Note: The following is a fairy tale that may especially interest those of you who haven't paid your payroll taxes in awhile!!
The Tax Prophet wishes to acknowledge the contribution of his assistant, poet and budding playright Shara Karasic, whose excellent writing made this story come alive.
While attending New York University, I delved into the mysteries of tax collection and the powers of the IRS. One day, a well-known professor of mine related to the class a famous legend told to all tax students. I henceforth share this amazing tale with you. --T.P.
In London, England, in the year 1580, during the reign of Elizabeth I, a Secret Society of London's most prestigious small business leaders would assemble once a week. They met in London's most gracious Inn, which overlooked the town's square, to discuss the affairs of the day. William Shakespeare, a man of letters, and Sir Walter Raleigh, a noble man, were among the regular participants. The room in which they met befitted nobility, with high ceilings and dark oak panels. A portrait of their beloved Queen hung on the wall.
Each week, an esteemed merchant would talk about his business. One day Simon, a man of ruddy cheeks and a merry air who sold magic carpets, stepped up to the podium. He had quite an astonishing series of events to relate!
Simon, a successful young businessman, was blessed with a lovely wife, two beautiful children and a charming cottage on the shore of a shimmering lake. He had everything going for him and was even prepared to become the president of the Secret Society, but - Simon had a deep, dark secret.
By mistake he had treated his magic carpet workers as independent contractors and so, had never fed the ferocious "Tax Dragon" its share of payroll taxes. If the Dragon ever found out, it would devour poor Simon, his family and all his possessions in just a few quick bites.
"Oh dear!" sighed Simon to himself. A fire crackled in his fireplace as he held his head in his hands. His elbows rested on his oak dining table.
"What do I do now? My family depends on me to put crusty loaves and goblets of wine right here!" With his fist he pounded the wooden table. It shook rather more than he expected from his medium-sized hand.
"Wait...what is that, thunder? Ooo-hhh, nooo-oo, it's the Dragon roaring!
"I meant feed that cursed beast, but things just spun out of control. Woe is me, who will save me now?"
Simon owed the equivalent of over $1.2 million in today's dollars.
Somewhere in the distance Simon could hear the Tax Dragon snorting in rage. Poor Simon shivered in his shirtsleeves, though the fire heated the room.
Crouching in its palatial, jewel-encrusted cave not all that far from Simon's cottage, the Tax Dragon raged. A miasma of hot air and noxious gas hung about its scaly head.
"I'm hungry!" It roared and whacked its tail against the gold-piece lined cave wall.
"Where are my vittles from all those delinquent taxpayers?" It licked its chops with its long, pointed tongue. A thin film of green slime coated its fangs. The Dragon stomped a clawed foot impatiently, sending a cloud of dust into the air.
"Heeh...heeh...where are my minions?" The Dragon lifted up his scaly head, as sparks flew out of his nose.
In a moment came a timid knocking on the jeweled cave entrance.
"YES?" roared the hungry Dragon.
"It is we, Inland Revenue, at your service, master," chorused a bevy of timid voices from behind the cave's door.
"Come in, hurry up, you fools," gruffed the Dragon. The door creaked open. In tiptoed five identically-dressed men in velvet suits and pointed boots, with frizzy hair and an obsequious air.
"We are ready for anything, master," offered one IR man in a nasal voice. He briefly brushed with his hand the scabbard attached to his waist. From it hung a sharp, gleaming sword. "Art there delinquent taxpayers, milord?"
"Yes, Lackey, you sop!...I haven't yet received all of my taxes and I'm ravenous-" here the Dragon licked his chops again, releasing a rank odor across the room. "Comb the land for all who haven't fed me!"
Simon packed a rucksack with a chunk of cheese, a loaf of bread, and a hunk of dried beef. He looked slowly around his dining room. As if he had suddenly thought of something, he glanced around. His eyes came to rest on his sword collection, leaning against the wall in the far corner. He took the biggest one and lay it on the table.
"For my dear one..." he whispered to himself.
He grabbed a smaller knife for himself and put it in his belt. He doffed a wool coat, flung his bag over his shoulder, and trudged toward his front door. As he turned the iron doorknob, his fair lady walked in the room.
"Why, Simon, where art thou going?" questioned the fair woman.
Simon turned. He gazed intently into the familiar face of his long-beloved wife. "My dearest..." he whispered.
"What is it, Simon?" she pleaded.
