Is your MBA tax deductible?

A recent article (PDF) in the Georgetown Law Journal explores the ambiguity surrounding deductibility of expenses associated with a MBA program. Generally, educational expenses which qualify the taxpayer for a new occupation are not deductible, but normal and ordinary expenses in your line of business are deductible. There is some interesting examination of the regulations and court cases where this issue has been challenged, and the author concludes:

Although the line of Tax Court cases considering the deductibility of MBA related tuition expenses may at first appear to be a confusing and winding maze of inconsistency, more careful inspection reveals that—in most cases—the courts probably got it right. For the most part, MBA students at elite schools who attempted to take enormous tax deductions for career-transforming educational experiences were turned away, whereas those toiling away in an effort to improve their established business skills while continuing to work full-time were permitted to take their deductions. In short, at the end of the day it appears as if the courts generally muddled through the cluttered, outdated mess that is Treasury Regulation § 1.162-5 and came out with the right answers.

Samsung TV USB Media Player: Tips and Troubleshooting

I recently bought a Samsung LCD HDTV LN52B630 and it's a great TV (fortunately I paid a lot less than what Amazon is selling it for). One of the best features of Samsung's LCD and Plasma TVs is the ability to play video files directly from a USB memory stick or hard drive. This feature is alternately referred to as USB Movie 2.0 or Wiselink. Sure, you could buy a TV without this and then add on something like WDTV or Roku but that's an added expense and one more remote to clutter things up. Samsung has done a great job of integrating the media player into the TV. However, the manual doesn't explain everything as clearly as it could, so I've written down some of the problems and solutions I've encountered.

The TV supports a variety of video file formats, such as AVI, MP4, MKV, and VOB. These are really just "containers" for audio and video information, so just because you have one of these files there's no guarantee that the TV will play it. Within the container, the audio and video is stored using a codec. Common video codecs are Divx, Xvid, and MPEG4. Common audio codecs are AC3, MP3, and DTS. You can use software like VLC to tell what codecs were used to create a particular file.

Not supported audio codec

MKV has become popular with high definition material (720p, 1080p). However, the most common problem when you try to play an MKV file is that the video works but the error message comes up: "Not supported audio codec" and there is no sound. Most of the time, this is because the audio was encoded with Digital Theater System (DTS) which the TV doesn't support (Samsung didn't want to pay the license fee). You can easily fix this by reencoding the file to Dolby Digital (AC3) using PopCorn Audio Converter.

Dialog is not in English

MKV files often contain more than one audio track. However, the TV has no way to select between the tracks, so if the default audio track is not the one you want, you can't change it while you're watching. First, open the file with VLC to make sure there is an English language track in the file. Then, open the file in MKVmergeGUI (part of MKVtoolnix) which will allow you to select exactly which audio track you want, and create (aka "remux") a new file that has only that audio track.

It is possible that a file could have both problems - DTS audio and a primary non-English track. In that case, first remux a new MKV using mkvmerge with only the audio track you want. Then, run it through the DTS to AC3 conversion.

The TV won't display subtitles

Just as an MKV file can contain more than one audio stream, it may also contain subtitles, however the TV doesn't support this subtitle format. First, extract the subtitles from the file using MKVExtractGUI. Then, run the output through Subtitle Workshop to convert to SRT format which the TV supports. Make sure you name your new SRT file exactly the same as your MKV file (except for the file name extension, which will obviously be different: .SRT versus .MKV) and put it in the same directory as the video file. Then, you can activate the captions using the CC button on the TV's remote control.

Archiving your DVDs to a hard drive

With 1TB hard drives available for under $100 now, you might want to backup your DVD collection. This would allow you to play any of your movies off the hard drive without having to search for the discs. However, if you try to just copy the files off your DVD and play them on the TV, you probably won't get what you're expecting, even though the TV supports VOB files. The file may not play at all, or the video will start and end in weird places. This is because the DVD menu also contains instructions on where the video should start and stop, but the TV doesn't know how to read that data. The solution is to use DVDShrink to remaster the DVD and extract just the video you want. This will work for both a movie that is one big file as well as a DVD with TV shows on it, where you want a separate output file for each episode. Put the DVD in the computer and start DVDShrink. Select the Re-Author function and then select the various video tracks that you want to extract. Select Backup to copy those files to your hard drive. Now you can open each of those VOBs will be a self-contained video file that the TV can recognize.

Puerto Rico: Day 5

Friday morning we headed over to the Bacardi tour, though it had some history of the distillery, you don't actually get to go inside the factory itself. Then, back to the airport and a short flight home. Overall we enjoyed Puerto Rico, but our agenda was too hectic - we should've things down a bit. While we expected Vieques to be undeveloped, the roosters are a real problem - I expect that I can sleep in on my vacation, but there's just no getting away from the noise pollution. Personally, I believe the added time and expense to get to Hawaii is worth it compared to Puerto Rico.

