The Marvelous Multimillionaires’ Tax Loss Machine

 

The actual components will be fancier than shown above, but you can bet tax practitioners are hard at work on mechanisms to offset tax on substantial capital gains. Early descriptions of president Biden't tax plans include a top income tax rate of over 40 percent, and that rate also would apply to capital gain realized by taxpayers who are income millionaires. Also vulnerable, nonmillionaires who realize once-in-a-lifetime gains that push their income into seven figures. If stepped-up basis is altered so that gains over $l million are taxed at death, inheritances would be diminished by what amounts to a junior-varsity estate tax.

For estates of the genuinely rich, the Tax Foundation estimates  the tax on gains plus the usual federal estate tax would produce a combined tax rate of 61%. The usual reliable sources think such a punishing blow is unlikely to become reality.

Meanwhile, wealth holders seek defensive measures. The Marvelous Multimillionaires Tax Loss Machine should help a lot. A Wharton study estimates the IRS  could receive 90% less revenue than expected from the proposed tax increases.

Dirigiste Plan Features Pigovian Tax

Learned two new words the other day.

Steven Rattner's op-ed, critiquing Senator Warren's plan for funding universal Medicare by "taxing the  rich," introduced me to dirigiste. The noun form is dirigisme, borrowed from the French, and it means state control of economic and social matters. Dirigisme is the opposite of laissez-faire.

Neil Irwin's column describes Warren's proposed 6% annual tax on billionaires' wealth as Pigovian. A Pigovian tax is "intended to reduce the prevalence of whatever it targets." Taxing cigarettes helped to reduce the number of smokers. Taxing billionaires could help to turn them into an endangered species.

Almost nobody (probably including Senator Warren) expects the wealth tax to become a reality in 2021. What might a Democrat controlled Congress do instead to raise revenue from the rich? Here's what Rattner suggests:

Raise the top federal income tax rate, imposed on incomes over half a million or so, from 37% to at least 42%.

Tax capital gains at regular income tax rates and do away with stepped-up basis for calculating gains on inherited assets.

Close egregious loopholes, like treating fund managers' "carried interest" income as tax-favored capital gain.

How many proposals to tax carried interest as regular income have you heard over the years?

Some tax breaks seem indestructible.

If Congress Won't Tax Carried Interest as Income…

. . . maybe New York and neighboring states should pick up the "lost" revenue. By collecting the equivalent of what hedgies save by having the carried-interest portion of their compensation taxed as capital gain, New York State figures it might collect $3.7 billion a year. For New York's ploy to work, neighboring states would have to follow suit. It's suggested that The Merrill Anderson' Company's home state, Connecticut, could collect a half billion or so annually. See New York Challenges a Tax Privilege of the Rich.

Could Laurence Fink’s Capital Gains Tax Cut Save the Economy?

Recovery from the Great Recession has been slow. Economic growth, productivity gains and stock market performance are generally expected to remain sluggish. One reason: many major corporations seem more inclined to tread water or downsize, via stock buybacks, than to invest in new business opportunities and productivity enhancements.

Laurence Fink, who as head of Blackrock might be called the world's most important shareholder, wants CEOs to stiffen their spines. Rather than give in to "activist investors" seeking quick payoffs from buybacks and enhanced dividends, they should be running their companies the old-fashioned way: doing their best to get bigger and better for the benefit of their long-term shareholders.

To ease the pressure for short-term payoffs, Fink proposes that capital gains be taxed as ordinary income when investments are held for only one or two years.

“Since when was one year considered a long-term investment? A more effective structure would be to grant long-term treatment only after three years, and then to decrease the tax rate for each year of ownership beyond that, potentially dropping to zero after 10 years.”

This blogger will buy that. Can't imagine Congress joining me.

Can President Obama Revive BypassTrusts?

For many a year, the most common trust used in estate tax planning has been the bypass or credit-shelter trust. The goal is to shield assets from tax at the later death of one's spouse. But there's a significant price: loss of stepped-up basis. When you shelter appreciated assets from estate tax, you expose the appreciation to capital gains tax when the assets are sold.

Now President Obama proposes to abolish stepped-up basis. Assets passed directly from parent to child would be subject to the same tax on capital gain as assets sheltered in trust. Curiously, he describes the provision as a trust fund loophole. 

Seems more like a trust fund plus.

Could bypass trusts make a comeback?  Possibly. Do you believe that a Republican Congress would abolish stepped-up basis?
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Can Three-Second Trades Produce Long-Term Capital Gain?

With a ploy called "basket options," a hypertrading hedge fund claimed billions of dollars in tax savings. The Senate Permanent Subcommittee on Investigations seems impressed.

