Programming note: Money Stuff will be off tomorrow.

The way US tax law works is that businesses mostly can deduct their business expenses from their taxable income, but people mostly can’t deduct their personal expenses. So a company that has $100 of revenue and spends $80 on inputs will have $20 of taxable income, but a person who has a $100 paycheck and spends $80 on food and rent will have $100 of taxable income. There are various exceptions. A person who has a $100 paycheck and spends $80 on food and a mortgage will have less than $100 of taxable income, because the interest on the mortgage is at least partially tax deductible.

Sometimes the lines blur. In particular, many people run businesses, and many of those businesses are not corporations (which file their own tax returns and pay their own corporate income tax) but what are called “pass-through entities,” like partnerships, whose income belongs to their owners. A pass-through business doesn’t pay taxes; its owners just count their share of its income as their income on their tax returns. And of course they deduct its business expenses: Intuitively, if you own a business that has $100 of revenue and spends $80 on business expenses, only the $20 of net business income will be income on your tax return.

And so, if you run a business, you will have enormous incentives to classify expenses as business expenses (deductible) rather than personal expenses (not deductible). And there are various specific rules and gray areas about what you can and can’t count, and this is a much-discussed topic with lots of potential for cheating.

One expense of particular interest is state income taxes. If you are a person with a high-paying job in New York, you will pay perhaps 35% of your taxable income in federal income tax and roughly 10% in state income tax. [1] For every $100 in your paycheck, the Internal Revenue Service will get $35, New York will get $10 and you will get $55. The rules used to be somewhat different: You could deduct that $10 New York tax from your federal taxable income, so you would only have $90 of federal taxable income, you’d only pay $31.50 in federal tax, and you’d have $58.50 left over for yourself. But in 2017, Congress changed that, capping the state and local tax (SALT) deduction at $10,000, so high-income taxpayers in high-tax states now can’t fully deduct their state income taxes.

On the other hand, businesses in high-tax states can still deduct their state income taxes: Those are business expenses, of course they are deductible. [2] Or, at least, corporations in high-tax states can deduct their state income taxes. What about pass-through businesses? 

From first principles the rule is that, if the business pays the tax, as a business expense, it is deductible. Intuitively, if you own a business that has $100 of income and pays $10 of state taxes, only the $90 of net income is income on your federal tax return; if you own a business that has $100 of income and doesn’t pay state income taxes (because it passes through the income to you), and you pay $10 of state taxes on that income, the full $100 is income on your federal tax return. Historically pass-through businesses didn’t pay state income taxes, because they were pass-through businesses: For both federal and state tax purposes, they passed their income through to their owners, and the owners paid all the taxes on that income. But the 2017 federal tax changes created an incentive to find a way for those businesses to pay state income taxes themselves, so that they would remain deductible from their owners’ federal taxes.

And so a lot of high-tax states created some sort of pass-through entity tax that lets business owners pay their state taxes at the business level, so that they remain deductible from federal taxes. So if you are a person with a high-paying job in New York, you’ll pay $35 to the IRS and $10 to the state for every $100 in your paycheck. But if you are a person with a high-paying law firm partnership in New York, your partnership will pay $10 to the state, you’ll only get $90 of federal taxable income, and you’ll only pay $31.50 to the IRS. [3]

We talked about this back in 2022. As a person with a job, this has always struck me as mildly unfair (I don’t get unlimited state income tax deductions), but also aesthetically pleasing (I do enjoy tax structuring), so I don’t complain too much.

But of course if you are a law firm partner, you would much prefer to pay lower taxes (like other business owners) rather than higher taxes (like me). And Congress’s current efforts to revise tax laws involve taking away that advantage, but only for “‘specified service’ businesses, a category that can cover entertainment companies in Hollywood, pharmacists and physicians on Main Street, legal and financial firms on Wall Street and many other industries.” The law firms are mad. The Financial Times reports:

US accountants and lawyers are mounting a furious lobbying effort on Capitol Hill to head off a tax rise targeted at professional services firms, which is buried in Donald Trump’s “big, beautiful bill”. ...

The American Bar Association this week wrote to senators calling the measure “fundamentally unfair” for singling out professional services firms, which include doctors, dentists and veterinarians as well as lawyers, accountants and consultants.

The American Institute of Certified Public Accountants called the measure “ugly” and has co-ordinated local accounting groups from across 53 states and US territories to write to senators demanding the measure be dropped. …

The move would be “fundamentally unfair and further widen the tax parity gap between professional service businesses and other pass-through businesses and corporations”, ABA president Bill Bay wrote in a letter to Senate leaders this week.

“The vast majority of law firms in America are small pass-through businesses, as more than 75 per cent of practising lawyers in our nation work as solo practitioners or in small law firms . . . These professional service businesses provide just as many benefits to the economy and society at large as other pass-throughs and corporations.”

