer is doing is probably legal. You won't always be right, but periodic high-profile class action lawsuits serve as a kind of warning signal to large employers to stick close enough to the law not to be caught out and become the next sacrificial lamb.Nonetheless, the fact is that it's virtually impossible for a worker to violate employment law.Instead, when people say a worker is "working illegally," they typically have one or more of three totally distinct ideas in mind:

• The worker is engaged in an illegal activity. For example, many forms of drug trafficking are illegal, so if your job is to traffic drugs, you might be "working illegally" in the sense of receiving pay for illegal activities, but the laws you're violating aren't employment laws, they're laws against drug trafficking.
• The worker is employed in violation of employment law. It is illegal to hire some categories of workers, like certain non-resident aliens and minors below a certain age for certain types of work. It's illegal to pay less than the applicable minimum wage. It's illegal not to report your employees' income. But it is not illegal for minors to work; it's not illegal to accept less than the minimum wage. These are crimes committed by employers, not by workers, and penalties are levied against employers for the benefit of the injured workers.
• Finally, there's a third sense which seems to be what our intrepid Washington Post reporter had in mind: a worker might have reporting requirements about the sources of outside income they receive, for example if a benefit program has restrictions on the amount of work they can do while continuing to receive benefits. But even in this case, it is still not employment law that is being violated; the work is not illegal, rather it is being reported improperly.

There's nothing that says these categories can't overlap: a non-resident alien (whose immigration status prohibits them from working in the United States) might engage in drug trafficking (illegal activity) and fail to report their income to the IRS (reporting violation). But none of these are violations of employment law: they're violations of immigration laws, drug trafficking laws, and tax laws, and knowing the difference between them is essential to thinking clearly about these issues.

Donna Jean Dempsey is not working illegally

Now let's return to the unfortunate case of Donna Jean Dempsey and Mallory, West Virginia. First, let's agree that there's nothing "illegal" about any of the work taking place:

• Donna Jean collects cans in order to sell them to a local recycling company. The recycling company does not appear to be violating any labor laws, and indeed operates a lively Facebook page so doesn't seem to be trying to operate "under the radar" in any way. It's possible there are tax reporting violations, for example if the owner deliberately declines to issue 1099-MISC forms where they're required, but nothing like that is alleged in the article.
• Donna Jean collects wild roots from the nearby mountains and sells them to the same recycling company. Again, you can imagine circumstances where this might be illegal, if she was collecting and selling bald eagle feathers for instance, but I don't know of any reason why Appalachian ginseng, Solomon’s seal, or bloodroot would be protected by any state or federal laws, and sure enough, that's not alleged anywhere in the article.

What is clearly true is that Dempsey is not properly reporting her aluminum-can-and-wild-root scavenging income.

14 easy steps to get right with the law

What would it take for Ms. Dempsey to bring herself into full compliance with the state? Here's a quick guide:

1. Apply for a West Virginia State Business Registration. This registration is required for "all purposeful revenue-generating activity engaged in or caused to be engaged in with the object of gain or economic benefit, either direct or indirect," so Donna Jean clearly qualifies.
2. Apply for an Employer Identification Number from the IRS. While not strictly required, this is going to make it easier for Donna Jean to file the state and federal taxes for her business.
3. Open a Free File Fillable Forms accounts.
4. Attach Schedules 1, 4, C, and SE to form 1040.
5. Begin with Schedule C, and add up all her income on line 1. Fortunately, since she's scavenging her inventory she doesn't need to deduct the cost of goods sold on lines 4 and 42.
6. In Part II of Schedule C, she'll want to deduct any expenses she incurred for the business, for example the "pruners for digging roots" she purchased, as well as any mileage costs she incurred driving to and from the mountain and the recycling facility. That means completing Part IV, "Information on Your Vehicle." She'll want to be especially careful keeping records of these expenses since vehicle deductions are a common target of IRS audits. Maintaining a paper log of her vehicle miles traveled is likely sufficient, but she should consider buying an app that allows her to track her vehicle travel more precisely in case of an audit. After completing Schedule C, she'll copy her net profit or loss over to Schedule 1, line 12, and Schedule SE, line 2.
7. At that point, she'll want to move over to Schedule SE and calculate her self-employment taxes. Thankfully she can probably use the "short" form of Schedule SE and use the Free File Fillable Forms "Do the Math" feature to calculate her self-employment tax, and then copy over her self-employment tax to Schedule 4, line 57, and half her self-employment tax to Schedule 1, line 27.
8. She can then complete Schedule 1 by copying line 12 to line 22 and line 27 to line 36.
9. Moving back over to Form 1040, she'll copy the numbers from Schedule 1, line 22, to Form 1040, line 6, and Schedule 1, line 36, to Form 1040, line 7.
10. Next, she'll subtract Schedule 1, line 36, from Schedule 1, line 22, multiple that number by 0.2, and write the result down on Form 1040, line 9.
11. Moving to Schedule 4, she'll copy the amount from line 57 to line 64, then copy that number back to Form 1040, line 14.
12. Now she'll subtract Schedule SE, line 6 from line 3, open up the Form 1040 instructions and turn to page 53, find the row corresponding to that number, and copy the figure on that line back to Form 1040, line 17a.
13. At this point she should be able to allow Free File Fillable Forms to complete the rest of the calculations, and print and mail or electronically submit her return.
14. Then do the whole thing over again for West Virginia.

Means-testing is a tax on those least able to pay it

At this point, you may have gotten the mistaken impression that I'm being sarcastic. After all, no one reasonably expects a disabled person with lifelong cognitive difficulties to file state and federal taxes in order to report $500 in income from salvaged roots and cans.But you're wrong. It may be unreasonable, but expecting sick and disabled people to report trivial amounts of self-employment income is exactly what's implied when a journalist drops in and reports uncritically that people are "working illegally." The statement is precisely that in addition to any health challenges they face, in addition to the grueling manual labor they perform, they should also meticulously report their income in order to avoid accidentally "stealing" benefits they're not entitled to.If that sounds insane to you, it's because it is. But it's not an exaggeration to say that's how our means-tested benefit system is designed to work.

Means-testing turns everyone into criminals and cops

There are two problems inextricably tied up in means-tested anti-poverty programs:

• program design is so arbitrary and absurd that people are encouraged to lie in order to game qualification requirements;
• program design is so arbitrary and absurd that non-beneficiaries rightly assume beneficiaries are gaming qualification requirements.

Gaming qualification requirements is easy. If your hours fluctuate week-to-week, nothing could be easier than applying for Medicaid or SNAP with a paystub from one of your "low" weeks, since benefit administration offices mechanically calculate your annual income from your weekly or biweekly paychecks. You're "supposed" to submit updated paystubs if your income rises, but obviously no one does if it will reduce their monthly benefit or disqualify them from Medicaid. Poor people can't afford to be that stupid.But gaming qualification requirements is so easy that non-beneficiaries are also aware of how easy it is. And that's how you end up with folks quoted saying things like:

"'I think it’s a joke,' his cousin, Nathan Vance, who applied for disability earlier this year, told him one night after seeing a man on disability sell Vance a bundle of roots for $12.50. 'People I know of run the mountains all the time. . . . And yet they’re on SSI. Beating the system.'" (emphasis mine)

This creates the absurd situation wherein beneficiaries are being encouraged to game the system through terrible program design, while non-beneficiaries are encouraged to judge and ridicule beneficiaries for gaming the system!And indeed, this is precisely the pattern you see in the real world.

Pay for universal benefits with progressive income taxes

There's no secret program design, no special form with particularly well-designed fields, no worksheet with particularly cunning flowcharts, no particularly well-trained administrators that can solve this problem. Naming the problem is itself naming the solution: provide universal benefits to everyone, then pay for them with a straightforward progressive income tax.No more phase-ins, no more phase-outs, no more checking in at the welfare office, no more continually reporting income to case officers. No more case officers at all. No more cheating, and no more accusing people of cheating.I do not say that this is particularly likely to occur in the next 5, 10, or 15 years, or even in my lifetime. But it doesn't ever have to happen at the federal level, or the state level: now that you know how our anti-poverty programs are broken, and how to fix them, you have the power to tell your friends to knock it the hell off when they accuse desperately poor people of "gaming" the system they're forced to live with as it actually exists.

What's the optimal amount of self-employment income?

Because of the antipathy of American politicians to low-income people, who mostly don't vote and mostly don't make large campaign contributions, we've been blessed with a fractured and dysfunctional welfare state, designed to make income support as cumbersome and difficult as possible to receive, even or perhaps especially for those people who are, in fact, entitled to it.One of the worst manifestations of that dysfunction is that programs have different, overlapping rules for eligibility: the earned income and child tax credits phase in, plateau, and then phase out, while the Supplemental Nutritional Assistance Program starts high and begins dropping almost immediately with each additional dollar of income you earn.While this creates certain benefit cliffs, for example between eligibility for Medicaid and eligibility for Affordable Care Act exchange subsidies, it mostly just creates confusion: will an extra dollar of income increase your earned income credit by more or less than it decreases your SNAP benefit?While employees may have little or no control over their annual income, and in fact may not even know their annual income in advance depending on how predictable their assigned hours are each week or month, people reporting self-employment income may be able to dial in their reported income to the dollar to maximize the available state and federal benefits.While Jared Kushner has a team of lawyers and accountants working tirelessly to help him maximize the benefits of the tax code, you just have me. So here we go!