Coming Clean on Bypass Trusts

Over the years your humble blogger wrote enough newsletter articles on bypass trusts to fill a dumpster. Don't waste your federal estate tax exemption! Prevent unnecessary estate tax at the later death of your spouse!

Rarely did clients encourage us to mention the income-tax downside: Although assets left outright receive a stepped-up basis at death. assets left in trust do not. If Grandpa dies when his Apple shares, purchased at $10 each, are worth $550, Grandma can sell at that price or less without realizing taxable gain. Only additional growth would be taxable. If the shares pass in trust, everything over $10 a share will be taxable gain.

When the Bush tax cuts lowered the top tax rate on capital gain to 15%, the income tax drawback of bypass trusts seemed less important. But this year the top federal income tax rate on capital gain is back up, approaching 25%. (And, of course, the effective tax rate on gain often exceeds the listed rate.)

Fortunately, new estate tax rules allow Grandma to make use of Grandpa's unused estate-tax exemption. Bypass trusts have become unnecessary. Or have they?

According to Deborah Jacob's dispatch from "the Super Bowl of estate planning," drafters of wills and trusts have faced up to the potential income-tax cost of bypass trusts. Nevertheless, for a variety of reasons they think the trusts still have a future.

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Caution: Don't take the title of Jacob's column, "Estate Planning for the 99%," literally. Candidates for bypass trusts are the 1% (the 1% threshold is around six to eight million, depending on who you ask) or at worst the top 2%. Remember, only 5% of U.S. households have a net worth of at least $1 million.

Federal estate tax is no longer an issue in most estate planning. But estate beneficiaries still need protection from creditors and divorce lawyers. Trusts will continue to be useful.

Should Capital Gain Be Taxed As Income?

On the question of taxing capital gain as income, the U.S. Supreme Court has spoken, writes Bruce Bartlett. Whether you think profit realized from the sale of investments should be taxed never, sometimes or always, at one time or another the Court has delivered a decision supporting your view.

If capital gain were truly income, in theory both realized and unrealized gain should be taxed annually. For obvious reasons that theory has never been put into practice.

Read Bartlett's informative column and see if you agree with those who "believe that only by adopting a pure consumption tax, and eliminating the taxation of incomes entirely, can we fully escape the problems inherent in capital gains taxation."

CRUTs, Collectibles and a Punch Bowl

For those with high incomes, Ashlea Ebeling points out in Forbes, the federal tax on long-term capital gain from the sale of collectibles, such as art or antiques, has risen to 31.8 percent. To eliminate tax the collector might use a charitable remainder unitrust. The charitable trust can sell the high-gain assets tax free, the donor may retain a generous lifetime income from the trust, and he or she gets a tax deduction for the estimated value of the trust "remainder."

Federal tax on capital gain from the sale of securities now rises as high as 23.8 percent, so here, too, selling via a CRUT might prove attractive.

One significant difference: When a donor moves publicly-traded shares into a CRUT and sells them tax free, the donor knows approximately how much the shares will fetch. A collector putting a family treasure up for auction ventures into the unknown.

To illustrate, consider this punch bowl. (We came across it while seeking an avatar for the figurative punch bowl that the Federal Reserve is about to take away). The silver bowl is venerable, made in New York around 1700-1710, only a few decades after the British renamed New Amsterdam.

Punch Bowl by Cornelius Kierstede

Descendants of a Boston Tory family put the bowl up for auction in 2010. Sotheby's expected it to sell for $400,000-$800,000. Instead, bidding escalated until only two contenders remained, one bidding by phone, the other an "anonymous bidder" in the auction hall.

Two million. Three million. Four million. Five million!

The anonymous bidder finally won the bowl for $5.9 million. That's by far the highest price paid at auction for a piece of American silver.

Wonder how a donor would feel if he or she realized such a windfall when selling via a tax-sheltered CRUT. Delight that what was expected to be a trust fund of $600,000 or so had ballooned to almost $6 million? Or remorse? "Why on earth did I tie up that much money!"

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As to why the punch bowl sold for such an amazing price, that remains something of a mystery. Was it a matter of provenance? You may not know the bowl's Revolutionary-era owner, Joshua Loring, but in your school days you probably read about his pretty young wife. After the Loyalist Lorings fled their suburban home (possibly leaving the punch bowl behind) for the safety of Boston, Elizabeth Loring earned trans-Atlantic celebrity as the mistress of the British general Howe.

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Note the sidebar to the Forbes article: Three Donors Tell Why They Set Up CRUTs.

Capital Gains: A Great Unlocking

Fifty years ago, when The Merrill Anderson Company created this ad, federal income tax on long-term capital gain was levied at the rate of 25 percent. Coaxing investors to sell was difficult.

