“Take money from your right pocket and put it in your left pocket. Now you have yourself a solution.” – Anonymous
One of the reasons I went to Budapest earlier this year was to see if it was a suitable city to establish a Financial Samurai Inc. subsidiary. Before my trip, I had learned that Gawker Global (now owned by Univision) had set up a subsidiary in Hungary to significantly reduce its tax liability. As an owner of a much nicer and more empathetic media company to help people achieve financial freedom sooner, I had to do some first-hand research!
Now, in a fascinating exposé, Jeff John Robert from Fortune magazine highlights how Gawker Media was able to “legally” reduce its IRS tax bill by ~80%. Here’s what Gawker Global did.
1) Set up a subsidiary in Hungary, a lower tax country. Gawker Global’s effective tax rate in Hungary was 5% versus 34% in the US.
2) Get the Hungarian subsidiary to bill the US subsidiary in order to reduce the US subsidiary’s taxable income. Let’s say the US side generated $1,000 in revenue from an article. To avoid the 34% effective US tax rate, the Hungarian side would send $1,000 worth of invoices for editorial and design to the US side so that taxable revenue in the US was $0. The Hungarian side now had $1,000 in revenue from its services, but since it only had to pay a 5% effective tax, it saved 29%.
3) Decide where the overall Gawker Global revenue flows. Between 2010 – 2015, Gawker Global generated roughly $200M in revenue. According to Fortune’s Jeff John Robert, of the $200M, 55% were U.S. profits diverted to Hungary, and 25% were profits that never entered the U.S. and were recorded in Hungary. This seems shady, but my guess is this is legal because apparently the IRS hasn’t gone after them all these years.
To justify geographic revenue recognition, perhaps one of the US-based writers did all his writing for the year while visiting the Budapest office for a week. But given that a media company’s revenue is derived mostly from advertising, it seems logical that if the advertiser is based in the US, the revenue should be taxed in the US. But wait just a minute! What if the advertiser itself is a global company with offices in Hungary like Coca Cola? Ah, so wonderfully confusing and clever.
4) Have one subsidiary lend back money to another subsidiary. Gawker Hungary would lend back the money it made with interest, from Gawker US so that Gawker US wouldn’t pay any taxes on cash flow.
The key for all of this to work is to be the owner of all the subsidiaries so all the money flows to you. It’s like taking money from your right pocket and putting it in your left pocket!
HOW TO STILL WIN AFTER A LEGAL SETTLEMENT
Now take a look at this beautiful chart below. According to the Hulk Hogan versus Gawker Global trial, Gawker Global owes Hulk Hogan $140M for violating his privacy ($10M of which is owed directly by Nick Denton, founder of Gawker Global). With Gawker being sold for only $135M, and Nick Denton owning only 53% of the company, it would seem Nick might be SOL given the liabilities are greater than the sale.
Not so fast! Filing for bankruptcy helps protect Nick and his interests outside of the company. Creditors can only go after what the company is worth. Further, prior to the judgement, Nick cleverly sold a portion of his company to a family trust called Greenmount Creek. As part of the sale, Greenmount Creek, controlled by Nick’s sister, agreed to pay Nick $12.8M tax-free in 2028! Why the payment is 15 years out, I’m not sure. Perhaps it’s due to the statue of limitations.
Check out this corporate structure.
LEARN HOW TO AVOID TAXES FROM OTHERS
I’m not a tax lawyer or a CPA. Please find one for tax advice. I’m just a tax enthusiast who’s been doing his own taxes for over 10 years. Tax is consistently the #1 expense for most of us working stiffs, so it only makes sense to learn how other people and companies legally reduce their taxable liability.
To verify what Gawker Global is doing is legal and whether the rest of us can do the same thing, I’d love to get the thoughts of all you tax lawyers and CPAs. The IRS can’t discriminate on the tax laws by favoring a British citizen making millions in America over its own American citizens, can they? And since the IRS hasn’t gone after Gawker Global for “transfer pricing,” are they giving their stamp of approval such actions are legitimate?
From a company called Buffer App, we learned they spend more on monthly company retreats than they make in monthly operating profits as a great way to lower their tax liability while having a good time. This strategy is directly applicable to small business owners, especially those that have raised investor money. It’s much more fun boondoggling on another’s dime.
From a company called Apple, we know it holds over $180B in offshore accounts and plans to continue keeping this money offshore in order to avoid paying a ~$60B tax bill. Apple’s effective tax rate on overseas earnings is under 3%. This strategy is not applicable to most of us, but gives people incentive to move abroad to take advantage of the Foreign Earned Income Exclusion.
And now from a company called Gawker Global, we learn specifically the benefits of creating subsidiaries in lower tax countries to drastically reduce tax liability through inter-company dealings. Most small businesses will just hire their friends and family to help them out or get favorable rates.
It’s important as a Financial Samurai reader to always be learning from others. I’ve heard about creating subsidiaries to save on taxes, but I’ve never read actually how to do so until I read Fortune Magazine’s article and created my own sample income statement above. The more you learn, the better your finances will be.
BUDAPEST IS GREAT
So what about the great city of Budapest? On a scale of 1-10, 10 being the best, I give Budapest an 8 in terms of livability. The public transportation is easy. The city is by a beautiful river. And the cost of living is relatively low. Budapest is definitely a great place to set up a subsidiary. But in order to do so, I think you may need to get your annual business revenue up to at least $1M before you can justify the necessary extra overhead and legal fees to ultimately take advantage of these tax savings.
Here are some pictures.
Being a personal finance blogger might very well be the best profession ever. What other business allows you see the world, write about what you’ve discovered, improve the financial well-being of others, and make money off what you’ve learned? I hope this article gives everybody something to think about regarding the power of starting a business to lead a more fulfilling life.
I never plan to go back to being a full-time W2 employee again. To work 12 hour days for the pleasure of paying a 50%+ Federal and State marginal tax rate is a very bad proposition. It’s much better to follow the lead of all these great companies to live a better lifestyle. If the IRS approves of their inner dealings, isn’t that good enough for you and me?
* Try to be nice to people. Nice people generally don’t get sued for $140M.
* Try and be congruent in how you act and how you think.
* Try and stay off the grid or earn less. The Defense Department’s Inspector General, in a June 2016 report, said the Army made $6.5 trillion in wrongful adjustments to accounting entries in 2015. Yet the Army lacked receipts and invoices to support those numbers or simply made them up. Despite this information, the IRS goes after individuals instead of its own government colleagues. Scary.
Tax enthusiasts, please share your thoughts about creating subsidiaries to save on taxes. Any other creative ways you know about to save on taxes? Why would the IRS bother to go after individuals when they could get a bigger return by going after huge corporations? Doesn’t moving your money from your right pocket to your left pocket seem a little shady? If so, why hasn’t the IRS done anything about it? What do people think of Budapest as a place to live and work?
Start A Business: A business is one of the best ways to shield your income from more taxes. You can either incorporate as an LLC, S-Corp, or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a schedule C). Every business person can start a Self-Employed 401k where you can contribute up to $54,000 ($18,000 from you and ~20% of operating profits). All your business-related expenses are tax deductible as well. Simply launch your own website like this one in under 30 minutes to legitimize your business. Here’s my step-by-step guide to starting your own website.
Updated for 2017 and beyond. Income taxes are set to come down under President Trump. As a result, those who contributed to their Roth IRA or Roth 401k and planned on retiring in 2017 – 2021 had wrong tax expectations.