The four primary federal anti-poverty programs

Federal income support is composed of four primary programs, which I want to split up to make them easier to digest:

• Supplemental Nutrition Assistance Program (SNAP). Monthly benefits begin at $192 and increase by $161 for the second household member, $152 for the third, $137 for the fourth, and so on. For most beneficiaries (excluding those with unusually low housing and utility costs), benefits decrease by roughly $24 per month for every $100 in additional income you earn above roughly $900 per month. Unlike benefits administered through the tax code, the number used in SNAP benefit calculations is your net self-employment income before income or self-employment taxes are deducted. That means $900 in monthly self-employment income will pass through to your 1040 as $10,800 in business income, from which you'll deduct $763 in self-employment taxes, resulting in $10,037 in adjusted gross income.
• Earned income credit. The EIC is one of the original "trapezoid programs," with a rapid phase-in, a benefit plateau, then a gradual phase-out. The EIC is maximized for single childless filers with "earned income" between $6,650 and $8,350, for married childless filers between $6,650 and $13,950, for couples with one child between $10,000 and $18,350, and for couples with two or more children between $14,000 and $18,350. Every additional $100 in self-employment income in the phase-out period reduces childless filers' EIC by $7.11, filers with one child by $14.85, and those with two children by $19.57. Note that for the self-employed, earned income is calculated based on your net self-employment income after deducting half your self-employment taxes.

Let's take a breather here and consider how you would maximize your benefits if these were the only two federal income support programs, since we'll have more moving pieces later.Childless adults, whether single or married, have an incentive to absolutely minimize their reported earnings, while remaining eligible for SNAP. This is because the earned income credit phases in too slowly for these filers: an additional $100 of self-employment income increases their self-employment taxes by $14.13, while increasing their earned income credit by just $7.11. Since SNAP benefits begin to phase out at $10,800 in self-employment income, single childless filers are best off keeping their reported earnings below that level, since each additional dollar they earn costs them more in taxes than the amount they receive in income support.The picture is different for filers with one child: here, the optimal self-employment income is $10,760 for married couples with one child, producing earned income of $10,000. Why? Because for filers with children, the earned income credit phases in faster than SNAP benefits are phased out. Each $100 in additional self-employment income increases the EIC by $31.60, while reducing SNAP benefits by just $2 and increasing taxes by $14.13, leaving such filers with $15.47 more disposable income.The same logic would apply to married couples with two children: maximizing SNAP benefits requires $10,800 in self-employment income, while maximizing the EIC requires $15,064 in self-employment income. Again, we need to compare three values: the phase-in rate of the EIC, the phase-out rate of SNAP, and the marginal tax rate: $100 of additional self-employment income increases the EIC by $37.57, decreases SNAP by $2; and increases self-employment taxes by $14.13, leaving you with $21.44 more in disposable income.Since $100 of additional self-employment income increases disposable income by $21.44, the optimal amount of self-employment income is the EIC-maximizing value of $15,064. Reporting income above that point decreases SNAP benefits and increases self-employment taxes without generating any additional benefits.Simple enough? Unfortunately, we've still got two more anti-poverty programs to go.

• The reformed 2018 child tax credit is another trapezoid program for households with children. Families can begin claiming the credit when their self-employment income reaches $2,690, and each $100 in self-employment income above that level produces a credit of $13.94 per child, up to a maximum credit of $1,400 per child when self-employment income reaches $12,732.
• Medicaid is the final keystone of the American welfare state, and there are very important income restrictions to keep in mind, depending on your state. In Medicaid expansion states, virtually all low-income people are eligible for Medicaid, while in most non-expansion states, most self-employed people are not eligible (Wisconsin is an exception, since they did not expand Medicaid but reached an agreement with the federal government to extend exchange subsidies to the Medicaid-expansion population). Since the Affordable Care Act was designed to make Medicaid expansion universal, in most non-expansion states households aren't eligible for subsidies on the private health exchanges until their income reaches 139% of the federal poverty line, based on household size. That means if you live in a Medicaid-expansion state, you need to keep your income below that threshold to qualify for Medicaid, while if you live in a non-expansion state, you need to make sure your income is above that level to qualify for the maximum ACA subsidy.

The child tax credit doesn't affect our calculation for married couples with one child, since each additional $100 in self-employment income above $10,760 will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, while only increasing their child tax credit by $13.94 and leaving the earned income credit flat, leaving them with $2.19 less in disposable income.In the case of a married couple with two children, however, we see $100 in increased self-employment income raising the child tax credit by $27.88, and the earned income by $37.17, swamping the $16.13 in increased taxes and lost benefits. That means the optimal self-employment income for married couples with two children rises all the way to the EIC-maximizing value of $15,064, at which point their total federal picture will be:

• $2,800 child tax credit;
• $5,616 earned income credit;
• $6,708 SNAP benefit;
• while paying $2,142 in self-employment taxes.

Their next $100 earned above this point will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, but have no effect on their child tax credit or earned income credit, leaving them with an effective marginal income tax rate of 16.13%.

Conclusion

So there you have it. If you have complete control over the amount of self-employment income you report each year, the amounts that optimize your federal income support benefits are:

• For childless adults (single or married): $10,800 or less. SNAP is the primary income support benefit for these households, so be sure to report 20 or more hours of self-employment per week.
• For parents of one child: $10,760. The EIC phases in more quickly than SNAP phases out, so your decreased food-only SNAP benefits are offset by a higher and more flexible EIC. Above that level, the increased child tax credit doesn't fully offset your higher taxes and lower SNAP benefits.
• For parents of two children: $15,064. At this level, the EIC and child tax credit are both fully phased in, so any earnings above this point increase your taxes and lower your SNAP benefits without providing any additional benefits.

Free Business Idea: Virtual Reality Saloons

The other day I went down to the mall and happened to arrive during a shift change at the customer service desk. I wandered over to a row of couches and sat down to watch a Microsoft Store employee playing a game using the store's virtual reality set-up. Seeing as I had 15 minutes to kill, I asked him if I could try it out.I believe the system they had set up was this HTC VIVE Pro Virtual Reality System, which involves two ceiling-mounted sensors, two wireless handsets, and a tethered headset (although it seems a version without the headset cable may be launching later this month).If, like me, you haven't used a virtual reality system since the Virtual Boy, it's difficult to convey just how incredible the technology has become. Immersive virtual reality like you see in "Ready Player One" is not science fiction, and it's not 5 or 10 years away — it's here right now.While the technology is ready, the people aren't, for two main reasons: it's too expensive, and it requires too much space. The answer is today's free business idea: virtual reality saloons.

What is a virtual reality saloon?

A virtual reality saloon is a karaoke bar for virtual reality gaming.A fully functional virtual reality gaming setup requires a fair amount of sophistication. The two ceiling-mounted sensors I mentioned have to be mounted on a ceiling, and oriented properly. The gaming area itself has to be free of obstructions. And you also need to pay for the equipment and the games themselves.For those reasons, I don't think home-based virtual reality systems have much of a future for the next 5-10 years. But the technology is already there, which means the obvious solution is for a business to undertake the upfront equipment cost, setup, and maintenance, and then rent the equipment out on an hourly or daily basis to individuals and groups.

Nuts and bolts

While the upfront equipment costs are quite high for an individual, they're quite modest for a business, at perhaps $4,000-5,000 per rig, including all the virtual reality equipment, a top-of-the-line gaming computer, and every currently-available virtual reality game. A virtual reality saloon could start at as little as one room customers could reserve for wedding parties, corporate events, etc, much like "escape rooms" do already.Since only one or two people can play the actual games at a time, the profit center would naturally be the bar. The model works better the more gaming saloons you can put under one roof, in order to keep the bar as busy as possible.Commercial real estate, liability insurance, and alcohol licensing are complex issues you'll want to consult with local specialists about. But if you want to own and operate your own business but don't have any business ideas, feel free to use one of mine. After all, they're free!

Differences between non-retirement investment options

If you're in the right mood, there's something a little bit depressing about the subject of investing: how boring it is. An easy way to think about this is that if you make the maximum contribution to a 401(k) and IRA every year, for 20 years, at the end of that 20 years, you'll be rich. How rich you'll be depends on a lot of factors, but the fact you'll be rich doesn't depend on anything except the steadiness of your contributions and the amount of time they're allowed to compound.$24,000 in annual contributions for 20 years turns into a million dollars at 6.6% APY. If you can only manage 6% APY, it takes a year longer, and at 7% APY a few months less. But all anyone has to do to become a millionaire is max out their 401(k) and IRA contributions for around 20 years.I don't mean to say that's easy. You can't contribute more than 100% of your income to a 401(k) or IRA, so if you make less than $18,500 you can't maximize that contribution (although you can contribute your first $5,500 in income towards both accounts). I'm just saying it's boring. Max out your contributions, wait 20 years, and you'll fall somewhere in the top 10% of households by net worth.The flip side of that fact is that as long as you make your retirement accounts as boring as possible (my solo 401(k) is invested in a single Vanguard mutual fund), you can do almost anything you like with the rest of your money without posing much if any risk to your chances of ending up rich. I've written a lot in separate posts about different kinds of non-retirement investments, so I thought I'd pull those different pieces together in one place.

