How do you say I love you? Apparantly, Howard Shih thought that the best way to show his affections for his live-in girlfriend was to send her a 1099!

In a recent court case, Jue-Ya Yang vs. Commissioner of Internal Revenue, Mr. Shih issued a 1099 to Ms. Yang (his girlfriend) argueing that the payments were payments for helping him in his business. Mr. Shih, an artist, deducted payments totaling $10,500 as expenses on his return. Ms. Yang, insisted that she did no work for Mr. Shih and that the payments were a gift and that they should not be taxable income to her. In the end, the court sided with Ms. Yang. The payments were a gift and were not for actual services performed.

Unfortunately, our happy couple are no longer together.

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?

I saw this a few years ago, but someone recently sent it to me again. Unfortunately, it is way too true.

The Tax System – Explained With Beer

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.

So, that’s what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. ‘Since you are all such good customers,’ he said, ‘I’m going to reduce the cost of your daily beer by $20.’Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (FREE BEER!).
The sixth now paid $2 instead of $3 (33%savings) .
The seventh now pay $5 instead of $7 (28%savings) .
The eighth now paid $9 instead of $12 ( 25% savings).
The ninth now paid $14 instead of $18 ( 22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

“I only got a dollar out of the $20,”declared the sixth man. He pointed to the tenth man,” but he got $10!”

“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than I!”

“That’s true!!’ shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”

“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

There has been a lot of discussion in the media lately (and among the Presidential Candidates) about what is considered rich? Obama has a much narrower view of “rich” than McCain and has said repeatedly that it is over $250,000 in income. Earlier this year, when McCain was asked what income threshold he thought would make someone “rich”, he suggested $5 million. Well, they are both wrong. Wealth and being “rich” has absolutely nothing to do with income. Basic theory would suggest that the more income someone has, the higher probability someone has to be rich. After studying this issue for some time and reading many books on the subject, I have learned that this is clearly not true.

Being rich, or wealthy, is not about income. It is about how much wealth an individual has on hand. Most Americans spend what they make. If they make $25,000, they spend all of it. If they make $250,000, they spend all of it. Their expenses naturally rise to meet their incomes. I am not saying this is the way it should work, but this is reality. This is one thing that scares me about some of the proposed tax increases on the “rich.” They are not tax increases on the rich at all. They are tax increases on high earners. These high earners are already locked into many high expenses – usually a high mortgage. What do these high earners do when their expenses are bumped another $50,000 or so to cover increased taxes? They are already spending all of their income and much of their expense may be locked in through mortgages, student loans and other concrete obligations. Could this increase foreclosures? Could this result in a further decrease in real estate prices as these individuals try to get out from under their mortgage obligations? Ultimately, I do believe these individuals should be paying more than someone making $100K, but I don’t think it is as simple as bumping their tax rates.

What should be considered “Wealthy”? In a sense, it is a state of mind. I once heard a speaker who was talking about the subject describe it as the point in which you can plan to go anywhere in the world for a week, call the travel agent and have her book the trip, and not care one bit about what the cost is. While, it is in large part a state of mind, surely their must be some dollar amount that most of us would agree is wealthy. $5 million in net worth? $10 million in net worth?

Ultimately, if we want the “rich” and the “wealthy” to pay for things in this country, we are going to have to develop a method to measure true wealth accurately and to tax it fairly. Just assuming someone is wealthy because they had a good year does not accurately reflect life in America.

Another problem with taxing “income” that may be indicative of “rich” is that different areas of the country have different cost of living. This is discussed in depth in How to Tell if You’re Rich, and article by Rick Newman from US News and World Report. An individual making $300,000 in El Paso, Texas may be getting by just fine, but someone making the same amount in New York, NY will have a lot more difficult time with the tax increases.