We all know we live in a global economy.
There maybe few industries that highlight that fact, more than the domain industry.
As Domainers we complete everyday in obtaining new domains, with other Domainers which live all around the world.
Many domainers are US based, but other major domainers are located in tax free countries thereby giving those domainers huge advantages over the US based domainers.
The bad news it the disparity may get much larger after the US presidential election.
US domainers are subject to a double whammy.
First, US Domainers are taxed on the revenue they receive from the parking companies at a tax rate of up to 35%.
The second, more brutal of the double whammy is that you can’t deduct the cost of the domains you purchase; you can only amortize the purchase price over 15 years.
So lets use a simple example.
Let’s say you own one domain that you acquired in 1995 and it made $150,000 in parking revenue for you in 2005.
You say to yourself, this is a pretty good deal and I want to invest all the $150,000 i made and buy more domains.
Fair enough
So in 2006 you go out and spend $150,000 and buy domains.
If you live in a non-tax country you can reinvest all $150,000 and buy domains and have a zero tax liability.
However if your US based you can only amortize the $150,000 in new domain purchases over 15 years, so you would receive a deduction for the tax year of only $10,000, and you would have $140,000 of taxable income, which could be taxed as high as 35%, or $49,000.
So you would either only have $91,000 to reinvest in new domains or if you went ahead and reinvested $150,000, you would have to come out of pocket, dig into your own savings to pay $49,000 in taxes on money you no longer had.
The more you make, and the more domains you buy the worse the tax bite hits you and the greater the disparity with non-us based domainers becomes. Each year the problem compounds and places you at an even great disadvantage compared to non-US domainers.
So back to our example, in 2006 if your new purchases combined with you one domain now generated you $250,000 in revenue and you wan’t to reinvest the $250,000 in revenue, you would have the $250,000 in revenue less the $10,000 in amortization of your 2005 purchase and $16,666 for your 2006 purchases or an income of $223,000 and a tax bill of $78K.
Once again you would not have the $78K because you would have spent it on domain purchases.
The problem is not only do you have to pay taxes on your profits, where other competing against you don’t, but you have to pay taxes on money you no longer have because you spent it buying other domains.
Sure you can stop buying domains but that itself places you at a tremendous disadvantage to those in no-tax countries.
Here’s the really bad news.
It is going to get worse.
Much worse.
The current tax rates we have were lowered by what is commonly called the bush tax cuts.
That legislation sunsets or expired on January 1, 2011.
So unless congress votes to extend the tax cuts they will expire on January 1, 2011 at which point:
Capital gains goes from 15% to 20%.
Dividends go from 15% to regular income rates.
and the regular income tax rate will increase to a max of 39.5%.
All of these of course this is just the federal tax rates and does not take into account all the additional state income taxes that many US domainers are subject, as well as residents of some cities like New York, which also have a city income tax, in addition to a state income tax and the federal income tax.
We have a presidential election on November and one candidate, and the front runner, is proposing to raise taxes by July 1 of next year.
Here’s how the average tax bill could change in 2009 if either John McCain’s or Barack Obama’s tax proposals were fully in place according to CNN.com
Income Avg. tax bill McCain Avg. tax bill Obama
Over $2.9M ($269,364) $701,885
$603K and up ($45,361) $115,974
$227K-$603K ($7,871) $12
$161K-$227K ($4,380) ($2,789)
$112K-$161K ($2,614) ($2,204)
$66K-$112K ($1,009) ($1,290)
$38K-$66K ($319) ($1,042)
$19K-$38K ($113) ($892)
Under $19K ($19) ($567)
So to be clear according to CNN taxpayer who make 2.9 million or more will pay $700,000 MORE per year if Obama’s tax plan is adopted than they do now, which at 35% would already be a little less than 1M per year.
If you make 600K or more you would pay another $115,000 per year on top of the $210K you would presently pay.
And you still won’t be able to deduct your purchase prices of domains.
You will still have to amortize them over the next 15 years.
On the other hand if you are not a US citizen and not US based you could get away with paying zero taxes.
Zero taxes now.
Zero taxes last year.
Zero taxes next year.
So how can you complete in a truly global economy when your playing against a stacked deck?
I don’t have an answer for it.
But its a problem which is going to get a lot worse before it ever gets a lot better.
Some of you might suggest just giving up your US citizenship.
However the senate last month stuck a provision in a bill for veterans benefits, that would basically treat all the assets you own as being sold at fair market value if you give up your US citizenship.
A provision inserted into the Heroes Act of 2008, passed by Congress on June 17, which increased benefits for veterans and families of deceased military, states that anyone voluntarily giving up his or her citizenship will be taxed on all of his assets as if he or she had sold them paying capital gains on assets that have increased in value, even though they have not been sold.