Right I mean the fairness issue here is that right now I pay higher taxes, and law firm partners and car dealership owners pay lower taxes, and the bill would tax the law firm partners like me rather than like the car dealers, and they’d prefer to be taxed like the car dealers. I understand their preference! 

I tell you what, if Meta Platforms Inc. paid me a $100 million signing bonus to come work for their artificial intelligence business, I would be the most dedicated worker they have ever seen until the check cleared! After that something different would happen! I would get even better! Ha ha ha! Mark, call me!

This is a well-known problem in the financial industry, where top performers are paid large discretionary annual bonuses. You want to pay your people enough that they don’t leave for a more lucrative offer elsewhere, but not so much that they never need to work again. The financial industry has developed sophisticated tools to address this problem, tools like “your office rival has a house closer to the beach in Amagansett so you have to keep working to outdo her.” The main financial centers offer an enormous array of arbitrarily priced positional goods, and the apprenticeship model of finance teaches people to value them, so by the time you are making $20 million a year you will find it perfectly reasonable to think “man if I made $30 million a year life would be good.”

Meanwhile artificial intelligence has gone from being a quirky academic quest to a gigantic lucrative business in virtually no time (OpenAI was founded as a nonprofit in 2016), and the competition for hiring AI researchers has gotten so intense that as far as I can tell the going rate for a top AI researcher is “enough money that you can retire immediately.” Also the AI researchers are all like 20 minutes out of PhD programs and haven’t had time to learn which Hamptons are déclassé. The gap between “enough money to be competitive” and “enough that they never need to work again” has been completely erased. From the outside that seems to make hiring and compensation very hard. 

I suppose I am exaggerating but not by that much! Here’s Sam Altman:

OpenAI Chief Executive Officer Sam Altman said Meta Platforms Inc. has offered his employees signing bonuses as high as $100 million, with even larger annual compensation packages, as it seeks to build a top artificial intelligence team.

“It is crazy,” Altman said on the podcast Uncapped, which is hosted by his brother. While Meta has sought to hire “a lot of people” at OpenAI, “so far none of our best people have decided to take them up on that,” Altman added. …

He had a theory for why people are turning down the offers. “There’s many things I respect about Meta as a company, but I don’t think they’re a company that’s great at innovation,” he said, noting the cultural risks of creating jobs that could become more about the money than the work. “I think we understand a lot of things they don’t.”

The cultural risks of creating jobs that could become more about the money than the work! One of those risks is surely that with enough money you don’t need to work.

A US dollar is, in most cases, an electronic entry on the ledger of a US bank. [4]  If you want to hold dollars, you will have to go to a bank and open an account. If you walk into the bank and say “hi I am interested in depositing the proceeds of my narcotics sales to fund terrorism,” or “hi I am Jeffrey Epstein,” the bank will refuse to open an account for you. The bank in fact has some affirmative “know-your-customer” (KYC) obligations to ask you questions like “are you a terrorist” and “are you Jeffrey Epstein” before opening your account.

Let’s say you get through that process and open an account, and then you want to send dollars to me. You have various ways to do that: check, ACH transfer, wire transfer, Zelle, debit card, etc. Most of these methods require that I also have account at a bank: not necessarily at your bank, but at some bank that also does KYC and makes sure that I am not a terrorist or a drug dealer or Iranian or Jeffrey Epstein. The point is that US dollars are electronic entries on the ledgers of banks, so if you want to send dollars to me, that means you want to increase the number in my entry on the ledger of a bank. For that to happen, I need to have an entry on the ledger of some bank.

There is one very important exception, which is that if you have a bank account and you want to send me dollars, you can go to an ATM, take out some $20 bills, and hand them to me. I do not need a bank account in this scenario: Paper currency is an exceptional form of US dollars, a form that is not an electronic entry on the ledger of a US bank. I can just take the $20 bills and put them in my pocket, even if I am a drug dealer. Later I can buy a sandwich with the $20 bills, and the sandwich shop probably will not ask any questions to make sure that I am not a drug dealer. There are limits to this, though. It would be hard for me to buy a house with $20 bills, both for practical reasons (that’s a lot of $20 bills) and for regulatory reasons (a real estate agent, seeing that pile of cash, probably would ask questions to make sure I am not a drug dealer). And so in fact there is an enormous illicit industry of “money laundering,” which means roughly “finding ways to turn a drug dealer’s pile of $20 bills into deposits at regulated US banks.” 

