[IMGCAP(1)]Tax rules continuously change, but the specific tax matter here is not what’s important. What is important is the process.
In the 1970s the tax law provided for a penalty for certain family corporations retaining “excess” earnings and not paying dividends. For the record the individual tax rate on dividends then was 70 percent, so forcing the payment of dividends would give the government that much more tax—on some level you can say that it almost was a confiscatory tax.
To determine “excess,” you had to go through various gyrations and formulas, and in this client’s case, I felt he would be penalized upon an audit if he did not pay the dividend. The penalty was 38.5 percent of the unpaid dividends. I told my client that based on his circumstances he needed to pay a dividend of a certain amount to avoid the imposition of that penalty.
The client asked me to show him calculations to convince him of the “benefit” of paying the dividend vs. being penalized. He said he wanted to see what he would have if he paid the dividend and what he would have if he did not pay the dividend but had to pay the penalty. I was annoyed at his request and insistence because “everyone knew it was better to pay the dividend rather than pay the penalty,” but I told him I would work out the numbers for him.
I wasn’t going to see the client for about a month, but that night after dinner I decided to put the numbers together to get it out of the way and off my mind. To my complete surprise, it looked like he was “richer” by not paying the dividend, but paying the penalty. It made no sense to me since the conventional wisdom was that the penalty avoidance was the preferred strategy.
During the next month I did extensive research on this and found nothing that indicated you should not pay the dividend but wait to have the penalty assessed. But my calculations showed the opposite. I met with some more experienced colleagues and asked them to show me my errors, which they were unable to do. I included this as a chapter in my first book, Successful Tax Planning, published by Martin Edelston and this was the thing I took the greatest pride in—it reversed the conventional wisdom in this area.
I learned that with taxes, there can be no assumptions and that everything has to be researched and number crunched. This lesson became a mantra for me. Push the Pencil! Do the Work!
After this instance, there have been many situations where pushing the pencil reversed the “conventional wisdom” for me. I also then never accepted anything less than a complete job from my staff. I have refused to work for clients who did not want to pay the proper fees for the thorough work I always insisted on.
Edward Mendlowitz, CPA, is a partner in WithumSmith+Brown, PC, CPAs. He has authored 20 books and has written hundreds of articles for business and professional journals and newsletters plus a Tax Loophole article for every issue of TaxHotline for 27 years. Ed also writes a blog twice a week that addresses issues his clients have at www.partners-network.com. He is the winner of the Lawler Award for the best article published during 2001 in the Journal of Accountancy. He has also taught in the MBA graduate program at Fairleigh Dickinson University, and is admitted to practice before the U.S. Tax Court. Ed welcomes practice management questions and he can be reached at WithumSmith+Brown, One Spring Street, New Brunswick, NJ 08901, (732) 964-9329, firstname.lastname@example.org.