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.

Tasty Taxes

The Old Farmer's Almanac says that in biblical times, people paid their taxes with herbs such as anise, and in medieval Europe, some used honey to pay their taxes. Since I live in New England, I'm sending the IRS a crate of lobster and clam chowder. I'll let you know how it goes.

– Teresa M. Hanafin

How to Raise Taxes?

Here’s The Washington Post’s wish list for revenue-raising tax reform. A number of the comments are enlightening. A few offer comic relief. Like, "Wealthy people who set up Trusts need to be reigned in.” (Not to be confused with Meghan and Harry, who needed to be reigned out.)

The Law That Made Everybody’s Tax Info Public

 After the Crash of ’29, tycoons like J. P. Morgan, Jr. had more than enough tax write-offs to reduce their income tax to zero. As this old WSJ item reminds us, the resulting public outrage led Congress to take bipartisan action:

Under the Revenue Act of 1934, anyone who filed a federal tax return would also complete another — pink — form, with his or her name, address, income, deductions and total taxes paid. Everything on the pink slips was public information, available to reporters, nosy neighbors or former spouses alike.

 With the pink slips, the theory went, upper-income toffs would be shamed into paying something. But ordinary taxpayers also would have their earnings and tax payments exposed to public view. What would the neighbors think? What if they looked affluent enough to attract kidnappers? (With the kidnapping of the Lindbergh baby still a fresh memory, the latter worry was real.) 

A Pittsburgh glass heir named Raymond Pitcairn led the effort to repeal pink slips. Using know-how gained while lobbying for the repeal of Prohibition, he quickly won the day. The “pink slip” law was repealed less than a year after it passed.

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The Supreme Court recently ordered the release of the income tax records of a wealthy serial nontaxpayer. But these days, living rich and tax free is a feat perhaps more admired than condemned.

Though Rare,Tax Audits Follow the Money

IRS tax audits have become an endangered species. From 2010 to 2018, the overall audit rate for individual tax returns dropped by 47%. The audit rate for top taxpayers – those with incomes of $10 million or more – dropped by 64%.

Amount of taxes owed but unpaid
in last fiscal year

To make the most of limited resources, Barron’s reports, the IRS has relied on technology and carefully targeted collection efforts. Income stashed offshore, for instance. From 2009 to 2018, the IRS persuaded 54,000 offshorers to hand over more than $11 billion in taxes due.

Taxpayers dealing in cryptocurrencies are another IRS target. Are Bitcoin and such really currencies or just investments? Lately the IRS has leaned toward the latter view.

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.

"Taxing the Rich"

Funding the government by taxing the wealthy has always had political appeal. In 1913 the ancestor of today's federal income tax was introduced to chastise the rich by imposing a tax ranging from 2 percent to 6 percent.

The 2 percent bracket started at an income level, in today's dollars, of over $500,000.

The top rate of 6 percent only hit incomes, again in todays' dollars, of $13 million or more.

Times have changed, haven't they? 

Taxes on wealth may trickle down even before they are enacted. Elizabeth Warren's proposed 2 percent tax on wealth over $50 million, for instance. One of her advisers has already suggested a lower tax bracket starting at $l million. 

This Tax Deduction Does Matter

Tax deductions don't matter after the Trump tax cuts? Well, that depends on the deduction.

Although far fewer taxpayers were able to claim deductions for mortgage interest or charitable contributions on their income tax returns for 2018, home sales and charitable donations seemed to survive unscathed.

Because of the expanded standard deduction, use of the SALT deduction for state and local taxes also declined. What's more, upper-income taxpayers who did claim the deduction couldn't claim much – the deduction was capped at $10,000 per couple.

As a result of the cap, income-rich residents of New York, California and other high-tax states now have an added incentive to pull up stakes. According to estimates cited by The Wall Street Journal, a Manhattanite couple with income of $500,000 could save $50,000 in state and city income taxes by moving to a no-tax state such as Florida. Californians with $500,000 incomes could save more than $46,000 by establishing residency in no-tax Nevada.

Connecticut, Merrill Anderson's home state, is feeling the pain. (A hypothetical $500,000 Connecticut couple might save over $32,000 in taxes by becoming Floridian). High income Wall Streeters flocked to Connecticut in recent decades, a migration encouraged by the destruction of the World Trade Center. Banks built huge trading floors in Stamford. Hedge funds flocked to Greenwich.

Then came the great recession. Connecticut's role as Wall Street East began to fade. High-income financial types have been leaving – a few involuntarily. Most have departed in search of friendlier tax climates.

 Like Florida. Especially the Palm Beach area.

Kelly Smallridge, president and CEO of Palm Beach County’s Business Development Board, told FOX Business that more than 70 financial services companies have moved into Palm Beach County within the last three years. Currently, the organization is working with another 15.