Taxable brokerage accounts

Pros: no withdrawal penalties, opportunities to manipulate income, cheap or free, $11.2 million estate tax exemption and stepped-up basisCons: taxable (at preferential rates), may affect financial aid eligibility, limited control over dividends and capital gains distributionsTaxable brokerage accounts have two huge advantages and a slew of disadvantages.On the plus side, you can access your money at any time for any reason. It's true you may owe taxes on any appreciated assets, but as I like to say, if you're afraid of paying taxes you're afraid of making money — you only owe capital gains taxes on capital gains, after all. Additionally, simply having a bunch of uncorrelated assets in a taxable account is a tool for managing your tax liability, since you're able to top up your income with long term capital gains in low-income years ("capital gain harvesting"), and sell losers in high-income years to reduce your taxable income by up to $3,000 in losses per year ("capital loss harvesting").The disadvantages are important to consider, however: mutual funds that are forced to pass along capital gains can trigger tax bills even if you don't sell your own shares. Unpredictable dividends can make it difficult to dial in your income precisely, for example if you intend to qualify for premium subsidies on the Affordable Care Act exchanges. If you or your kids are applying for federal financial aid using the FAFSA, you don't need to report qualified retirement savings, while assets in taxable brokerage accounts will reduce your assessed financial need (under some circumstances).One other thing taxable brokerage accounts are perfect for is gambling. If you walk into a Vegas casino and lose $500 playing roulette, you're out $500. If you buy $500 of Enron stock and it drops to $0, you might be out as little as $250, depending on your federal and state income tax situation.

Variable Annuities

Pros: tax-free internal compounding, asset protectionCons: gains taxable as ordinary income, inherited assets fully taxable, very expensive, early withdrawal penaltyI wrote relatively recently about variable annuities so I won't belabor the point here, but one point that reader Justin brought up in the comments to that post is that depending on your precise situation, annuity assets may be protected from creditors in a civil judgment or bankruptcy filing. This is, obviously, not protection afforded to taxable brokerage assets, and I think in certain circumstances an annuity might be worth considering for this reason alone.However, if your primary goal is asset protection, you should first consider shopping around for an umbrella insurance policy, since the management fees and tax consequences of a variable annuity might be substantially higher than the annual cost of comprehensive liability insurance. However, this would not apply if you're contemplating bankruptcy in a state that protects annuity assets from creditors.

529 College Savings Plans

Pros: low-cost, state-dependent tax benefits, tax-free internal compounding, flexible beneficiary designation, tax-free qualified withdrawalsCons: non-qualified withdrawal penalty, contribution limitsLong-time readers know that 529 plans are a crime committed in broad daylight against the American people. But that doesn't mean they can't still be useful. It's useful to think of 529 plans in two ways:

• qualified withdrawals are completely tax-free;
• pro-rated gains on non-qualified withdrawals are taxed as ordinary income with a 10% penalty.

While my main problem with 529 plans is the tax-free transmission of wealth between generations, it's trivial to conceive of an even simpler hack to achieve both tax-free internal compounding and tax-free withdrawals. Since 529 plan beneficiaries can be changed without any tax consequence to immediate (and not-so-immediate) relatives of the current beneficiary, who does not need to be related to the account owner, all you need to do is find a family with a bunch of kids and designate the oldest (or smartest) as the beneficiary of the account.Whenever they have any qualified educational expenses (which, thanks to Zodiac Killer and Republican Senator Ted Cruz, now include up to $10,000 in private and religious K-12 expenses per year), you can issue a qualified, tax-free distribution to the school and be reimbursed by whoever would otherwise pay their tuition.To be clear, this is completely illegal. But if you think that's stopping our plutocrats from doing it, I've got a tax-advantaged infrastructure investment in Brooklyn to sell you.The other reason to consider 529 plans as an alternative savings vehicle is that the penalty on non-qualified withdrawals just isn't that harsh. Here's an example using the 20-year investment horizon I described earlier:

1. Contribute $100,000 to the Vanguard Total Stock Market Portfolio in Vanguard's (Nevada-sponsored) 529 plan;
2. Using a 5% APY average return after fees, in 20 years the account's value will be about $265,000, representing $165,000 in gains, or roughly 62% of the account's value.
3. Assuming a standard deduction of $12,000, you can withdraw $19,354 per year without owing any income tax: 62% of the withdrawal will be taxable as ordinary income and 38% will be a tax- and penalty-free withdrawal of your original contribution. You will, however, owe a 10% penalty on the gains, or $1,200.

In a taxable account, meanwhile, you'd owe taxes annually on every dividend and capital gain distribution as well as taxes on the sale of the asset itself. Under the right circumstances, the 10% "penalty" can be lower than the taxes you've avoided on internal compounding, and over even longer time horizons that's even more likely to be the case.In other words, over long enough time horizons, 529 college savings plans function like variable annuities with substantially lower management fees and expenses, and the opportunity for completely tax-free withdrawals. In Vanguard's case, compare the 0.18% all-in fee for their 529 Total Stock Market Portfolio to the 0.42% for the same portfolio in their variable annuity product. The key point is that the higher management fees and expenses are charged on the entire variable annuity portfolio, while the 10% withdrawal penalty is only charged on the gains in the 529 portfolio.This technique even allows you to replicate the old "horse race" strategy of IRA recharacterizations. Since the gains in each 529 account are calculated separately for the purpose of non-qualified withdrawals, you could open one Vanguard 529 plan invested entirely in the Total Stock Market Portfolio, and one My529 plan invested entirely in the Vanguard Total International Stock Index Fund (and another state's plan invested in the domestic bond market, and another state's plan invested in the international bond market, etc.). Since non-qualified distributions are taxed and penalized on an individual account basis, you would always have the option of making non-qualified withdrawals from the account with the most (or least) gains, depending on your tax situation in a given year.And this, unlike the "sell your 529 plan assets" strategy mentioned earlier, is 100% legal. Hell, it's practically encouraged.

Non-traded investment scams

Pros: high "expected returns"Cons: expensive, illiquid, obviously doomedToday there are a million crowd-funded investment options, from old-school players like Prosper and LendingClub to newfangled bill brokers like Kickfurther. But the investment that most naturally lends itself to crowdfunding is real estate. Real estate is expensive (so you can raise a lot of money), it's illiquid (so you can lock investors' money up for years), and it's opaque (so no one has any idea if you're getting a "good" or "bad" price on the real estate you acquire or the management fees you charge).I have a lot of respect for these scams. They charge huge upfront fees and huge management fees for an investment they have no control over the performance of. Fundrise is one of my favorite examples: one thing you could do if you identified a promising piece of real estate is to take out a loan and buy it. Alternately, you could raise money from a group of investors who would then share ownership of it. But Fundrise has an even better idea: collect money from strangers, issue them unsecured claims on a future stream of revenue, charge your expenses against that stream of revenue, then return their money minus your own healthy share of any eventual profit.If you want to invest in a mutual fund, you ought to invest in a mutual fund. If you want to invest in real estate, you ought to invest in real estate. But if you want to get ripped off by some Silicon Valley dweebs who paid $300 for a graphic artist to design a sleek website, Fundrise is for you.

Rental real estate

Pros: generous tax treatment, stepped-up basisCons: expensive, illiquid, volatileAs a leveraged bet on the cost of housing, owning rental real estate doesn't have any advantages over simply buying a residential REIT on margin. You have all the risks of declining real estate prices, rising vacancy rates, and property damage, and none of the benefits of spreading that risk across hundreds or thousands of properties.All the advantages come from the special tax treatment real estate receives. While you own a rental property, you're allowed to deduct the interest on any mortgage you took out to buy it. You're allowed to deduct the property's depreciation. And you're allowed to sell the property and make a "like-kind" exchange for another property (in the US) without triggering taxes on the sale. Finally, like other taxable assets, your heirs will receive the property with a stepped-up basis, meaning they won't owe taxes on the appreciation of the property during your lifetime.This is especially valuable in the case of real estate if the original owner was deducting depreciation and reducing their own basis in the property: a property purchased for $200,000 whose owner deducted $100,000 in depreciation, but is worth $400,000 when inherited and sold, avoids capital gains taxes on $300,000 that would have been owed if sold during the original owner's lifetime.

Collectibles

Pros: interesting conversation piecesCons: losing all your moneySome people think the problem with "greater fool" assets, whether it's bitcoin, Beanie Babies, or Hummel figurines, is that you'll run out of fools, but I don't think that's quite right. If you try hard enough, you'll likely always be able to find someone, at some price, to take your junk off your hands. The problem isn't finding a fool, it's finding a greater fool — someone willing to pay more for your trinkets than you did.Note that there are strict rules on the tax treatment of hobby losses, so consult a lawyer and/or CPA  (again, I am neither) before starting to gamble in any of this stuff.

Start a business

Pros: preposterous tax advantages, higher Social Security benefits, larger 401(k) contributionsCons: unknownI'm here to promote entrepreneurs and entrepreneurship, so obviously I'm a bit biased. Nonetheless, the advantages of starting a business are undeniable, whether or not you also work as an employee elsewhere.First, if you don't hit the Social Security earnings cap through any other work you do, self-employment allows you to raise your annual contribution and increase the old age and disability payments you're entitled to. For folks who spent a long time unemployed or in higher education due to the late-2000's breakdown in global capitalism, the only way to make up for those missing years is higher contributions during the remaining years before retirement.Second, while your voluntary employee-side 401(k) contributions are capped at $18,500 in 2018 across all your employers and your self-employment, each employer — including yourself — has a separate cap on the amount they're able to contribute to an employer-side 401(k). That means you can take advantage of any employer matching program at your day job and make additional employer-side contributions into a solo 401(k) subject to a totally separate cap.Finally, the 2017 Republican tax heist added an additional 20% discount on the taxable income of many small businesses. This is an extremely confusing topic so, again, consult a CPA if you have any questions about whether your small business qualifies, since certain industries and legal structures are excluded under certain circumstances.

