by Linda Beale
Ten tax tricks (non-rich need not apply)
Back on tax day in April, Bloomberg.com ran a good story on the tax tricks the rich can use to reduce, defer or avoid altogether federal income taxation. Jesse Drucker, How to Pay No Taxes: Ten Strategies Used by the Rich, Bloomberg.com (Apr. 17, 2012).
As Drucker notes, the very very wealthy at the top of the income distribution have made out extraordinarily well in the last decade as to amount of taxes paid.
For the 400 U.S. taxpayers with the highest adjusted gross income, the effective federal income tax rate—what they actually pay—fell from almost 30 percent in 1995 to just over 18 percent in 2008, according to the Internal Revenue Service. And for the approximately 1.4 million people who make up the top 1 percent of taxpayers, the effective federal income tax rate dropped from 29 percent to 23 percent in 2008. It may seem too fantastic to be true, but the top 400 end up paying a lower rate than the next 1,399,600 or so.
They don’t even necessarily have to cheat to do it. They just use the tried and true tax reduction methods built into the system for their benefit–like “monetizing” their wealth through borrowings that they don’t pay back in their lifetimes, but are paid out of the estate (which can sell stocks with the step up in basis resulting in no taxes).
That’s because those figures fail to include the additional income that’s generated by many sophisticated tax-avoidance strategies. Several of those techniques involve some variation of complicated borrowings that never get repaid, netting the beneficiaries hundreds of millions in tax-free cash.
The article lists ten common ways the rich avoid taxes.
(After the jump)
1. The no-sale sale (borrowing against stock, combined with puts and calls, so that the rich guy can either pay back the cash or hand over shares, years after the sale is actually conducted. (Drucker notes that Philip Anshultz used one of these deals and ended up with the tax court saying he owed $94 million in back taxes. But the deals are still going strong.)
2. the skyscraper shuffle (using tiered partnerships to borrow against partnership property, move the loan into a subsidiary and then distribute the subsidiary to liquidate a partner, letting him cash out of a real estate partnership and avoid taxation, retaining ownership of the entity with the cash and deferring taxes indefinitely)
3. the estate tax eliminator (leaving stock earnings to kids and avoiding the estate tax with a GRAT)
4. the estate freeze (using an intentionally defective grantor trust and debt to freeze the value of an estate–and avoid estate taxes on future appreciation–by moving assets out of the estate tax free for the benefit of beneficiaries and benefiting from valuation discounts due to the use of the trust)
5. The option option (receiving options rather than shares as compensation so that the tax bill won’t be due til the options are exercised)
6. the bountiful loss (purchasing identical underwater shares and using puts and calls to protect against any risk of further loss, and then selling the old shares to realize the loss–with just enough of a time window to avoid the wash sale rule–while retaining the same property in the form of the new shares)
7. the friendly partner (selling real estate by forming a partnership with the buyer, taking out a loan collateralized by the property, and ultimately distributing the cash to the seller who retains an interest in the partnership)
8. the big payback (buying various life insurance products that completely escape t income tax and, if owned by the appropriate type of trust, also the estate tax)
9. IRS Monte Carlo (converting traditional IRAs to Roth IRAs, especially in sets so that you can take advantage of the 21-month “change your mind” period selectively as it benefits you)
10. the venti (having a chunk of your big CEO compensation paid through a deferred compensation plan where earnings grow tax-deferred for years or decades).
What’s the moral of this tale? That Congress could easily stop every one of these tax avoidance schemes if it wanted to. And it should want to, so that the ultra-rich don’t continue to have access to schemes that allow them to avoid taxation that are simply not available to ordinary people.