Simon took her smooth hand in his. He looked into her big doe-eyes. "My dear, I must go. The Tax Dragon wants to send the IR after me. I must seek protection. I have heard that somewhere may be ones with good magic. Here, take this to guard yourself and the children." He handed her his prize sword.
"This has protected my forefathers for generations, and it shall protect you now."
"Don't go, Simon!" she cried.
"It's our only chance, my love; our only chance." And with that Simon slipped out the door.
Simon searched far and wide, over hill and dale, in alleys and boulevards, near rivers and forests. Everyone he came upon he asked if they knew of help against the Tax Dragon. People would instantly pity him at the very mention of that creature, and widen their eyes and shrug their shoulders.
"Aaah...the Tax Dragon is very powerful!" they would say. "There's not much you can do!"
And with that they'd offer him a swig of rum, perhaps, or an apple, and purse their lips in concern.
"Oh dear," sighed Simon, throwing up his hands by the side of the road. "What am I going to do?"
"About what?" came an old woman's voice. Simon turned. A bent-over crone with a wrinkled, cheery face grinned toothlessly at him.
"The Tax Dragon's after me, my magic carpet business, and my beloved family!" moaned Simon. "I'm in despair!"
"Now there, there, my lad," countered the woman. "You know, I have heard of a wizard who may be able to help you."
Simon raised his head. "A wizard? Where could I find him?"
"Take this path through the forest." She pointed a long, crooked finger. "Go up the hill and way up near the very top there's an ivory tower. Ask there for the Wizard."
After a long trudge up the hill, Simon finally came to the tower. He set down his rucksack and looked up to the ivory turret penetrating the clouds. A tall, arched doorway stood at the top of five stone steps. Our friend tiptoed up, and with great anticipation, tapped on the carved door with a huge iron knocker.
"Come in, please," boomed a wise, gentle voice.
Simon pushed open the heavy door. With a sweep of his flowing robe, the Wizard ushered Simon in. What a sight he was: a tall, commanding figure with flowing white hair and beard, intense twinkling eyes, long gentle hands and a kind turn to the lips.
The Wizard was pleased to see Simon. He winked to him.
"What can I do for you?"
"Can you save me from the Tax Dragon, milord?"
"Have no fear, Simon, my lad," said the Wizard. "I will help you. My life's work is reading and divining the strange codes that govern the Inland Revenue's ability to extract vittles for the Tax Dragon from the citizens of England."
Then Simon revealed his terrible secret. The Wizard told Simon, "Don't fret, my lad, many of the small business owners in London get themselves in trouble with the Inland Revenue every once in a while."
The Wizard leafed through a thick, ancient tome. Clouds of dust puffed into the air.
"Simon, while your company is responsible for the full amount of the tax, plus interest and penalties, you are only personally responsible for the "trust fund" portion of the taxes -- 1/2 the Social Security taxes and the full amount of payroll withholding."
"I'm only responsible for the trust fund portion, Wizard?" Simon raised his fuzzy eyebrows.
"Yes, Simon. The magic that can douse the Tax Dragon's fiery breath is to pay off the portion of taxes that you are personally responsible for, my lad, and then make a deal with the Inland Revenue on the rest of the taxes, penalties, and interest. In your case, out of the $1,200,000 owed, your personal share is about $500,000.
"Simon, you must understand, it is all a matter of leverage. If you can pay off the portion of taxes you owe personally, then the Inland Revenue can never collect the balance from you. Your assets and future earnings will be forever protected from the Tax Dragon."
Simon's face began to glow, and his mouth slowly curved into a grin.
The Wizard continued, "However, if the Inland Revenue discovers your secret and seizes your business before you have a chance to pay the trust fund portion of the taxes, you might never discharge your tax liability without full payment and the Tax Dragon will have its way with you forever!"
The color drained out of his face as Simon cringed.
"To keep the Dragon at bay, Simon, you must form an employment company to hire your employees since it is crucial that no further payroll liabilities be incurred -- you must be current with your payroll tax liabilities.
"The employment company will serve to process the payroll and then "lease" the employees back to your magic carpet company. That way, Simon, the IR will not discover your carpet company's tax liability!" The Wizard nodded in triumph.
Fortunately, Simon had been collecting the money for withholding taxes, but had not yet paid it over to the Inland Revenue. He already had about $300,000 saved, yet he still needed another $200,000.
Simon decided that he would sell his cottage in order to raise the balance of the funds needed. He contacted Mr. Heisy, another member of the Secret Society, who was adept at selling gentlemen's homes for the very highest price.