What a culture of entrepreneurs and entrepreneurship would look like

I write a lot about entrepreneurship. This is not because I think everyone should be an entrepreneur. For one thing, not everyone wants to be an entrepreneur, and part of having an economy that works for everyone means making room for folks who just want to show up at work and do their job.The problem with our current system of social and economic organization is that we've swung too far in the other direction: entrepreneurship is so maddeningly difficult that folks who would be better off starting their own business remain as employees, both occupying jobs that would be better filled by folks who want jobs, while also not pursuing their own goals.But it's easy to complain. Instead, I want to share my actual, concrete, actionable vision for what a culture of entrepreneurs and entrepreneurship would look like.

Simplify the tax code

Self-employed people and entrepreneurs don't talk as much as they should about the complexity of the tax code because once you're self-employed you've almost by definition figured out the tax code. It takes me perhaps half an hour to do my taxes these days, because they're basically the same every year.That's unfortunate, because it means people aren't talking about the initial hurdle of figuring out how the tax code applies to entrepreneurs. The half hour my taxes take me today is the product of hundreds of hours of poring through tax schedules to figure out how all the pieces fit together.Fortunately, the answer's simple:

• tax capital gains as ordinary income;
• eliminate the floor and ceiling on FICA taxes;
• eliminate the 20% pass-through income deduction introduced in the smash-and-grab tax reform bill of 2017.

Obviously running a business will never be exactly the same as being an employee. But if you use the basic idea of adding up all your income each year and paying taxes on the resulting number as the core principle of the tax code, we can demolish an enormous hurdle to entrepreneurship.

Eliminate (tax preferences for) workplace health and retirement benefits

I've never pretended to have all the answers; I don't know how much money people should be able to shield in tax-advantaged retirement accounts. My gut feeling says the number should be $0, but whatever amount you think they should be able to shield in tax-advantaged retirement accounts, there's obviously no reason that number should depend on their employer.

• If the number is $5,500 (the limit on individual retirement account contributions), then the number should be $5,500 for everyone.
• If the number is $24,000 ($5,500 in IRA contributions and $18,500 in employee-side 401(k) contributions), then the number should be $24,000 for everyone.
• And if the number is a full $60,500 ($5,500 in IRA contributions, $18,500 in employee 401(k) contributions, and $36,500 in employer 401(k) contributions), then the number should be $60,500 for everyone.

To be clear, since this is an area where people tend to develop some very strange ideas, your employer's contribution to your workplace retirement plan is part of your labor income; it's not a gift and it's not done from the generosity of their heart. Even if you believe that there should be tax advantages to contributing to investment accounts that can only be tapped penalty-free in old age, there's no reason to believe that the investment management company, investment options, and fees should be determined by your employer, instead of by you.Meanwhile, eliminating the exclusion from personal income of workplace health insurance benefits would almost immediately end the disastrous American experiment with employer health insurance plans, and keep every business in America from having to run a small, terrible health insurance company on the side.

Make hiring easy

There was a period in the late 90's when it was fashionable to attack and vilify political candidates who hired landscapers, housekeepers, or nannies "under the table," the idea being that they were either facilitating undocumented immigration or saving money on the taxes they'd owe if they were operating on the level.This is bullshit. It is not, in fact, possible to hire someone to work legally in the United States. Don't believe me? Just try it!I've written before about E-Verify, which doesn't work, but E-Verify isn't mandatory, so set that aside.It's impossible to comply with US and state employment laws. Now, it's true that you can pay someone to handle payroll for you, but that means the hurdle to hiring an employee is not "is this employee going to produce more value than they cost?" but rather "is this employee going to produce more value than they cost plus the cost of hiring them?" The lower we can make that extra drag, the easier businesses will find it to expand and hire.The obvious way to deal with the information asymmetry between employers and the IRS is for the IRS to design a single interface that calculates federal, state, and FICA tax withholding and accepts payment for those taxes.The fact that we haven't done so is the most striking proof that we don't take entrepreneurship seriously.

Eliminate means testing and (paper)work requirements

A non-exhaustive list of big national welfare benefits:

• the Earned Income Credit
• the Retirement Savings Contribution Credit
• the Child Tax Credit
• Supplemental Nutrition Assistance Program
• Women, Infants, and Children
• Medicaid
• Low-income Heating Energy Assistance Program

These programs all have different requirements, each of which has to be documented, and which can push in different directions.

• They all require you to have a low income. What qualifies as a low income depends on the program, however: in Medicaid-expansion states "low-income" means up to 138% of the poverty line, or $16,146. Meanwhile, the EIC is phased out completely at $15,000 in earned income, and the CTC at $240,000 in adjusted gross income.
• But not too low! The same programs also have minimum income requirements. SNAP requires recipients to work 20 hours per week; the RSCC can only be credited against taxes owed, meaning recipients have to have more income than their standard deduction; and only $1,400 of the new CTC is refundable, so $600 of the credit is reserved for folks with income high enough to owe at least that amount in tax (but less than the phaseout amount, remember).

This means someone's disposable income is dependent on their income from work, but not in a coherent or dependable way. It's impossible to guess whether an additional dollar of income will actually raise your disposable income, or whether it will reduce your welfare benefits by more than a dollar.The obvious answer is to replace all the cash-like welfare programs with a universal basic income (per adult) and child allowance (per child), and pay for the higher costs with higher marginal tax rates on higher incomes. This would act as the same "phase-out" the designers of welfare programs are so enamored with, but through the simple mechanism of a progressive income tax instead of having to calculate the phase-in and phase-out points of dozens of different benefits.In this way, earning a dollar of extra income will still not increase your disposable income by a dollar, since it will be reduced by the taxes owed, but it won't be reduced again by the loss of eligibility for multiple interlocking welfare programs.

Conclusion

One of the most destructive, counterproductive tendencies in American life is to talk about entrepreneurship as something other people do. Whether it's venture capitalists in Silicon Valley or restauranteurs in Brooklyn, we hear that it takes a special kind of person, willing to work 20 hour days, spend Christmas at the office, and never see their family in order to finally hit the jackpot when their vision is realized.But when I say "entrepreneur," I mean the stay-at-home dad who screenprints t-shirts when the kids are napping. I don't care if he ever turns the business into a global conglomerate, I just want to make his life as easy as possible so he can get back to work on the t-shirts.We were not put on Earth to fill out paperwork.

How much is your obsession with tax efficiency costing you?

Something that I find separates me from the classical financial independence/early retirement community is the particular obsession of that community with achieving financial independence in order to retire early from work.In the framing I see regularly repeated, you're supposed to study for the most lucrative degree possible, then get the most lucrative job available, then earn as much money as possible and save as much of your income as possible, in order to quit the job you despise as soon as possible.To me this is obviously nuts: if you're able to survive on a pittance, why not cut out all the middlemen and simply earn a pittance doing something you actually want to do?But much more importantly to me, the focus on paid labor means FIRE types tend to put off entrepreneurship until after retirement, or look at it as a means to finance retirement, rather than as a shortcut to the life they actually want to live.An under-appreciated obstacle to pursuing entrepreneurship earlier in life is the focus on the tax efficiency of investment decisions. I think that focus is a mistake.

The strong case for tax efficiency

One offshoot of the obsession with paid work is the obsession with tax efficiency of the investments made with one's labor income. I always like to address the strongest possible case for positions I disagree with (partly because sometimes I change my mind!), and the strong case for taking maximal advantage of tax-advantaged savings plans is quite strong:

• The upfront tax savings afforded by traditional IRA's and 401(k) plans allows your after-tax income to be invested at a higher value than they otherwise would. In the 25% marginal income tax bracket, $1,000 in after-tax savings would require $1,333 in pre-tax disposable income. That same $1,333 in pre-tax disposable income could instead be used to invest $1,333 if directed to a traditional IRA or 401(k) plan. That's a 33% "bonus" to your initial capital, which will hopefully compound happily for years to come.
• The tax-free withdrawal of Roth assets allows the appreciation on your assets to be withdrawn without tax liability in retirement and in certain other circumstances. A $1,000 contribution compounding at 5% annually for 30 years will produce $3,321 in capital gains. In a taxable account, dividends would be taxed annually and any final capital appreciation would be taxed on withdrawal. Meanwhile rebalancing transactions within the account may produce additional intermediate taxable gains (although they might also create losses).
• Both types of account permit tax-free internal compounding, which both disentangles your total return from the vagaries of your year-to-year tax situation and saves you the hassle of calculating your capital gains tax liability each year, which is not fun.

The simple case against tax efficiency

The simplest way to explain the problem with tax-efficient investing is through the restrictions on what kinds of investments can be made with tax-advantaged retirement vehicles:

• you cannot live in real estate owned by your tax-advantaged retirement vehicles (or receive any other pre-retirement benefit from your investments);
• S-corporations cannot accept investments from tax-advantaged retirement vehicles.

Of course most custodians restrict your investment options even more, limiting you to publicly traded securities offered through their own brokerage platform. My point is broader though: in exchange for the tax efficiency of your investment you explicitly restrict your ability to invest your excess income in your own business.