A US dollar stablecoin is an electronic entry on a distributed ledger, a crypto blockchain like Ethereum or Solana. [5]  If you want to hold stablecoins, you can go to a stablecoin issuer, open an account, wire in some dollars and get back the same number of stablecoins. The stablecoin issuer will ask you the standard know-your-customer questions before doing that transaction with you. (I am oversimplifying: For most normal people, what you would do is go to a crypto exchange, open an account, answer the KYC questions and buy stablecoins on the exchange. The stablecoin issuer will mostly deal with exchanges and other institutions, and effectively outsource the KYC to them. [6] )

And then you will have some stablecoins. And then you might want to send them to me. You can — really this is the point of crypto — you can just do that. You can hold the stablecoins directly in a digital wallet on the blockchain. [7] You can send them to me, on the blockchain. The blockchain — the distributed permissionless ledger of transactions — will record that transaction; it will record that now I own the stablecoins. I do not need to have an account with a bank, or a stablecoin issuer, or a crypto exchange. The stablecoins are an entry on the distributed digital ledger; I don’t need anyone’s permission to open an account there. 

What if I am a terrorist, or a drug dealer, or Iranian, or Jeffrey Epstein? Well, I have stablecoins now; I have digital entries representing dollars on a distributed ledger. What can I do with them? Possibly less than I could do with cash: It is somewhat harder to buy a sandwich with Tether than with $20 bills. If I want to use the stablecoins to buy real estate or stocks, I will probably have to come back into the regulated financial system; even if I want to use them to buy Bitcoin I might want to open an account at a regulated crypto exchange and go through KYC checks. On the other hand the stablecoins do have some advantages over cash. They are easier to move electronically, for one thing; for certain high-dollar transactions they might be more convenient than sacks of cash.

There is something a bit odd about this situation. The stablecoin is, in some sense, an electronic entry on the distributed ledger, the blockchain. But in another sense it is an obligation of the stablecoin issuer, an entry on the ledger of the issuer. A stablecoin represents a claim for $1 on the stablecoin issuer; the point of a stablecoin is that it can be redeemed, by going to the issuer and asking for $1 back. [8]  And so the oddity is that a stablecoin issuer will have “depositors” — people with valid electronic claims on its deposits, anyway — whom it doesn’t know, who have no direct or indirect customer relationship with it, who have never answered the KYC questions.

Maybe this doesn’t matter? Maybe stablecoins are just “digital cash”: They are dollars that can move around without touching the ledger of a regulated financial institution, and so without any KYC checks, but if you want to use them for anything particularly useful you’ll have to come back into the regulated system. That’s how $20 bills work, and it could be how stablecoins work. An electronic ledger entry that is the philosophical and regulatory equivalent to a $20 bill. 

Anyway the GENIUS Act passed:

The Senate passed legislation to regulate a widely used type of cryptocurrency, a key victory for the digital-asset industry after it poured money into last year’s election.

The bill, the first of its kind to put federal guardrails on digital currencies, sets up oversight of stablecoins, a popular crypto asset typically pegged to a government currency such as the U.S. dollar. That peg keeps their price steady, making them attractive to traders looking for a store of value while they buy and sell more volatile cryptocurrencies. Stablecoins can also be used for cross-border payments.

Known as the Genius Act, the bill passed the Senate 68-30. It now moves to the House, where passage is viewed in Washington as likely but could take time. President Trump has said he wants to sign stablecoin legislation before Congress’s August recess.

The roughly $240 billion stablecoin market is expected to surge in the coming years, with financial-industry titans such as Visa and Mastercard getting into the sector, attracted in part by the prospect of regulatory certainty created by the bill. Amazon.com and Walmart are among the big companies also exploring stablecoins. 

Many Democrats got on board with the GOP-led effort after strengthening consumer protections and national-security provisions. Supporters of the bill argued that doing nothing would push the industry offshore and lead to more nefarious activity. …

The Senate passage is a big win for Circle, the largest U.S.-based stablecoin issuer, which recently went public. Circle has argued for regulations to legitimize the industry and in part to hurt Tether, its main rival and the biggest player globally. Tether is based overseas and hasn’t shown it can meet the standards outlined in the bill. Tether didn’t immediately respond to a request for comment.

Here is the text of the act. Here is a Davis Polk & Wardwell summary of its terms (and of the House’s “STABLE Act”). The basic points of the act are:

1. To make it clear that stablecoins are legal, that they should be regulated by someone (the Office of the Comptroller of the Currency, for federally regulated stablecoins issued by non-banks), and that they are not securities.
2. To require stablecoins to be backed: Under the act, $1 of stablecoin would have to be backed by at least $1 of reserves consisting of bank deposits, short-term Treasuries, repo and reverse repo, Fed deposits or government money market funds. [9]
3. To require stablecoin issuers to be “treated as a financial institution for purposes of the Bank Secrecy Act,” so they have to ask know-your-customer and anti-money-laundering questions before opening accounts.