“I cannot keep up with the number of companies coming in,” Smallridge said. “Some are headquarters, some of them are regional operations. Many of them, once they get here, within short order establish [Palm Beach] as their home base." 

Firms are primarily coming from three main areas – New York, Boston and Connecticut (specifically Greenwich).

As Greenwich and Connecticut have discovered, extremely-high-income-people aren't willing to remain sitting targets for state and local taxes. They and their advisers are adept at sheltering wealth from taxation. That's something for Elizabeth Warren to keep in mind if she's able to pursue her idea for an annual wealth tax.

Income Tax Deductions Don't Matter

The Trump income tax cuts abolished personal exemptions but greatly expanded the standard deduction. That meant most taxpayers could gain nothing by itemizing their mortgage interest payments or their charitable contributions. Without these tax breaks, some predicted, home prices would plunge and charitable contributions would shrivel.

Sure enough, far fewer taxpayers claimed itemized deductions on their 2018 returns.

But so far, Felix Salmon points out, the economic impact of those lost deductions has been nil:

Only 8% of taxpayers now deduct mortgage interest, yet home prices continue to rise,  with no indication that the new law changed anything at all. 

Similarly, the charitable contribution deduction has had no visible effect on charitable contributions. Total giving rose by 0.7% to a new record high in 2018, despite a late-year stock market plunge.

Can the IRS be Saved?

Paragraph we never expected to read in the newspaper:

One 2020 candidate already has a bold proposal to resuscitate the I.R.S. It’s a plan to pump tens of billions into the agency, enough to fund a second army of agents. That candidate’s name is Donald Trump.

In political folklore Republicans are known for disliking federal taxes and fiercely disliking paying taxes, so the future of the president's budget proposal is anyone's guess.

Still, this op-ed by two Politico reporters reminds us that the IRS is an endangered bureaucracy, underfunded and understaffed. Notably lacking: hundreds of highly-trained auditors needed to go toe-to-toe with aggressive tax planners.

Will the IRS receive the many billions needed to restore the agency to fighting trim? Probably not, unless the president is tired of being the only high-income celebrity under constant audit.

How Tax Refunds Drive the Economy

Unhappy taxpayers may not be the only victims of the winter of tax discontent. Last year the new tax

law made folks feel flush – and automobile sales, a key driver of the U.S. economy, exceeded expectations. This year millions of Americans are expected to receive lower refunds or, worse, owe more to the IRS.

"Without that seasonal bounce," Axios warns, "2019 auto sales may be lower, making a recession more likely."

A Winter of Tax Discontent?

Income tax season is never fun. This one could be a real downer.

One reason: the new tax law created a much larger standard deduction – $12,00 for singles, $24,000 for married couples. Though some taxpayers will benefit, others accustomed to itemizing their deductions may feel shortchanged. A couple whose state and local taxes, mortgage interest and donations add up to, say, $22,000 will find that their accustomed deductions are worthless.

According to estimates cited by the WSJ, the number of returns claiming the mortgage-interest deduction for 2018 will drop to 16 million from almost 40 million. Returns claiming deductions for charitable contributions also are expected to drop by more than 50%.

Tax withholding could be another sore spot. The withholding tables for 2018 may result in some taxpayers receiving smaller refunds or owing more at tax time.

And, smaller or not, taxpayers' refunds will be delayed if the partial government shutdown persists.

Portrait of a Tax Audit

Printmaker Warrington Colescott died September 10 at the age of 97. according to his NY Times obituary. Known for his biting etchings, Colescott once experienced a tax audit. His painful descent into IRS hell prompted him to create "Inside IRS."

The Tax Act's Marketer in Chief

President Trump advised Congressional Republicans to make their tax legislation palatable by communicating simply, the Washington Post reports. Talk tax cut, not tax reform. A big, beautiful tax cut. Biggest ever (well, not quite, but still pretty big).

To his great credit, the President questioned the Walmart-pricing approach to setting tax rates. What's with this 39.6%, 38.5% nonsense?

Reportedly, the President feels the most marketable tax rates are multiples of five. Congressional Republicans didn't achieve that simplicity, but at least the new rates are free of percentage points.

Tax Plans Stranger Than Fiction

 Generally, well-compensated employees should pay income tax at higher rates than business owners and investors. 

However, certain high-income business owners should pay tax at a marginal rate of 85.2%.

Haste and input from billionaires have produced weird taxation possibilities.

Fun and Taxes

The tax legislation being hurried through Congress is serious business. Still, haste sometimes makes humor.