The best case for investing in public markets is that you don't have any ideas

I constantly have ideas for businesses, so I find it kind of hard to get inside the head of someone who doesn't have any ideas for businesses (I occasionally post free business ideas if you're having trouble coming up with one of your own).But the most convincing case to direct as much of your disposable income as possible into tax-advantaged savings vehicles is that you think the public markets as a whole, your preferred asset allocation, or even a particular active mutual fund or hedge fund manager will perform better, taking into account the relevant tax advantages, than you will investing in your own business.In my experience, this intuition isn't very convincing.

Business is more profitable than you think (but less profitable than you want)

I have a sort of unique position since, on the one hand, my own business is extremely capital-unintensive: I pay a few hundred dollars per year for my web domain and content management system, then I get paid depending on how good people think my websites are.At the same time, I have a lot of friends who have extremely capital-intensive businesses: buying and reselling merchandise and gift cards. Their overall profit depends largely on the amount of volume they're able to push through their supply and distribution chains, and the more capital they have to buy products, the higher their profits are.The reason I raise this juxtaposition is that I think it's informative about how you should direct the profits from any given line of business. A capital-light business that has a rapidly decreasing return on reinvested capital makes tax-advantaged investment accounts more attractive as a way to boost the returns on the business's retained earnings. Meanwhile, a capital-intensive business that has a steady or only-slowly declining return on reinvested capital should make tax-advantaged accounts less attractive since once profits are shielded they're unavailable for reinvestment in the business.The reason this result should be counter-intuitive is that the capital-intensive business is likely more profitable than the capital-light business! In other words, the more profitable your business is, and the higher your returns are on reinvested capital, the less you should want to shield your profits in tax-advantaged accounts which can only be invested in public markets.

We don't need tax reform, we need mind reform

Alright, the preceding was a bit pedantic. My unfortunate literal tendency at work, no doubt. But I wanted to lay it all out to make as clear as possible my case for abandoning your obsession with the tax advantages of your workplace retirement plan and finding, as soon as possible, the business that will let you live the life you actually want.If we want to create a society of entrepreneurs and entrepreneurship, we don't need to cut corporate taxes, or cut taxes on pass-through income, or accelerate depreciation, or have a tax holiday on repatriated earnings.We don't need tax reform, we need mind reform.We need to tell people that it's good and right that they leave their jobs to start their own businesses. Every second spent on the potential tax consequences if or when they ever turn a profit, and how to shield that profit from taxes, is time that could be spent on the actual business an entrepreneur is trying to bring into the world. Our economy needs more businesses and fewer workers, and the obsession with tax policy is a major obstacle in the way of that vision.The reason tax reform can't be the answer is that even in our current tax regime entrepreneurship is much more profitable than labor. What anti-tax evangelists have done is convince entrepreneurs that the taxes they pay are extravagant, exploitative, and destructive, when they're nothing of the sort: business is just so profitable that entrepreneurs end up paying more in taxes on their small businesses than they did as employees. That's because their income is higher as entrepreneurs than as employees.At the end of the day, no just system of taxation is going to levy lower taxes on entrepreneurs with a given level of income than on employees with the same income. Yet that's precisely the regime Republican members of Congress are currently trying to implement. I think they'll fail, and I hope they'll fail, but your decision whether or not to start your own business should have nothing to do with their eventual success or failure. You should start a business based on the life you want to live.The taxes will work themselves out. Of course you can decide to withhold your own ingenuity from the marketplace, but the marketplace is going to be fine without you. Will you be fine without the marketplace?

6 things I wish I knew before starting a business

Running a small business is as fun and easy as you'd expect, and more people should do it. I'm an unabashed promoter of self-employment, not because it will make you rich quickly (getting rich quick is the wrong goal on the wrong time frame), but because it will make you self-employed. That's my unfortunate literal tendency which I can never seem to keep suppressed for long.Saverocity's glorious leader Matt recently posted on the Forum a request for suggestions about what he should include in an entrepreneurship course he'll be leading. I assume he's going to include all sorts of important lessons about networking, flexibility, failing fast, and all sorts of other things I never learned.Instead, I thought I'd share a few things I wish someone had told me before I became self-employed.

1. Immediately apply for an EIN and use it for everything

I've written about this before, but the fundamental lesson is this: the IRS "prefers" you use your Social Security Number for your tax and payment documents because the IRS thinks your business is going to fail. If your business is not going to fail, then it's going to be a pain in the ass to start using your EIN in the future when you want to hire people, apply for business credit cards, open business bank accounts, etc.Apply for an EIN immediately here, and use it for everything, the IRS's "preferences" be damned.

2. Use (and adapt) this spreadsheet

I created this spreadsheet to calculate my own quarterly self-employment tax liability, retirement savings account eligibility, and earned income. Obviously I wish someone had given it to me so I didn't have to make it myself!Self-employment spreadsheetThat basic spreadsheet gets me within $2-3 of my self-employment tax liability every year.Once you have a spreadsheet that you're plugging your income and expenses into each month, you can start tricking it out with additional calculations. My own has calculations like the self-employment retirement plan contributions I'm eligible for, earned income (to see if I qualify for the Earned Income Credit), and others.

3. Starting a self-employment retirement plan is easier than you think

The government makes it inhumanly difficult to find, fill and file required taxes and paperwork properly. But private companies actually want your money, and make it substantially easier.When I finally got around to opening a solo 401(k) for my business, it was laughably easy. Just download the paperwork from Vanguard, correctly identify your beneficiaries (I didn't), and choose your mutual funds wisely.Why start a self-employment retirement plan? Because you can contribute the first $18,000 you make and deduct that contribution from your taxable income (assuming you don't contribute to a retirement plan at another job), plus 25% of every dollar you make after that (up to an annual limit). This makes self-employment extremely tax-advantaged compared to employment, since your ability to shield income from present-year taxes at a traditional job depends on your employer's contributions to your plan. If you're the employer, you get to decide those contributions, and they can be very high.

4. 92.35%, or 0.9235

For very simple, but extremely boring reasons, you never use your actual net self-employment income for anything: you use 92.35% of it (you can see this on line 19 of the spreadsheet in item #2).So in item #3 above, I said you can contribute your first $18,000 in self-employment income to a solo 401(k) plan. I was lying. You can contribute $18,000 of your first $19,941 in self-employment income, because the federal government is waging a war on entrepreneurs and the self-employed.

5. Per diem meal deductions while traveling

When traveling for your business, you can deduct the actual cost of your meals subject to fairly complicated restrictions, or you can deduct the federal government's "meals and incidental expenses" amount for each full day of travel and half that amount for the day you arrive and leave.It is a pain in the ass to find these rates each time you travel; bookmark this page.

6. Every dollar you spend costs 85.8 cents or less

As you can see looking at the spreadsheet in #2, if you increase your expenses by one dollar, the amount of your income subject to tax falls by 92.35 cents, and the amount of self-employment tax you pay falls by 14.12 cents. That means the net cost of spending a dollar on your business is, at a maximum, 85.8 cents. If your income puts you in a higher tax bracket, the cost is even lower.This discount is worth taking into account when you see opportunities that might have value to your business: what might not be worth $1,000 may well be worth $858.

Conclusion

I bragged on Twitter that I had 8 things I wish I knew before starting a business, so for now consider #7 and #8 reserved for a future post.

This should be a golden age of entrepreneurship; why isn't it?

It's no secret that I'm a cheerleader for self-employment and entrepreneurship. I now run two blogs, this one here on the Saverocity network and another at freequentflyerbook.com. I've never asked anyone permission to start a business, I don't have a "business license," I just run a business like a goddamn American. That's the spirit I'm trying to promote here: if you aren't willing to start a business until you're convinced you'll be able to replace your salary as an employee, you'll never start a business and you'll never be an entrepreneur. The only way to start a business is to start a business.Moreover, there are a number of factors that should make our times a golden age of entrepreneurship:

• comprehensive health insurance is now affordable to entrepreneurs through the expansion of Medicaid and subsidized insurance on the Affordable Care Act exchanges. So-called "job lock," which kept people slaving away as employees instead of implementing their small business ideas in order to retain access to affordable health insurance should be a thing of the past: today you should be able to start a business with no income whatsoever, and graduate from Medicaid, to subsidized exchange health insurance, to unsubsidized exchange health insurance. While pre-ACA only those confident or stupid enough to go without health insurance, or young and male enough for insurance to be affordable, could ever dream of venturing out on their own, today anyone should be able to quit their job and immediately enroll in comprehensive health insurance with premiums, deductibles, and co-pays corresponding to their income level;
• on the flip side, employee benefits have gotten stingier and stingier as conservative ideologues do everything they can to strip employees of the protections unions and defined benefit pension plans used to provide. While waiting for a pension to vest and seeing your benefits in retirement grow and grow used to be a compelling reason to stick with a unionized workplace for as long as possible, the gutting of both unions and retirement plans in the private sector has made self-employment relatively more attractive than becoming a "company man;"
• meanwhile, current public market asset prices are so elevated that it's reasonable to expect relatively low returns on investments in publicly traded securities. If you don't have enough money or contacts to subscribe to one of the few high-quality venture capital funds, you can do the next best thing: start your own private business, and keep every dollar you earn.

What happened?

Given the confluence of factors above, why is it that I still need to be out here in the wilderness shouting at people to start their own businesses? I don't have a definitive answer, but I do have some suggestions.