This year could be the last for paying tax on stock profits at 15 percent. (That's 15 percent at the Mitt-Romney income level. Lesser mortals have paid much more.) As a result, The New York Times reports, we're experiencing a Great Unlocking – a stampede to take profits that's reminiscent of the Reagan years:

[S]ome experts expect a substantial bump in tax collections in the short term as investors take a multitude of steps now that they would have taken in future years. After the top tax rate on capital gains rose to 28 percent from 20 percent at the end of 1986, federal receipts from such gains doubled to $52.9 billion in 1987, as sales surged at the end of the previous tax year.

Maybe our much-maligned U.S. Congress deserves a little respect for cutting the deficit by cliff-hanging.

Taxing Capital Gain. Is It Double Taxation?

A comment on Richard Thaler's blog links to Steve Landsberg's fervent argument that taxing capital gains is always double taxation – that is, a surtax on income that has already been taxed before it was invested.

Valid point?

Valid even when I invest the interest from tax-exempt bonds?

Hoover on Taxing Capital Gain

From an editorial in the June 24, 1931 Wall Street Journal, as summarized at News from 1930:

Pres. Hoover's apparent recent stand against all capital gains taxes on grounds they intensify both booms and busts may be logical, but is probably too radical a change for the US tax system. Current concept of capital gains as income is so deeply ingrained in our income tax system that its elimination would require "pretty complete rewriting and reinterpretation of this complex law."

New Tax Hike For Estates?

Tax Boost Proposed for Estates, announces The Wall Street Journal. Turns out to refer not to a hike in federal estate tax rates but to a potential loophole closing:

The provision regarding estates would prevent taxpayers from using two different valuations for the same items. Under current law, the White House official said, some people estimate a particular inherited item at one value for the purposes of the estate tax, but estimate the value of the same item at a higher amount when reporting it as a gift.

That is because the incentive is to undervalue items when paying the estate tax. But the incentive is to overvalue them when reporting gifts, so that the basis will be higher when calculating capital gains if the item is sold. Under the proposal, taxpayers would have to use the same value for both purposes.

This gambit must be popular. Closing the loophole, according to the Obama administration, would raise an estimated $24 billion over 10 years.

There is, of course, another way to eliminate the loophole, the method proposed by Douglas Holtz-Eakin, a former director of the Congressional Budget Office: Kill the "Death Tax."

Tax Hike Targets Red Staters?

Income millionaires nationwide would be hit by the rate hikes in President Obama's proposed budget. Families at the $200,000-$400,000 level may escape if they live on the East or West Coasts, strongholds of Obama-leaning liberals. Many Red Staters with comparable incomes but lower expenses could see their taxes go up.

The New York Times explains: Many of the Californians and East Coasters have already left the regular income-tax system. They pay AMT, the Alternative Minimum Tax. And they'll still be paying it if the regular rates rise as proposed. The Times offers this example:


Could the proposed hike in capital gains tax, to 20%, also be rendered moot for many taxpayers because of the AMT? From personal experience, I wouldn't be surprised.

Do You Know the Top Tax Rate on Long-Term Gain?

Careful! It's a tricky question.

Last year, when the family needed to add to its cash reserves, we sold shares of Apple. The shares had been purchased for under $10 per share (split adjusted) back in the dot.com bust, so the capital gain was humongous.

We had little in the way of investment losses to offset the gain (remember those days?). Still, the federal income tax on long-term gain is no more than 15%. Could be worse.

It was worse. At tax time we discovered that, except for people with exceptionally large incomes, long-term gain is not truly exempt from the Alternative Minimum Tax. The result, as explained here, was to boost the tax on our Apple gain to around 22%.

Oh, well. It could have been worse.

And it is. As senior citizens, my wife and I recently received polite notes from a Social Security computer, announcing a boost in our retirement benefits to offset inflation, negated by a significant cut in the benefits we would actually receive in 2009.

The cut results from a surcharge – the SS computer calls it "an income-related monthly adjustment amount" – on the premium we pay for Medicare Part B. The surcharge is based on MAGI:

We ask the Internal Revenue Service (IRS) for your tax [sic] income. We then add your adjusted gross income together with your tax-exempt interest income to get an amount that we call modified adjusted gross income (MAGI) . . . .

MAGI may include one-time only income, such as capital gains . . . . One-time income will effect your Medicare Part B premium for only one year.

Thanks to the humongous capital gain, our MAGI results in surcharges for 2009 equal to another two-percent tax on the gain. That brings the overall tax rate to 24%.

During the election campaign, weren't the Democrats talking about a 20% capital-gains tax? Sounds good to me!