Puerto Rico: Day 4

Thursday we left Vieques (and the roosters) and picked up our rental car in Fajardo (which was no worse for wear). An hour drive to us back to San Juan, where we checked in to the Andalucia Guest House which was a great place to stay. The owners were very friendly and pointed out some good places to eat nearby. Even back on the main island, I was reminded of the fact that everyone operates on "island time" when it took 20 minutes to get two cups of coffee at the nearby McDonald's (two days in a row, and it wasn't very busy).

We drove into Old San Juan and took a tour of Fort San Felipe del Morro. Old San Juan is a nice place to visit but very touristy. One fun attraction was the Don Q rum tasting room near the cruise ship terminal. Who doesn't like free samples of rum? Dinner at Pal Cielo was excellent...a funky little place that we wouldn't have otherwise found except for our host's recommendation. Great ceviche.

Puerto Rico: Day 3

On Wednesday we woke up early thanks to the thousands of stray roosters that wander the island. Unfortunately these roosters make it difficult to regard Vieques as a relaxing place to unwind as they are constantly crowing, starting early in the morning and continuing on throughout the day. We drove over to green beach, which is located in the abandoned navy base. The road there was quite rugged and parts of it were closed for repairs, making the beach deserted. It's a really nice beach, only downside was horrendous noseeums that would eat you alive if you didn't wear plenty of Off. Wednesday night we did a tour of the bioluminescent bay with Island Adventures. Difficult to photograph the effect of millions of dinoflagellates, but highly recommended if you're going to be in Vieques on a night with low moonlight.

Puerto Rico: Day 2

I wouldn't say that I had the best rest ever at Casa Cubuy, given the rubber sheets on the bed and the chirping of millions of coqui frogs. Fortunately breakfast at sunrise looking out over the rainforest made up for it. Afterwards, we took a 10 minute hike down to the river in the valley. The water was pretty churned up because of the recent rainfall. Nothing against Casa Cubuy but it is fairly rustic as a result of its location, and if I could do it again I would've made the rainforest into a day trip rather than staying overnight.

Leaving the hotel, we drove to Fajardo to catch the afternoon ferry to Vieques. We didn't have any trouble getting a seat, and for $2 it's a lot cheaper than flying. We left our rental car at the ferry terminal and hoped it would still be in once piece upon our return. Martinque Car Rental picked us up at the ferry and took us to their office, where we rented a Jeep Wrangler that had definitely seen better days. Surprisingly, we had a hard time reserving a car, most of the places were booked up several weeks in advance. It was a short drive to the Esperanza Inn. Our room was a nicely furnished apartment that had air conditioning (thank goodness) and a television. The owners were very friendly and gave us a hand when we had trouble starting our rental car. We spent the rest of the evening walking along the Esperanza beach plaza.

Puerto Rico: Day 1

We flew in to San Juan and hopped in a rental car for the drive into El Yunque National Forest. Our hotel, Casa Cubuy, had no official address - it's just 26 kilometers up the road. Note that if you are coming in from the airport, you can't reach the hotel by driving into the park from the north, you have to go all the way around and use the south entrance because the road through the park has washed away. The drive there took a couple of hours, partly owing to rush hour traffic and the rain that slowed the ascent up the windy mountains roads. Dinner at the hotel was okay but a bit overpriced for somewhat generic chicken and pasta. The views from the hotel were spectacular but the rooms were a bit more rustic than I was expecting. Running water, but no air conditioning. Up on the mountain, it wasn't that hot, but the humidity was a killer. It did cool off a bit after the sun went down.

The Sovereign Ceiling

Let's say you're a well run company with a low debt to capital ratio and a high interest coverage ratio. Your bondholders sleep soundly at night, knowing that their principal and interest is coming back to them. However, you happen to be located in a country that is not known for its fiscal conservatism, such as Argentina. If your home country is only rated BBB by S&P/Moody's, what's the best rating your company can hope for?

The sovereign ceiling says that the private sector should not be able to borrow on better terms than the government, since the government has the most senior claims on the firm's earnings (priority ahead of both debt and equity). If the government runs into economic trouble, it may be more likely to expropriate assets. Additionally, the government's problems may reflect broader economic issues that will also impact the firm. Therefore, lenders should not offer better terms to a private company than they would to its host country. The country's credit rating is a cap on all firms' credit ratings.

A graphical representation of the federal budget

April 15 has come and gone, but that's no reason not to look at where all those tax dollars go (and all those Treasuries we sell). WallStats has created an image that does exactly that. Click on the image below to expand (it's quite large), or use the previous link for an interactive graphic.