• the refusal to expand Medicaid in many Republican-governed states has created an enormous obstacle to affordable health insurance. Instead of being able to seamlessly transition up through Medicaid eligibility to subsidized and then unsubsidized exchange coverage, these states are left with an enormous coverage chasm. If an entrepreneur knows that she'll be left without affordable, comprehensive insurance coverage if she becomes pregnant, let alone suffers a serious disease or injury, under what possible circumstances would she risk that?
• Businesses are privileged in the provision of certain benefits. Everyone knows about the exclusion of health care benefits from taxable pay, but there are other considerations as well: when employers match contributions to 401(k) plans or HSA's, the benefit to participants is subsidized by the contributions of non-participants. In other words, an employer that matches 3% of payroll contributions to a 401(k) isn't spending 3% of payroll on 401(k) matches. They're only matching the contributions of participants in the plan, reducing the overall impact on wages of the employer match. While the self-employed are free to open 401(k) accounts, they're solely responsible for both the employee and employer contributions to the plan. An obvious solution would be to create a generic retirement plan open to everyone, whether employee or self-employed, which would reduce or, preferably, eliminate the role of the employer in our retirement savings regime.
• In connection with the above, businesses which provide paid family or maternity leave have an advantage over the self-employed, since entrepreneurs have to pay for their benefits out of retained earnings (or debt), instead of spreading the cost over an entire workforce. An obvious solution would be to support a universal paid leave policy funded by a modest increase in payroll taxes on all workers, whether they work for themselves or for someone else.
• Bureaucratic malfeasance. There is an important difference between regulation (good) and implementation (typically terrible). It's the difference between getting a facility inspected and approved before using it to prepare and sell food and requiring 30+ days to get an inspector on site to inspect and approve your facility. It's the difference between requiring a license to drive and requiring people to wait in line for 2 hours to get their picture taken for their driving license. It's the difference between requiring entrepreneurs to register for an account to pay estimated taxes quarterly and requiring entrepreneurs to get their bank to notarize a form before getting their estimated tax payment account approved.
• Finally, the self-employed are treated with suspicion and disdain by most civic institutions. If you follow me on Twitter you've probably seen me talk about this anecdote before, but it is absolutely representative of the general experience of being an entrepreneur. The Brookings Institution and the American Enterprise Institute recently released one of their "consensus" proposals on a program for paid family leave. On page 25 of the report, you'll find the following paragraph: "Requiring that employers protect the job of a worker who takes leave is desirable (see Chapter III), but sensible restrictions on eligibility and work history will ease the burden on employers, especially smallbusinesses, and reduce workers’ ability to abuse the system. Expanding the coverage to the self-employed is potentially vulnerable to fraud and misuse." I was fortunate enough to attend the presentation of the report (if you listen or skip to the end you can hear me ask the panel about this apparently deliberate insult to the self-employed). Why would anyone, let alone an organization ostensibly dedicated to free enterprise, accuse entrepreneurs, the very people whose risk-taking is the backbone of a competitive capitalist economic system, of fraudulently misusing state programs of support? What would it even mean to fraudulently misuse paid family leave? Faking a pregnancy? This is the United States of America, not a long-running Broadway musical.

We can fix this, but we have to decide to fix it first

If we want to promote entrepreneurship and self-employment, there's nothing standing in our way. Start with asking actual entrepreneurs a few questions: what obstacles did you face while starting your business? What could be done to help others pursue self-employment? I've provided some answers, but I don't have all of them. Maybe tax attorneys face different issues than restauranteurs, who face different issues than artists, who face different issues than musicians, who face different issues than garment retailers, who face different issues than mail scanning and forwarding services. There may not be a single solution to the problems faced by entrepreneurs in different industries. It may take time and ingenuity. But the first thing required is discovering the issues that entrepreneurs face and tailoring solutions to make entrepreneurship a real possibility for more people who are discouraged by the misuse and abuse of small businesses by the American political system.

Yes, we have to talk about the Senate healthcare bill

This is a blog about self-employment and entrepreneurship, and access to affordable comprehensive health insurance has always been one of the biggest obstacles to entrepreneurship. That makes the newly-released draft of the Senate's healthcare reform bill squarely in this blog's wheelhouse, just as the House's version was back in March.First, we need to briefly review the Affordable Care Act and how it made comprehensive health insurance affordable.The majority of Americans under the age of 65 receive health insurance through their employers. The Affordable Care Act made that insurance somewhat more comprehensive by specifying the "essential health benefits" such plans had to provide, and somewhat more affordable by eliminating annual and lifetime spending limits. If, like most Americans, you work for an employer who provides your family with health insurance, those are the only changes that affected you (the original ACA also included a so-called "Cadillac tax" on especially generous employer-provided health benefits, but it has never been implemented due to repeated delays by Congress). Employer-provided health insurance was already prohibited from discriminating against employees based on their pre-existing conditions and from underwriting their premiums, and the ACA didn't change that.Then the Affordable Care Act did something unprecedented in American history: it attempted to make comprehensive health insurance affordable to people who didn't receive health insurance through their employer. It did this in 4 ways:

• Income up to 133% of the federal poverty level: expanded Medicaid eligibility. Medicaid is an extremely generous single-payer health insurance scheme with low negotiated reimbursement rates for doctors and hospitals, no premiums, and low co-pays on prescription drugs. (For reasons that are unclear to me, the District of Columbia has unusually generous Medicaid eligibility, stretching up to 210% of the poverty level);
• Income up to 250% of the federal poverty level: private marketplace health insurance plans with subsidies and cost-sharing reductions. Since only "Silver" plans are eligible for cost-sharing reductions, in this income range you're expected to choose such a plan: advance tax credits will cover most or all of your insurance premium, since they're anchored to the second-lowest-cost Silver plan on the exchange (more on that in a moment), and cost-sharing reductions dramatically lower your out-of-pocket maximum. As a personal example, while living in Wisconsin (a non-Medicaid-expansion state) I chose a Silver plan with a $200.84 monthly premium and received an advance tax credit of $200 per month. Due to the cost-sharing reduction my deductible and out-of-pocket maximum were each lowered to $500 from the plan's original $5,150 deductible and out-of-pocket maximum.
• Income up to 400% of the federal poverty level: private marketplace health insurance plans with subsidies but without cost-sharing reductions. Here you will receive federal tax credits that cap your premium at a certain percentage of your income, anchored to the second-lowest-cost Silver plan on the exchange, but you're responsible for the plan's deductible and co-payments. You can choose a Bronze plan instead and the second-lowest-cost Silver plan subsidy will go further towards paying the plan's premium, or a Gold plan and the SLCSP subsidy will cover a smaller portion of the premium.
• Income above 400% of the federal poverty level: you're responsible for paying the entire premium for the marketplace plan of your choice.

Once you understand this simple four-part structure, you can see that there are several dials you can turn up or down to affect the overall shape of the system:

• You can turn the Medicaid dial down and the subsidy dial up, reducing the number of people eligible for the Medicaid expansion and increasing the number eligible for marketplace subsidies and cost-sharing reductions. This would reduce the amount of federal expenditures on Medicaid and increase the amount spent on advance premium tax credits. Since private insurance is more expensive to provide than Medicaid (Medicaid only pays out on actual treatment, while private insurance collects payments whether or not you receive treatment), this would be somewhat more expensive to the federal government but would improve the health profile of private insurance pools, which would help steady premiums in the medium and long term, including for non-subsidized high-income enrollees. The Affordable Care Act struck one balance between those two forces, but perhaps a different balance would be better overall.
• You can turn the cost-sharing reduction dial up or down, increasing or decreasing the number of people with access to lower out-of-pocket costs. An important complaint of people who are eligible for subsidies but not eligible for Medicaid is that people with lower incomes have better health insurance, due to their lower out-of-pocket expenses. This is true: Medicaid is great health insurance, and people with Medicaid are very happy with it. You may not have heard this because doctors (who receive lower reimbursement from Medicaid) have louder voices than the poor, who actually benefit from Medicaid. One solution would be to raise the income limit on cost-sharing reductions, so more people benefit from the lower out-of-pocket costs that lower-income people pay.
• You can turn the subsidy dial up or down, increasing or decreasing the number of people with access to advance premium tax credits to pay for marketplace health insurance plans. Personally, my view is that once you've gone to the trouble of calculating the second-lowest-cost Silver plan and basing a subsidy on it, you should simply provide that subsidy to everyone, and pay for it with a progressive income tax, since means-testing is an expensive, flawed bureaucratic nightmare.

The Senate bill smashes all the dials and tips over the mixing board

With this framework we can see what the Senate healthcare bill does on each of these fronts:

• turns the Medicaid dial all the way back to zero, then breaks it off and turns it even further. Starting in 2020, states would receive no additional federal money to cover the Medicaid expansion population. Since expansion states would be responsible for covering that shortfall, most or all would end the Medicaid expansion and dump those low-income adults onto the exchanges. Then the amount provided for the existing pre-expansion Medicaid population will be linked to inflation instead of to the actual health expenses Medicaid enrollees incur.
• turns the cost-sharing reduction dial down to zero. Moving people from Medicaid to the exchanges would be a defensible policy choice if new enrollees received premium subsidies and cost-sharing reductions that kept their premiums and out-of-pocket expenses minimal. However, as explained above, that would increase the cost of covering such people, since Medicaid costs so much less than private insurance. Instead, the Senate bill ends cost-sharing reductions entirely after 2019. That means the new exchange enrollees would be responsible for the entire deductible and co-payments associated with their new private insurance plans.
• turns the subsidy dial way down. In addition to increasing the out-of-pocket costs of the lowest-income population, premium subsidies are also reduced in two key ways. First, eligibility for premium subsidies is reduced to 350% of the federal poverty level, so folks earning between 350% and 400% of the poverty level are cut off completely from premium subsidies. Second, those who continue to be eligible for subsidies will receive subsidies anchored not to the second-lowest-cost Silver plan, as they do today, but rather to the median Bronze plan. What's the difference? Across the enrolled population, a Silver plan is required to have an actuarial value of 70% (it will cover 70% of the expenses of the enrolled population), while a Bronze plan's actuarial value is just 58%.