So if the option of paying taxes on money you haven’t gotten is unappealing you get to either do it for the rest of your life as you pay taxes on money you no longer have because you spent them on domains, or you stop acquiring domains and let the competition have them all.
This post is not to imply that the US tax system is the worst.
There are many other high tax jurisdictions around the world that place their citizens and residents at a tremendous disadvantage to those living in no-tax countries, some of these are even worse than the US.
However we need to realize what environment we have to do business in and the inherent and distinct disadvantages that we face as US domainers.
Finally I know there is a belief that weathly people in the US don’t pay “there fair share” of taxes.
Nothing could be further from the truth.
according to Fortune Magazine, April 14, 2008 issue, the top 10% of taxpayers paid 70% of all federal income tax collected and the top 1% of taxpayers paid 40% of all income tax, “a proportion which jumped dramatically since 1986.
On the other hand the bottom 40% of taxpayers had an “effective tax rate that’s negative: Their households received more money thorugh the income tax system, largely from the earned income tax credit than they paid”.
So what we have is a repressive tax system, which buy all accounts is going up.
It hits our industry especially hard since it does not allow us to deduct the major expenses of our business, i.e. acquisition of domain names, which we all do largely in cash out of pocket and makes us pay taxes on money we no longer have.
A global economy.
In the US the rules may kill our chance to compete.
In your post simply replace 35% by 60% and you have what is happening in France.
And 60% is thanks to the Sarkozi tax cut because before it could raise until 75%
So trust me, US domainers are currently 2 times more lucky than french domainers.
What is the most comfortable places for domainers?
Cayman? 🙂 Panama? Belize? Gibraltar?
Interesting. Thought only start-up expenses were amortized. Wonder the rationale behind that.
Jody
Domains are considered as “intangible assets” and therefore subject to being amortized over 15 years for tax purposes.
Newbie
You are going to have to retain the services of a very good tax professional and figure out the best way to conduct your business
Mike,
There are some legal ways to minimize taxes for domainers. You’ll need to set up an legal structure, pay some annual fees to a management company etc. But most of the larger domainers can afford to do a legal structure.
BVI is a very good place to incorporate, BTW.
@Francois
The French have many tax minimisation solutions available to them.
There is no need for you to pay 60% tax. You should find a new financial advisor. :-).
“It is very lightly to get worse.”
“(which is highly unlighted)”
“…the lightly winner at this point…”
Is this some new slang I’m not aware of?
Mike,
Excellent post. You clearly put much time into this and its much appreciated. You informed many, many people who probably operated in a knowledge vacuum with respect to these issues.
There is a larger point beyond domain holders. The greater Internet economy is moving money from all US business overseas to more favorable tax nations. Its not just domain holders losing, its most US businesses online losing. Domain name business entities (and other online businesses) should write their congressmen informing them current and proposed US tax laws prohibit Americans from competing equally in the Internet economy and the larger result is wealth being transferred overseas to far more tax favorable locales.
For those considering writing their congressman/woman first make sure you are a registered voter. If you are not, your letter is literally meaningless. Second, make a contribution to your member even if its only 10 dollars. There is a huge difference between a contributing constituent and a non-contributing constituent. Yes, contributions and people who are contributors are tracked and tracked very closely. A letter from a registered, contributing constituent gets an ear. A letter from less than than gets thrown away. It should go without saying that if you write, you do so as an established business entity such as a corporation, LLC, etc.
I wouldn’t mind paying taxes so much, even higher taxes , if I knew the money was being used appropriately and not wasted on ridiculous special interests.
Help http://www.endsma.com btw 😉
Pure
No not new slang, just what happens when you do a post at 4am.
Anyway, thanks for pointing out the incorrect language and I have made proper adjustments.
Adam
The question isn’t whether you mind or don’t mind paying higher taxes, but as a nation how are we going to complete in a global economy when many of our largest competitors do not have to pay any tax.
Moreover we have to pay tax on money we no longer have, so we can actually run at a overall negative cash flow taking taxes into account.
That is not an environment for success.
>>You will still have to amortize them over the next 15 years.
Not everyone does it this way. Most I know don’t.
Domains are not something we own, we are only paying for the rights to use them for a certain period of time (basically renting them).
They are business expenses to us which we write off the same year we pay to use them.
But that doesn’t help much being based in the US either.
We paid 47% in taxes total the last couple of years.
Fed + State + Corp taxes + other taxes that kick in once you pass certain income levels.
It’s crazy…and it’s going to get worse, is right!
WQ
I know people treat domain purchases in all different ways for tax purposes.
I have spend over 10K in accounting and legal fees getting an opinion of how these should be reported.
All I can tell you is that a domain is an intangible asset and the purchase price must be amortized over 15 years.
A domain is not a license, or a right to use, or anything else.
Court have so ruled.
I know guys that also treat domain purchases and sales as “like kind exchanges”, also not correct unless you follow very precise rules.