The foreign profits tax "loophole"

Since it is April 15...Much political hay has been made about the supposed "loophole" that allows companies to defer US taxation on profits earned overseas until those profits are repatriated. Is this really a loophole, or is it simply consistent with how most profits on investments are treated? Consider the following.

Scenario 1: You're an individual investor and who buys a share of stock in Toyota in January for $100. Over the course of the year, the company earns $5/share in pre-tax profit. They pay corporate taxes of 20% on their earnings, so your share of the after-tax profit is $4. The local government collects $1/share in tax revenue. The company pays no dividend and reinvests those $4 profits into developing new products, hiring workers, expanding factories, etc. At the end of the year, your share is now worth $104. You haven't sold your share, so your profits are unrealized, and the tax you owe is $0, because although your investment is worth more on paper, you haven't actually received any cash. You have deferred your tax burden until you either sell the shares or receive a dividend.

Scenario 2: You're a corporation who buys a small company that owns several companies in Estonia for $100 million. Over the course of the year, the subsidiary earns $5 million in pre-tax profit. They pay corporate taxes of 20% on their earnings, so your share of the after-tax profit is $4 million. The local government collects $1 million in tax revenue. The company pays no dividend back to the US and reinvests the $4 million profit into developing new products, hiring workers, expanding factories, etc. At the end of the year, your investment is now worth $104 million. Your company in the US hasn't received any cash or profits and under the current system you wouldn't owe any additional tax on top of what the subsidiary already paid the local government.

However, if the tax laws were changed to make foreign income taxable, you would have to immediately pay US taxes on the entire $5 million, even though the parent corporation never received any cash from the foreign subsidiary - all the cash and profits were either paid in the first round of local taxation or reinvested in growing the company.

This is a highly simplified example. Obviously there is a distinction between normal foreign earned profits and truly abusive tax shelters in some countries that should be eliminated. But this example shows that foreign earned profits are not much different than profits earned on other similar investments. So is it equitable to treat them differently? Investors who have a 401k or IRA also take advantage of tax deferral - is that a "loophole"?

This paper talks about the impact of collateral levels on the economy, not just interest rates. I particularly like this quote:

"Over 400 years ago Shakespeare explained that to take out a loan one had to negotiate both the interest rate and the collateral level. It is clear which of the two Shakespeare thought was the more important. Who can remember the interest rate Shylock charged Antonio? But everybody remembers the pound of flesh that Shylock and Antonio agreed on as collateral. The upshot of the play, moreover, is that the regulatory authority (the court) decides that the collateral level Shylock and Antonio agreed upon was socially suboptimal, and the court decrees a different collateral level. The Fed too should sometimes decree different collateral levels."

Risk Management

Bling & your computer's input devices

If you've been watching late night TV commercials, or the afternoon fare on CNBC, you're probably convinced that this is the right time to invest in gold. Inflation is bound to return at some point. But how do you advertise your goldbug proclivities to friends and coworkers without actually spending $900/oz? The gold bullion wireless mouse is just what you need. It contains no actual gold, and can be purchased for around $35.

Divergence: Job losses and time to recovery

From a WSJ article on the job market. The interesting thing is at the bottom of the chart - the divergence between the percentage of jobs lost from peak to trough versus the number of months it took to recover post-recession. Until the most recent downturn, there is a clear trend of job losses becoming less and less severe (the great moderation?), going from 7.9% to 1.2%. In spite of this, the time to recovery shows the opposite trend, increasing from 18 months to 48 months.

Cap-and-trade market structure, lessons from the past

From an article in the JACF on Designing a US Market for CO2. Most interesting are the lessons learned from the US SO2 (sulphur dioxide)market, a successful cap-and-trade system that began in 1995. How did the market's design and structure affect trading and contribute to the massive price spike in 2005-2006 (see graph below)? Prices increased from $220/ton to over $1600/ton before declining back to $200/ton. One explanation points to a change in the EPA's regulations in 2005 (CAIR) that put a tighter cap on emissions starting in 2010 and tightening more through 2015. Since emissions credits can be banked, expectations of increased demand in the future should be reflected in the current price. However, this regulation was only supposed to increase the cost to ~$600/ton, and while it might explain the spike it cannot explain the subsequent drop. A second explanation relies upon a shortage of low-sulphur coal due to railroad outages. This shortage increased demand for allowances and correspondingly, the price. While the shortage might have increased demand in the short-run, credits were available that could have been drawn upon to reach a slightly higher price equilibrium rather than a massive spike. So why didn't anyone step in and sell their credits at a massive profit? The answer lies in the restricted float - a low number of credits available for trade - which is due to the way the market was designed.