Each of these dials produces cost savings: ending the Medicaid expansion and capping pre-expansion Medicaid reduces the cost of that program by kicking people off Medicaid; ending cost-sharing subsidies reduces the cost of enrolling low-income people on the exchanges; drastically cutting subsidies reduces the amount of aid going to low-income people by forcing them into stingier health insurance plans.Why do this? Why turn all the dials down, instead of adjusting them so they cover more Americans with more comprehensive, more affordable health insurance? Why make entrepreneurs decide between health care and investing in their business? Why stand by and watch the number of uninsured, the number of medical bankruptcies, and the amount of unreimbursed health care return to its pre-ACA levels?In order to reduce the marginal tax rate on passive investment income for the very wealthy by 3.8 percentage points.

S corporations: logic and illogic

I've been doing a deep dive lately into one-participant 401(k) plans, which has caused me to observe that people are often extremely unclear about what they are talking about when they talk about one-participant 401(k) contribution limits. The reason is that multiple types of legal entities can sponsor one-participant 401(k) plans, including unincorporated sole proprietors (like your humble blogger).This led me to the further observation that many self-employed people seem to prefer S corporations to sole proprietorships. There is a very specific logic to this preference, but if you don't understand the logic, you're unlikely to correctly decide which is right for you.

Self-employment income versus S corporation distributions

As an unincorporated sole proprietor, I report all my net profit on schedule C, pay 15.3% in self-employment tax, and then deduct half my self-employment tax to calculate my earned income for IRS form 1040.As an S corporation employee-owner, you pay reasonable W-2 income to yourself, with the corporation paying (and deducting from profit) 7.65% and you, the recipient of the income, seeing another 7.65% deducted from your paycheck. The remainder of the S corporation's profit is issued as "distributions," which are subject to ordinary income tax but not the 15.3% FICA tax.For this reason, many people believe they are "saving" 15.3% of the amount they receive as distributions, since neither the S corporation nor they themselves pay FICA tax on it.This is an error. Consider someone who, for 35 years, earns $100,000 in 2016 dollars. They have the option of receiving $100,000 of it in self-employment income reported on schedule C, or $50,000 in W-2 income and $50,000 in S corporation distributions, taxed at their ordinary income tax rate but without paying any FICA taxes.At full retirement age, the person receiving $100,000 in self-employment income will receive a monthly Social Security benefit of $2,670.Reducing their FICA contributions 15.3% of $100,000 to 15.3% of $50,000 will receive that monthly benefit to $1,845.At full retirement age, our sole proprietor will receive $825 fewer 2016 dollars per month.The next question is, how much will she have saved in the 35 years of shielding her income from FICA taxes? The answer is 15.3% of $50,000, or $7,650 per year, for a total of $267,750.The "breakeven" point in this case is roughly 27 years: if you live that long, you'll collect more in wage-inflation-adjusted Social Security benefits than you "saved" in FICA taxes.

Eligibility for tax-advantaged retirement savings accounts

Of course, as a self-employed person, hopefully you're also saving for retirement, and you'd think those unpaid FICA taxes could help.Both sole proprietors and S corporation owner-employees are eligible for retirement savings accounts, but in slightly different ways.To calculate their earned income for purposes of contributions to retirement savings plans like 401(k)'s, an unincorporated sole proprietor uses 92.35% of their net self-employment income. Of that total, the first $18,000 can be contributed to either a traditional or Roth 401(k) account, and up to $54,000 total can be contributed on self-employment income of a little over $190,000.Owner-employees of S corporations can only make employee elective and employer non-elective retirement savings contributions based on their W-2 income, not their S corporation distributions. Of course, you're free to save rather than spend your S corporation distributions, but those savings won't compound tax-free and will be subject to capital gains taxes upon sale.While non-elective S corporation retirement plan contributions aren't subject to FICA taxes, the employee-owner's W-2 earnings are. This creates a tension: the point of the S corporation is to minimize your W-2 income subject to FICA taxes, but minimizing your W-2 income reduces your capacity to defer taxes on retirement savings. You can raise your W-2 income in order to contribute more to a one-participant 401(k) plan, but your increased W-2 income will then be subject to FICA!

Squaring the circle

All of this is to say that while many self-employed people and finance hackers treat an S corporation election as a no-brainer or default option, your decision on how to organize your business depends on several factors. Here are a few:

• for businesses with net income below about $22,077, there's zero justification for incorporation, since you can contribute your entire net business income to a 401(k) and pay no federal income tax on it at all (an $18,000 elective deferral and $4,077 non-elective deferral).
• for businesses with net income substantially above $180,000, and for business owners with more than $127,200 in W-2 income from another employer, an S corporation election is, ignoring setup and maintenance costs, tax-advantaged compared to sole proprietorship, since you can maximize your Social Security wage base ($127,200) and defer the maximum $54,000 into a one-participant 401(k) by paying $144,000 in W-2 income and making an $18,000 elective contribution and $36,000 non-elective contribution. Distributing profit in excess of $180,000 will avoid the 2.9% Medicare tax. Note: that is just $2,900 for each $100,000 in additional S corporation profit, so if your setup and ongoing maintenance costs are high they could take years to recoup, if ever.
• For businesses in the middle of that range, the question comes down to what you actually intend to do with the FICA taxes you avoid with a S corporation distribution. If you're simply going to invest the money in a taxable brokerage account, you're trading one investment, an inflation-indexed annuity (Social Security), for another less tax-advantaged one. On the other hand, there are investments that are difficult or impossible to make in a retirement savings account: real estate, futures, private equity, or even more creative options. A high level of confidence in your ability to deftly manage the money you save on taxes could alone justify taking the money as a taxable distribution instead of squirelling it away in a tax-advantaged account.

The sole proprietor's marginal federal tax rates

[edit 6/13/17: I've been convinced that employee "elective" and employer "non-elective" solo 401(k) contributions can be made with the same money, so have slightly updated the values below to reflect that employer contributions don't have to be made with what's "left" after deducting up to $18,000 in elective employee contributions. I'll have a post soon exploring this issue in more detail.]Everybody gets a song stuck in their brain sometimes, the only proven cure for which is putting on the song at maximum volume and belting it out in your underwear.Along with songs, I also get personal finance calculations stuck in my mind that I can only stop thinking about once I work out the math and blog about it.Recently I've been thinking about what should be, but isn't, a trivially simple question: what is the marginal federal tax rate on a sole proprietor's income?For each calculation I'll be assuming the sole proprietor is filing as a single taxpayer and has no other taxable income. Additionally, all retirement contributions will be made pre-tax. In other words, this is a taxpayer whose only objective is to pay as little as possible in current-year federal taxes. Adjusting these rates for your own situation is an exercise left for the reader.Finally, these rates are calculated on the net business income reported on line 48 of Schedule C. Don't confuse that with "earned income" or "adjusted gross income." These are just the marginal tax rates paid on your actual profits from your actual business, if it's your only source of income.

Marginal federal tax rates on a sole proprietor's income

• 15.3% for income up to $54,142 $60,638. At $60,638 in self-employment income, you'll owe $9,277 in self-employment tax. Reducing your self-employment income by half that amount, $4,615, will leave you with $56,000 in earned income. A $5,500 traditional IRA contribution, $18,000 pre-tax "employee" solo 401(k) contribution, and $14,000 "employer" solo 401(k) contribution will reduce your adjusted gross income to $18,500. After deducting your $4,050 exemption and $6,300 standard deduction, you'll be left with taxable income of $8,150 and income tax due of $818 which will be fully offset by your retirement savings contribution credit of $818.
• 41,800% on the next dollar or two of income. It's actually a bit tough to calculate the precise point when your adjusted gross income will tip over to $18,501 due to the multiple decimal places involved, but at that point, you'll owe the same $818 in taxes but your retirement savings contribution credit will drop to $400. You'll pay $418 in taxes on a dollar or two of income, leaving you with a marginal tax rate of 41,800% (or 20,900% if you want to spread it over two dollars of income).
• 23.4% for income up to $62,336. It's important here to note that, having maxed out your $18,000 in straight employee 401(k) contributions, you can only contribute one out of every four dollars as an "employer" contribution to your solo 401(k). That means the $1,500 in adjusted gross income up to the next retirement savings contribution credit threshold is actually $2,000, which has to be adjusted for the usual and obnoxious 92.35% adjustment, for a total of $2,165 in net self-employment income you can earn before the next threshold. In this band, every $72 in net self-employment income results in an additional $5 in federal income tax and $11 in self-employment tax ($72 reduced by 7.65%, then by 25%, results in $50 in adjusted gross income).
• 25.7% up to $62,804. In this band, every $72 in net self-employment income results in roughly an additional $7.50 in federal income tax and $11 in self-employment tax.
• 20,000% on the next dollar or two of income. As above, moving from the 20% retirement savings contribution credit band to the 10% band reduces your credit by $200.
• 25.7% up to $78,686. Here you're still in the 15% income tax bracket and receiving a $200 retirement savings contribution credit.
• 20,000% on the next dollar or two of income. This is the final phaseout of the retirement savings contribution credit. Earn a buck, pay $200.
• 25.7% up to $103,230. At $103,230, your adjusted gross income will total $48,000, leaving you with $37,650, the top of the 15% income tax rate.
• 32.7% up to $127,200. In 2017, $127,200 in net self-employment income will max out the Social Security component of your self-employment tax (finally!), and leave you with $54,252 in taxable income, squarely in the middle of the 25% income tax bracket.