Basically a stablecoin issuer would be a sort of narrow bank. But other questions are open. Davis Polk says: 

Payment stablecoin issuers would be required to (1) maintain effective AML and sanctions programs, (2) retain appropriate transaction records, (3) monitor and report suspicious activities, (4) comply with lawful orders to seize, freeze, burn, or prevent the transfer of outstanding stablecoins, and (5) maintain an effective customer identification program. 

But also:

Neither GENIUS Act nor STABLE Act specifically addresses BSA/AML, CFT or sanctions standards for secondary market transactions directly in the legislation. 

“Secondary market transactions” — me sending you stablecoins on the blockchain — are harder to police; again, that is sort of the point of crypto. A regulated US stablecoin issuer has to know its customers, that is, the people who buy stablecoins directly from the issuer. But after that, the stablecoins can do what they want.

We talked yesterday about a fun lawsuit against Kalshi, the prediction market. Basically Kalshi offers event contracts on sporting events; as of this morning, you can put $93 on a contract that pays $100 if Oklahoma City wins the NBA Finals, or $9 on a contract that pays $100 if Indiana wins. Or you can go to a sportsbook and bet on Oklahoma City or Indiana. Those transactions seem identical to me, [10]  but not to Kalshi — “I just don't really know what this has to do with gambling,” its chief executive officer has said — and there is an important regulatory difference:

1. Sportsbooks are regulated by state gaming regulators.
2. Kalshi is a commodity futures market regulated by the US Commodity Futures Trading Commission, which preempts state regulation.

Kalshi’s sports contracts are in a regulatory gray area. The CFTC has rules specifically prohibiting exchanges like Kalshi from listing “gaming” contracts, and when those rules were created everyone understood that they referred to sports betting, but that was before the Trump administration took office, and the CFTC’s attitude is different now. So, since January, Kalshi has gone ahead and listed these sports contracts — which it can do without prior approval from the CFTC — and the CFTC has not stopped it. 

Meanwhile several state gaming regulators have told Kalshi to stop listing sports contracts, but Kalshi has gone to court to push back, arguing that (1) CFTC regulation preempts state gaming regulation, (2) only the CFTC can stop it from listing these contracts and (3) the CFTC hasn’t. Kalshi has mostly won these arguments so far, though nothing is final yet and this outcome — that Kalshi can offer sports betting nationwide with essentially no regulation — seems quite odd.

If you think this outcome is wrong, you can bet against it. The case we discussed yesterday was brought by a company called Ohio Gambling Recovery, arguing that (1) Kalshi is offering illegal gambling in Ohio and (2) Ohio law lets anyone sue an illegal gambling company for everyone’s gambling losses. So if Kalshi is running an illegal sportsbook in Ohio, Ohio Gambling Recovery might be entitled to all of its winnings. Good trade if true!

I thought this was fun, but Ohio is not alone in this, and in fact there are other “_____ Gambling Recovery” firms that have been set up to sue in other states. Front Office Sports reported yesterday:

Kalshi, Robinhood, and others have been hit with five new lawsuits in five different state courts over allegations that their sports event contracts are in fact illegal sports betting products disguised as financial products. The nearly identical lawsuits each cite versions of the Statute of Anne, a centuries-old provision that voids certain gambling debts and allows third parties to sue for damages if the original bettor fails to act within six months.

The five suits were all filed last week, in state courts in Kentucky, Illinois, Massachusetts, Ohio, and South Carolina. The plaintiffs are all newly formed limited liability companies with uniform names—Kentucky Gambling Recovery LLC, Illinois Gambling Recovery LLC, and so on. Each LLC was incorporated in Delaware on March 18. No additional information about them was immediately available.

I have to say, I love it as a trade. I don’t know who stood up these Gambling Recovery firms, but I assume it is either an entrepreneurial lawyer or an entrepreneurial hedge fund or prop trading firm. If you are a trading firm, one way to respond to the boom in legalized sports gambling is to try to get in on it, to become a market maker on sportsbooks and on Kalshi. But this is a way to take the other side.

Hedge Fund Traders Are Pushing Their Firms Into Dubai and Abu Dhabi. Nippon Steel Closes $14.1 Billion Acquisition of US Steel. Dealmakers fear Trump has set precedent with ‘golden share’ in US Steel. Musk’s xAI Burns Through $1 Billion a Month as Costs Pile Up. Trump Flexes Security Powers to Keep Global Tariff Goal Alive. HSBC considers ordering all staff back to office 3 days a week. Developers Are Finally Dealing With the Office-Oversupply Problem. Pimco and King Street’s AmSurg Windfall Caps Ugly Distressed-Debt Saga. CEO’s Wealth Hits $33 Billion as Unprofitable Chinese Medicine Firm’s Stock Soars. Bessent reveals all on Musk clash, says he’s more ‘ninja’-like while Elon ‘fancies himself more of a Viking.’ 

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