First, the credits were initially distributed to natural shorts (e.g. a power plant that produces SO2) that expected to use them at some point in the future. Except for relative emissions reductions (a plant installs a better scrubber and thus needs fewer credits), most of the market participants will stay long the credits to offset their natural short exposure. Thus, incentives to trade are reduced and the market is less liquid. Lower liquidity means that small changes in supply or demand can have a magnified effect on price.

Second, the credits were distributed for free, and were held on the firms' balance sheet at zero tax basis. When a credit is redeemed, the increased value is recognized as a gain, but offset by the increased environmental liability from generating the SO2, so it's a wash for tax purposes. If a firm believed the price spike was temporary, it could sell some of its banked credits while prices were high, then buy them back once the market returned to normal, netting a profit. But this action creates a taxable gain today, while the liability is still off in the future. The potential gains from this arbitrage must be weighed against the acceleration of the tax liability.

Third, many of the firms with credits are publicly regulated utilities. If the firm were to profit from selling credits high and buying them back low, regulators might force the firm to pass the profits along to customers (rather than letting shareholders and management keep them). On the other hand, if the arbitrage failed and the firm lost money, regulators might view this as speculation and punish management for being imprudent.

Thus, the owners of SO2 credits failed to create a viable market for them. Note that financial intermediaries, such as the much maligned short sellers and speculators, could help provide liquidity to a market like this and thereby enable more efficient price discovery, reducing the risk of disruptive price spikes.

Law and Economics: The Bimodal Distribution of Lawyers' Salaries

A New York Times op-ed recently reminded me of the graph below, showing the bimodal distribution of lawyers' salaries: public service on the left, private law firms on the right. Time for more two year law schools? Lower biglaw salaries? People don't think of law firms as highly leveraged institutions but while they don't usually have much debt, they do have operational leverage from the partner-associate structure. Each associate is a fixed cost that has to be paid (debt) before the partner gets his earnings (equity). So a firm with 1:1 partner:associate ratio is about 50% leveraged. Of course, associates can be laid off during bad times, while debt is defaulted on.

Cross-listed Shares and the Bonding Hypothesis

A foreign company can issue shares on the US equity markets, if it agrees to comply with the US regulatory regime. The bonding hypothesis says that this improves corporate governance by forcing the firm to respect minority shareholder rights and increasing the amount of information that's disclosed about the firm. Thus, a company from a country with low investor protections can "bond" itself with the US, where investor protections are high. In turn, this could lower the firm's cost of capital and allow it greater access to capital markets. However, some challenge the bonding hypothesis because enforcement actions by the SEC against cross-listed firms are rare.

Encyclopedias and the Pace of Change

Last week, Microsoft announced that they are shutting down Encarta, the digital encyclopedia that was originally released on CD-ROM. A brief history:

• 1778-1993 (215 years): Encyclopædia Britannica rules the day
• 1993-2009 (16 years) Microsoft's Encata quickly takes over
• 2009-?: Volunteer-edited Wikipedia ascends to the throne

The question is, how long will Wikipedia reign? If the average lifespan of encyclopedia technology continues to shrink at the speed implied above, a challenger may already exist. Ironically, Microsoft helped force Britannica's capitulation by giving away free copies (excuse me, "bundling") of Encarta when you bought a new computer with the Windows operating system. Wikipedia's product managed to undercut them on price while offering greater value and a lower cost of production.

Trop50: An Orange Juice Ripoff

Tropicana (a wholly-owned subsidiary of PepsiCo) recently released a new juice drink product called Trop50. The sales pitch: it has 50% fewer calories and 50% less sugar than regular orange juice. I'm all in favor of reduced calorie/sugar beverages, but do the economics of this make sense?

I spotted a container of Trop50 at the store and although it is the same shape and price as the regular Tropicana ($2.96), the Trop50 package is 8% smaller by volume (64 ounces versus 59 ounces). The problem compounds when you flip the carton around and notice the statement "contains 42% juice." The back panel reveals that the primary ingredient is water, followed by reconstituted orange juice, then some vitamins, and finally stevia (a non-sugar "natural" sweetener). So Trop50 expects you to pay an 8% premium for a product that contains 58% less juice (58% more watered-down) than regular OJ?

Here's a cheaper alternative: fill your glass halfway with regular orange juice, then add water until it's full (cost per 12 oz serving: $0.28). Or, buy Trop50 (12 oz for $0.60), and pay a 117% premium for the 30 seconds it will save you in the morning.

The MBA Job Market for the Class of 2009

As of mid-March, anecdotal evidence from three schools: Emory (Goizueta), SMU (Cox), and Georgetown (McDonough) indicates that about 40-50% of the full-time MBA students set to graduate in May have accepted job offers. The pace of hiring is well below last year. First-year students (the class of 2010) are having an even tougher time securing internships for the summer.

In what could be mistaken for a headline from The Onion, Harvard Business School is launching a case study to determine why their case studies didn't keep us out of our current mess.