Well, Mr. Heisy helped Simon sell his abode for a rather good price and in December of 1580, Simon had all the funds necessary to pay his portion of the taxes owed.
Simon then notified the Wizard, who thenceforth sent a separate payment to the Inland Revenue for each quarter of taxes that was owed, with precise instructions on how to apply the payments.
"Simon," said the Wizard, beaming, "although the Inland Revenue has now learned of your secret, you and your family are safe from the noisome jaws of the Tax Dragon!"
Simon grinned widely.
It was now time to rescue Simon's business from the clutches of that fearsome creature.
In February, 1581, an Inland Revenue messenger unfurled a scroll and tooted a trumpet to send notice of delinquent taxes regarding Simon's magic carpet company. Another $780,000 was still owed. At that point Simon again met with the Wizard to discuss what to do.
The Wizard tugged on his long white beard and told Simon:
"You could file for bankruptcy, but that would take years to resolve.
"Or, you could submit an Offer in Compromise to the IR for the balance, but it might take them a year to decide whether to accept it."
Simon replied, throwing his hands in the air, "I'm in a hurry, Wizard; can't you think of a quicker solution?"
"Hmmm..." responded the Wizard. He rested his chin in his hand. "Let me consult my codes, umm...there does not appear to be a solution...wait, it has come to me! It's diabolical and risky, but it might just work!"
"What pray tell, what?" implored Simon.
"Simon, since the IR is all-powerful and has all the rules, and the Dragon, on their side, why not use their own rules against them?"
"What?" Simon said. "How is that possible?"
And the Wizard laid out his plan. "We will let the IR seize your business. But then you'll tell them you will buy it back at auction.
"And then we'll tell them that we will pay twice as much as the price that they would get at auction, if they let you continue to operate the business after their seizure through the date of the sale."
The Wizard clasped together his slender hands and beamed in triumph.
Simon was skeptical. "Why would the IR go for such a deal?"
"Because, Simon, they will collect much more money if the business is sold as a whole, rather than divided up into assets and sold at auction piecemeal.
"And since the IR cannot collect from you personally, the sale of the business is the IR's last chance to collect the revenue owed!"
Simon then understood what the Wizard meant when he talked about leverage and why it was so important to have paid the personal portion of the taxes owed first.
"Well, then, Wizard," asked Simon, "how should I go about reacquiring my business?"
The Wizard responded: "The financing company we formed should acquire the business assets since it is considered a separate, independent company."
And with that the Wizard threw back his bearded head and let out a laugh.
The Wizard and Simon then discussed how to present their plan to the IR.
The Wizard explained, "Simon, the negotiation with the IR is about value, and value is a very elusive concept. What you, Simon, think the business is worth is much higher than any other third party, including the IR, will think it is worth."
On March 4, 1581, the Wizard and Simon met with Mr. Lackey of the IR with his sharp nose and his velvet suit, at Speaker's Corner in Hyde Park.
The Wizard told Mr. Lackey, "What Simon was buying was not what you are selling. Simon needs the business intact and the "goodwill" preserved."
Mr. Lackey pursued his shiny lips and looked thoughtful.
"Once you seize the business, Lackey, er...um, MR. Lackey, you need to let Simon continue to run it as a custodian of the IR, until the auction date, to preserve the value of the business."
Mr. Lackey responded, "I see your point about allowing the business to operate, but I cannot allow Simon to act as custodian; it would not look proper and his creditors might complain."
Mr. Lackey frowned. "But, if Simon could find a neutral custodian to operate the business, I would agree to seize it, though let it continue in operation until the sale."
Simon and the Wizard felt joy surge through their bodies.
Simon found a friend who would act as custodian. The custodian's work was merely to open and close the business, and account for all sales that occurred from the date of seizure until the date of sale.
Simon was delighted. He could continue to operate his business and the custodian would pose no practical problems.
March 10, 1581 rolled around, and the business was seized. There were no padlocks on the door and no notices posted on the business. An advertisement in the local paper announcing the sale was made in the back pages, but that was all the publicity that was generated about the seizure.
Simon had to quickly arrange the financing necessary to buy back his business. He spoke with his friend, Mr. Battletank, another member of the Secret Society, who managed apartment buildings around London. Mr. Battletank was a jovial man with a gift for gab. He agreed to loan Simon some of the money and the documents were prepared.
The IR set the minimum bid price at $155,000.