I have spent paid time with five different accountants in the last eight years and each has a different opinion – some falling into the camp or amortizing domain expenses and others treating it as passive sales.
One thing that a couple pointed out to me is that deciding how to treat the expenses is dependent on if you are into domain sales…… or domain income where you are not selling your assets. I fall into the latter.
Another accountant who has been in business 40 years, said that it could be argued that amortizing thousands of domains is not practical and as such could be argued to the IRS that expenses can’t be treated that way. He said it can be done, even though that still sounds hard to me.
As mentioned above, throwing out a blanket statement that all domains should be handled on a 15 yr amortization is wrong. Every business is different.
The real test is when an audit comes. . . .and I’d say for most US domainers, it’s probably right around the corner.
Mike,
You are absolutely right about the 15 year amortization. Years ago people disputed things like US trademark law with respect to domains, now some dispute US tax laws with respect to domains. Trademark law has ground a few domain owners into dust already, and people now are only playing a jail delaying game with the IRS if they are expensing names. It will probably take an example before they wise up.
Johnny
I think you confusing the treatment of the sales of domains and the purchase of domains.
Some people treat the sale of domains as a capital gain and other treat it as ordinary income.
However on the purchase side of things, the treatment does not change depending on how much you purchase.
For example real estate is an assets which you have to depreciate over 27.5 years for a rental building or 39 years for an office building.
If you have one building you have to depreciate it over that period or if you have thousands of buildings like Donald Trump you still have to depreciate it over that same period
Adam
All domains have to be treated for tax purposes the same way, just like any other class of asset.
Nice and informative post – thanks
In the end, neither of us are accountants I guess.
Sandra Brooks is . . . http://www.domaintaxguide.com
I believe until there is an IRS ruling on how domains are handled these are all just educated opinions.
We also drifted from your topic on how domainers in the US are at a disadvantage. .. . I’d say domainers arent the only US business people at a disadvantage though in the global economy. vote republican.
>>>I have spend over 10K in accounting and legal fees getting an opinion of how these should be reported.
So have I.
I have also spoken with the IRS directly.
Same old issue keeps coming back up.
From Sandy Brooks herself on domainnamewire.com:
February 26th, 2008 | 10:27 pm
Paul, there are plenty of examples of assets which require annual registrations or even for which title never passes. It is the perpetual right to renew the domain name that creates value and makes domain names assets. I want to be clear that I am talking about domain names that are bought for something more than the registration fee (i.e., an after-market sale). Registration fees are expenses; both the initial year’s fee and each subsequent year’s renewal can be written off in the year they are incurred.
There are two major problems with expensing the cost of domain names: 1) it will most likely not stand up under IRS audit; 2) a subsequent sale of the domain name would be ordinary income, with no chance of getting the favorable capital gains rates.
Even attorney Paul Keating outlined the same proper amortization position for domain names at a Traffic conference in 2005.
This game already has enough TM cheats making problems for others, it does not need tax cheats making everyone get audited.
Mike,
I thought the accepted strategy for this was to hold the domains in an offshore company such as BVI, Cayman, Barbados etc. and then rent or lease the domain to a USA, Canadian, EU person or company to use and make monthly revenue both for the person or company and the offshore owner of the domain name.
That way the sale of the domain is separated from the income generation of the domain.
But I see a lot of comments that make me think that many people are handling this in different and, likely, less tax efficient ways.
“accepted” by whom? The IRS?
Its becoming clearer why Frank stopped blogging.
jblack,
You are posting the opinions of two people, not actual law.
So accusing people of cheating is pretty lame.
@jblack
Remember that the IRS is interested in Americans or foreigners with assets inside the USA. 🙂
Canadians (like me) have a whole other set of regulations to follow. Most noteably that taxation is based on RESIDENCY, not CITIZENSHIP like it is for Americans.
WQ,
Feel free to ignore the attorneys and accountants. Like Paul Keating said, “expensing domain names is a ticket to jail”. His quote, not mine.
Guys,
The blog post was to point out the disadvantages that US domainers are at because of US tax law, when you compare other domainers who live in tax free countries.
There is no debate on how domains are treated for tax purposes.
The law is clear.
The post reflects the law.
The debate raging on the board regarding the tax treatment of the purchase price of domains is needless. This is not a matter of opinion. It is a matter of law.
>>This is not a matter of opinion. It is a matter of law.
>>The law is clear.
Please post this law.
(Not how you interpret it).
Thanks.
MHB is correct. Confirmed by my accountant some time back as well…15-yrs depreciation on purchases. Sales can be either revenue or capital gains based on your business, length of hold, investment, and other factors.
So, agree…don’t argue about it, but take note of the disadvantage. And, before you just ship from the US to a tax haven, seek serious consultation as well. It is not as easy to be legally compliant as you may think. There are solutions, but I see magnitude being large before many gain.