Reinventing the bubble that killed the 1986 tax reform
Back in '86, last-minute tinkering increased the nominal top income-tax rate from 28% to 33%. But it was just a "bubble" – for the highest incomes, the rate dropped back to 28%. Without this silliness, the '86 reforms might have survived longer.

So what did House Republicans just come up with? A new bubble that would raise the current top tax rate of 39.6% to 45% before dropping back to 39.6%. (Members of Congress will do anything for a laugh.)

Before-tax loss, after-tax gain
Senate Republicans propose delaying the 20% corporate tax rate for a year while allowing immediate deductions of some business expense from income taxable at 35%. Professor Dan Shaviro of New York University Law School gave the NY Times an example of the fun possibilities:

Normally no one would invest $100 to earn only $90 back. But under the Senate plan, where some business expenses could be immediately deducted at a 35 percent rate, you would get $35 back in 2018. So your actual cost is $65. By the time your $90 earnings are paid in 2019, though, the tax rate would be 20 percent. That would cost you $18 in taxes, and leave $72 in your wallet. So even though your investment lost $10, you are still coming out ahead: with $72 on a net investment of $65.)

Best new tax acronym

"To reduce their home tax bill, " the Times reports, "companies like Google and Pfizer, for instance, often relocate patents and copyrights in tax havens and then sell use of that intellectual property back to their American subsidiaries at eye-popping prices." This Global Intangible Low-Tax Income is known as GILTI.

The tax bill will seek to cut off GILTI, but the restrictions could prompt companies to move more research and manufacturing off shore.

Tax Reform‘s Fierce Foe

Alarmed by talk of lost deductions for mortgage interest and state and local taxes in the Republican tax bill, the National Association of Home Builders flexed its lobbying muscle to promote a homeownership tax credit. No luck, apparently, but give the builders full credit for chutzpah.

Homebuilders don't like the current effort at tax reform any better than they liked the 1986 version. They blame the '86 act, explains Damian Paletta, for discouraging real estate investment and thus triggering the savings and loan crisis.

There were numerous causes of the savings and loan crisis, but the home builders aren’t the only ones that think the 1986 tax law is a precipitating factor. During congressional testimony in 1991, then-real estate developer Donald Trump made the same argument. He called the 1986 tax law an “absolute catastrophe.” 

"It has taken all the incentive away from investing in real estate," Trump complained. Nevertheless, he soldiered on for another twelve years before launching his career on reality TV.

The Sound of Trial Balloons Popping

Every Congress has to learn the lesson: Cutting income tax rates is easy; expanding the tax base is difficult. Every tax break has beneficiaries who claim they can't live without it.

Legislators seeking ways to limit the cost of President Trump's tax plan  realize that citizens regard deductions for mortgage interest and charitable gifts as inalienable rights.

Could SALT, the deduction for state and local taxes, be a candidate for elimination? Nope. Republicans from high-tax states wouldn't hear of it.

Next trial balloon: a suggestion that the annual limit for contributions to 401(k) plans be cut from $18,000 to $2,400. Pop! After widespread criticism, that idea has suffered death by tweet.

Back in the Reagan years, cutting tax rates was relatively quick and easy.  Cutting rates and broadening the tax base in the 1986 tax reform act was not.

When Deficits Meant Tax Hikes, Not Cuts

From half a century ago, August, 1967, comes this Life magazine editorial. 

"The case for a tax increase…is a persuasive one." Although the U.S. had run deficits in nine of the previous 10 years, "the sheer size of the one now confronting the nation is fearsome."

Current deficits run bigger, in terms of GDP, than they did half a century ago. Can you imagine our president or any member of Congress proposing a tax increase? 

Life also mentions the need to restrain high inflation? How high? Three percent, a level today's fiscal engineers seek to promote.

You're right, Dorothy. We're not in the 20th century any more. 

Tax Legislation, Anyone?

Last spring the Trump administration came up with a vague, one-page proposal for revising the Internal Revenue Code. After months of reportedly serious effort, a six-man task force has expanded  the proposal to a vague, nine-page plan.

But "it's not really a plan," as Catherine Rampell points out in The Washington Post:

At best it’s an outline, offering barely more detail than the bullet points the Trump administration released in April. It doesn’t even specify the thresholds for the individual income-tax rates it proposes. It also doesn’t identify a single individual tax preference it would kill, despite claiming to simplify the code and close lots of “loopholes.” Even the state and local tax deduction, which administration officials have talked about eliminating, isn’t explicitly mentioned.

While we wait for Congressional Republicans to come up with an actual tax bill, there's plenty to wonder and worry about. How can abuse of the proposed 25% tax rate on income "passed through" businesses such as partnerships  be prevented? What if repeal of the estate tax (which affects almost nobody) exposes millions of Americans to capital gains tax on inherited assets?