Simon couldn't believe it. "You mean that even though actual value of my carpet and receivables is $650,000, I can buy my entire business back for only $150,000! I can make $500,000 on this deal, which is the amount which I originally paid towards my personal tax liability!"
The Wizard smiled wisely and said, "That's not all, Simon. What's more, over $400,000 in trade debt will be discharged, for since the IR has seized the assets, those trade creditors will not be paid."
Auction day came and Simon's knees were knocking. His teeth chattered a bit. What was going to happen to his magic carpet business?
He and the Wizard met Mr. Lackey in the town square where the auction was to take place, but no one else was in attendance, except a certain beast waiting under a far clump of trees. It was a quiet day, except for the steady growling of the Tax Dragon's stomach.
Mr. Lackey looked towards Simon. "Hear ye, hear ye! Whereas you, Simon, are the only bidder and you have bid the minimum price of $155,000, I hereby sell the entire carpet business back to you!"
Mr. Lackey then took the money and fed the waiting Tax Dragon. The Dragon voraciously gulped down the final payment and waddled satiated back to his lair, knowing it could never bother Simon again.
Simon was ecstatic. "Holy Moly! I've just repurchased my business for $155,000 although it was worth at least $650,000 to me, and in addition, discharged $780,000 of IR taxes, penalties and interest, and another $400,000 in trade debt."
The $500,000 in potential profit would offset his original payment of $510,000 to the IR; therefore, Simon had discharged over $1,700,000 in debt and cleared himself with the IR, without it costing him much, if anything!
But what about Mr. Lackey and the IR? Well the actual tax bill came to about $670,000, excluding penalties and interest, and it collected $665,000, practically all the taxes owed. It received the highest price possible under the circumstances, because Mr. Lackey cooperated with Simon.
Simon quickly paid back Mr. Battletank his loan, and, eventually, Mr. Heisy found Simon another beautiful home near the Tower of London.
Simon held a big party and invited all his friends. His lovely wife and two plump children, decked out in fine laces, merrily hosted the guests. The wooden tables creaked under baskets of fruits, sides of venison, and slabs of French cheeses. Simon, up in the front of the room, raised a goblet of wine into the air and shouted, "I hereby thank the good Wizard for his magic!"
The Wizard smiled, as the crowd burst out in applause. Then he took Simon aside and quietly told him, "Simon, my lad, my magic only works once for each taxpayer. I hope you learned from this experience and will never tempt the Tax Dragon again..."
Simon promised the Wizard he would always feed the Tax Dragon on time.
Then Simon said, "I realize now I should have consulted with you at the first sign of trouble, rather than allowing my problem to explode out of control!"
Simon's eyes widened. "But what happened, Wizard, how was this result possible; I thought I was ruined?"
The Wizard responded, "Our plan worked, Simon, because you gained leverage over the Tax Dragon by paying the trust fund portion of the taxes owed, you see.
"Also, the issue of value played a critical role since we were able to value the company for IR sales purposes at about 25% of its value to you.
"Finally, because you voluntarily paid $510,000 in past due taxes, you were current with your payroll taxes and even sold your home to pay the taxes, Mr. Lackey looked favorably at your request to keep the business operating under the seizure period."
And what happened to the employment company? Well, since none of Simon's workers had made any worker's compensation claims, its experience modification for workers' compensation dropped to below 100, a very good rating.
In the succeeding months, the Wizard and Simon turned that company into a successful employee leasing company which generated over $1M a year in revenues. And even some of the members of the Secret Society prospered by using Simon's employment company!
With that Simon ended his story. He looked up and saw the amazed faces on the members of the Secret Society. They began applauding wildly.
Shakespeare leaped to his feet and slapped Simon on the back. Sir Walter Raleigh then stood up and shouted, "Willie, knock it off, I've got something important to say."
Raleigh told the group that when he had laid his so-called cape across a puddle for the Queen, it had not really been a cape, but, in fact, one of Simon's carpets!
The stunned audience looked up at the painting hanging on the wall and, sure enough, it was one of Simon's carpets that Sir Walter Raleigh had laid across the puddle.
The members now understood the magic of Simon's carpets: good fortune came to those who purchased them.
When my tax professor finished telling his story, one of the students asked what ever happened to the Wizard. The tax professor smiled and told the class that the Wizard's spirit lives within the hearts of young tax lawyers everywhere, and even suffuses the World Wide Web on the Internet --- and with that - class was over. --T.P.
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