Let's take a break here to talk about the next two things that are going to happen. First, the amount by which your net self-employment income will be adjusted is going to change. Before we'd been using a variable 7.65% adjustment to account for half the self-employment tax, which is figured as 15.3% of your net self-employment income up to $127,200. Now we're going to use a fixed $9,730 adjustment, which is half of the 15.3% levied on the first $127,200, plus a variable adjustment of 1.45% on the amount over $127,200, which is half the self-employment tax levied on amounts in excess of $127,200. So $128,000 in self-employment income will be reduced first by $9,730, then a second time by $11.60 (1.45% of $800). That's going to bring down your marginal tax rate, a lot. We can still contribute 25% of what's left as an employer contribution to our solo 401(k). In this case, that employer contribution is $29,564.That brings us to the second thing that's going to happen: the ability to make employer contributions to your solo 401(k) will end when total employer contributions total $35,000. We'll have $35,000 in employer contributions when our total self-employment income is $150,061. Reduce that amount by $9,730 and 1.45% of the amount in excess of $127,200 ($331) and we'll have $140,000. The quarter of the remaining amount is your maximum employer non-elective 401(k) contribution: $35,000. Just as lower self-employment taxes lower your marginal tax rate, losing the ability to contribute a quarter of what's left will have the effect of raising your marginal tax rate.One final note here: Matt and I have disagreed about whether you can contribute the same dollar twice: once as an employee and once as an employer. I think you can only contribute the same dollar once, which is why I have assumed all employer contributions are made from what's left after the maximum employee contribution is made. If anyone has a definitive answer to this question, I'm all ears. I've been convinced that Matt is right about this.Ok, back to business.

• 21.4% up to $150,061. Between $127,200 and $150,061, you'll pay 2.9% in self-employment tax on each dollar of net self-employment income, then 25% of 75% of 98.55% of what's left.
• 27.5% up to $171,117. In this band you're paying the lower self-employment tax rate of 2.9% on each marginal dollar of self-employment income, but now have to pay 25% of the entire 98.55%: you're no longer able to make additional employer contributions to your solo 401(k).
• 30.5% up to $272,334. Here you'll pay 2.9% in self-employment tax on each dollar, then 28% of the remaining 98.55%. 
• 32.5% up to $330,173. At $330,173 in net self-employment income, you'll have an adjusted gross income of $259,000.

At this point, the personal exemption starts to phase out, until it's eliminated completely at an AGI of $381,900 (net self-employment income of $454,881).

• 33.6% up to $454,881. For each $2,500 you earn, you'll pay 33% on 98.55% of your net self-employment income plus 33% on 2% of $4,050 (no, I'm not kidding).
• 32.5% up to $496,586. Now that the personal exemption has been completely phased out your marginal tax rate drops back down to 33% of 98.55% of your net self-employment income.
• 34.5% up to $498,331.
• 39% on all additional marginal dollars of net self-employment income.

Conclusion

Now that my brainworm has been well and truly exterminated, there's only one thing to do to reward folks who have made it all the way to the end, and that's show exactly the same data in chart form:One hell of a way to run a railroad.

Solo 401(k) accounts from Vanguard, with beneficial illustrations and calculations

One of the great advantages of being self-employed is the ability to open and manage your own small business retirement account. Employed people have to either take or leave their employer's 401(k) or 403(b) plan offerings, regardless of the quality or cost of the funds it offers, while the self-employed get to choose their own plan provider and pick exactly the assets they want to invest in. Naturally, many choose Vanguard, and since I recently opened a solo 401(k) with them, I thought it would be useful to share my experience.

Opening an account (1): selecting funds

To open a solo 401(k) with Vanguard you have to download and print the "Individual 401(k) kit for employers" from their small business website. The kit is pretty straightforward, although there are a few sections I want to highlight.In section 3 of the New Account Form you have the option of opening either a traditional, pre-tax account, a Roth, post-tax account, or both.If you open a pre-tax account, you have to select at least one fund to receive your contributions:Likewise if you open a Roth account, you have to select at least one fund:There's a $20 annual fee charged per fund held in each account, so if you open both accounts you'll have to pay $20 per fund each year, even if you hold the same fund in both accounts. The $20 fee is waived if you have $50,000 in assets across all your Vanguard accounts (so-called "Voyager services").Note that Solo 401(k)'s do not have access to Vanguard's lower-cost Admiral shares. That matters for two reasons: first, you'll pay slightly more for funds that you currently own as Admiral shares. That's bad. But it also matters because when people compare the fees on Vanguard's all-in-one funds to a "do it yourself" portfolio of Vanguard funds, they are usually comparing the all-in-one fund costs to the cost of Admiral shares. But if you don't have access to Admiral shares, that's not the right comparison.For example, Vanguard 500 Admiral shares have a hyper-low expense ratio of 0.05% — a third the cost of a Target Retirement or LifeStrategy fund. But Vanguard 500 Investor shares, the ones you have access to in a Solo 401(k), have an expense ratio of 0.16%! Suddenly the comparison doesn't seem so compelling, particularly if it comes with the added $20 per-fund fee and the additional hassle of periodic rebalancing. That's one reason I chose the LifeStrategy Growth fund for my 401(k), as you'll see below.

Opening an account (2): designating beneficiaries

Vanguard has what appears to be an extremely straightforward system for designating beneficiaries. First, you select your primary beneficiary:Then, you select your secondary beneficiary:This is not, in fact, an extremely straightforward system. As my primary beneficiary, I selected "To the person I'm married to at the time of my death," and as my secondary beneficiary I selected my partner. About a week later I got a call from Vanguard to clear up their confusion. It turns out that in spite of all logic and reason, you're only supposed to select "To the person I'm married to at the time of my death" if you're already married, which seems to me to defeat the purpose of such a checkbox, but what do I know?

Making contributions

Once Vanguard has accepted your plan documents, you'll receive a barrage of mail from them, including information on configuring your online account administrator access. Unlike the fairly powerful personal investor interface, the small business interface is extremely primitive:When you select "Make a contribution online" you're first asked which tax year the contribution is for, and then taken to this screen:The "Individual 401(k)" contribution fields are for pre-tax contributions, which can be made as employer or employee contributions (more on that in a moment). The "Individual Roth 401(k)" contribution fields are for post-tax contributions, which can only be made as employee, not employer, contributions.

Contribution limits

Solo 401(k) contributions limits aren't hard, they're just complicated. I think the best way to think about them is in three parts:

• 100% of net self-employment income, minus half the self-employment tax, up to $18,000. If your net self-employment income from Schedule C is less than $19,491, then you can contribute 92.35% of your net self-employment income in the left-hand "employee" contribution columns. You can split that amount between the pre-tax Individual and after-tax Roth fields however your own tax needs dictate.
• 25% of your remaining net self-employment income, minus half the self-employment tax. If your net self-employment income is $30,000, then after deducting half the self-employment tax ($2,295), you're left with $27,705. You can contribute 100% of the first $18,000 in the left-hand "employee" column and 25% of the remaining $9,705 ($2,426) in the pre-tax right-hand "employer" column.
• $54,000. The most you can contribute in total to a solo 401(k) plan per calendar year is $54,000 in 2017. To make $54,000 in solo 401(k) contributions you'd need to make $175,419 in net self-employment income. Deducting half the self-employment tax would leave you with $162,000, and after contributing the maximum $18,000 in employee contributions you'd be left with $144,000, 25% of which is the $36,000 in employer contributions you need to reach the maximum.

Note that you do not need to actually make contributions in this order!This is simply the order that will maximize your contributions for a given level of self-employment income. You can reach the $54,000 contribution cap exclusively from employer contributions. However, the required net self-employment income is much higher: $54,000 is 25% of $216,000, which is almost $234,000 in net self-employment income after the self-employment tax is added back in.And of course if you want to take advantage of Individual Roth 401(k) contributions those can only be made as employee, not employer contributions.

Adding and exchanging funds

An important benefit of Vanguard retirement accounts is that it's possible to contribute to funds without meeting the minimum initial investment requirement. In other words, you don't need to contribute $3,000 in order to purchase shares of a fund that otherwise has a $3,000 minimum investment.However, this benefit is only extended to contributions processed through the small business investing portal. When you log into your personal investor account, you'll see your 401(k) account(s) there but won't be able to transact the funds in those accounts until you meet the minimum investment requirements.If you want to add a new fund to your 401(k) but don't want to exchange shares in an existing fund, Vanguard can do this over the phone if you call 1-800-205-6189. The reasons for doing so might be to trigger the minimum investment waiver for future contributions to the account, or simply to diversify your existing funds.

Conclusion

Solo 401(k) plans are a way to defer taxes on a substantial amount of self-employment income and, in Roth accounts, potentially avoid taxes entirely by making Roth contributions in years when you are able to pay little or no federal income tax.Vanguard's Solo 401(k) kit makes it just about as easy as possible to get started, given the legal requirements involved. And even if you make a mistake when designating your beneficiaries or selecting funds, their phone personnel have been extremely capable every time I've had to speak with them (including researching this post).And of course, best of all a Vanguard Solo 401(k) gives you access to Vanguard's suite of low-cost mutual funds!