GILDED GRAFTERS: ULTRA-RICH DODGE BILLIONS IN TAXES
For the Wealthiest, a Private Tax System That Saves Them Billions
The very richest are able to quietly shape tax policy that will allow them to shield billions in income.
Daniel S. Loeb, shown with
his wife, Margaret, runs the $17 billion Third Point hedge fund. Mr.
Loeb, who owns a home in East Hampton, has contributed to Jeb Bush’s
super PAC and given $1 million to the American Unity Super PAC, which
supports gay rights.PatrickMcMullan/PMC
WASHINGTON — The hedge fund magnates Daniel S. Loeb, Louis Moore Bacon and Steven A. Cohen
have much in common. They have managed billions of dollars in capital,
earning vast fortunes. They have invested millions in art — and millions
more in political candidates.
Moreover,
each has exploited an esoteric tax loophole that saved them millions in
taxes. The trick? Route the money to Bermuda and back.
With
inequality at its highest levels in nearly a century and public debate
rising over whether the government should respond to it through higher
taxes on the wealthy, the very richest Americans have financed a
sophisticated and astonishingly effective apparatus for shielding their
fortunes. Some call it the “income defense industry,” consisting of a
high-priced phalanx of lawyers, estate planners, lobbyists and anti-tax
activists who exploit and defend a dizzying array of tax maneuvers,
virtually none of them available to taxpayers of more modest means.
In
recent years, this apparatus has become one of the most powerful
avenues of influence for wealthy Americans of all political stripes,
including Mr. Loeb and Mr. Cohen, who give heavily to Republicans, and
the liberal billionaire George Soros, who has called for higher levies on the rich while at the same time using tax loopholes to bolster his own fortune.
All are among a small group providing much of the early cash for the 2016 presidential campaign.
Operating largely out of public view — in tax court, through arcane legislative provisions and in private negotiations with the Internal Revenue Service
— the wealthy have used their influence to steadily whittle away at the
government’s ability to tax them. The effect has been to create a kind
of private tax system, catering to only several thousand Americans.
The
impact on their own fortunes has been stark. Two decades ago, when Bill
Clinton was elected president, the 400 highest-earning taxpayers in
America paid nearly 27 percent of their income in federal taxes,
according to I.R.S. data.
By 2012, when President Obama was re-elected, that figure had fallen to
less than 17 percent, which is just slightly more than the typical
family making $100,000 annually, when payroll taxes are included for
both groups.
The
ultra-wealthy “literally pay millions of dollars for these services,”
said Jeffrey A. Winters, a political scientist at Northwestern
University who studies economic elites, “and save in the tens or
hundreds of millions in taxes.”
Some
of the biggest current tax battles are being waged by some of the most
generous supporters of 2016 candidates. They include the families of the
hedge fund investors Robert Mercer, who gives to Republicans, and James Simons, who gives to Democrats; as well as the options trader Jeffrey Yass, a libertarian-leaning donor to Republicans.
Mr.
Yass’s firm is litigating what the agency deemed to be tens of millions
of dollars in underpaid taxes. Renaissance Technologies, the hedge fund
Mr. Simons founded and which Mr. Mercer helps run, is currently under
review by the I.R.S. over a loophole that saved their fund
an estimated $6.8 billion in taxes over roughly a decade, according to a
Senate investigation. Some of these same families have also contributed
hundreds of thousands of dollars to conservative groups that have
attacked virtually any effort to raises taxes on the wealthy.
For the Richest, Lower Taxes
The average tax rate for the ultra-wealthy has fallen dramatically.
Income Tax Rate
In
the heat of the presidential race, the influence of wealthy donors is
being tested. At stake is the Obama administration’s 2013 tax increase
on high earners — the first in two decades — which amounted to a
significant increase for the ultrawealthy. Also at stake is an I.R.S.
initiative to ensure that, in effect, the higher rate sticks by cracking
down on tax avoidance by the wealthy.
While
Democrats like Bernie Sanders and Hillary Clinton have pledged to raise
taxes on these voters, virtually every Republican has advanced policies
that would vastly reduce their tax bills, sometimes to as little as 10
percent of their income.
At
the same time, most Republican candidates favor eliminating the
inheritance tax, a move that would allow the new rich, and the old, to
bequeath their fortunes intact, solidifying the wealth gap far into the
future. And several have proposed a substantial reduction — or even
elimination — in the already deeply discounted tax rates on investment
gains, a foundation of the most lucrative tax strategies.
“There’s
this notion that the wealthy use their money to buy politicians; more
accurately, it’s that they can buy policy, and specifically, tax
policy,” said Jared Bernstein, a senior fellow at the left-leaning
Center on Budget and Policy Priorities who served as chief economic
adviser to Vice President Joseph R. Biden Jr. “That’s why these
egregious loopholes exist, and why it’s so hard to close them.”
The Family Office
Each of the top 400 earners took home,
on average, about $336 million in 2012, the latest year for which data
is available. If the bulk of that money had been paid out as salary or
wages, as it is for the typical American, the tax obligations of those
wealthy taxpayers could have more than doubled.
Instead,
much of their income came from convoluted partnerships and high-end
investment funds. Other earnings accrued in opaque family trusts and
foreign shell corporations, beyond the reach of the tax authorities.
The
well-paid technicians who devise these arrangements toil away at
white-shoe law firms and elite investment banks, as well as a variety of
obscure boutiques. But at the fulcrum of the strategizing over how to
minimize taxes are so-called family offices, the customized wealth
management departments of Americans with hundreds of millions or
billions of dollars in assets.
Family
offices have existed since the late 19th century, when the Rockefellers
pioneered the institution, and gained popularity in the 1980s. But they
have proliferated rapidly over the last decade, as the ranks of the
super-rich, and the size of their fortunes, swelled to record
proportions.
“We
have so much wealth being created, significant wealth, that it creates a
need for the family office structure now,” said Sree Arimilli, an
industry recruiting consultant.
Family
offices, many of which are dedicated to managing and protecting the
wealth of a single family, oversee everything from investment strategy
to philanthropy. But tax planning is a core function. While the specific
techniques these advisers employ to minimize taxes can be
mind-numbingly complex, they generally follow a few simple principles,
like converting one type of incom
Mr.
Loeb, for example, has invested in a Bermuda-based reinsurer — an
insurer to insurance companies — that turns around and invests the money
in his hedge fund. That maneuver transforms his profits from short-term
bets in the market, which the government taxes at roughly 40 percent,
into long-term profits, known as capital gains, which are taxed at
roughly half that rate. It has had the added advantage of letting Mr.
Loeb defer taxes on this income indefinitely, allowing his wealth to
compound and grow more quickly.
(The
Bermuda insurer Mr. Loeb helped set up went public in 2013 and is
active in the insurance business, not merely a tax dodge. Mr. Cohen and
Mr. Bacon abandoned similar insurance-based strategies in recent years.)
Organizing
one’s business as a partnership can be lucrative in its own right. Some
of the partnerships from which the wealthy derive their income are
allowed to sell shares to the public, making it easy to cash out a chunk
of the business while retaining control. But unlike other publicly
traded corporations, they pay no corporate income tax; the partners pay
taxes as individuals. And the income taxes are often reduced by large
deductions, such as for depreciation.
For
large private partnerships, meanwhile, the I.R.S. often struggles “to
determine whether a tax shelter exists, an abusive tax transaction is
being used,” according to a recent report
by the Government Accountability Office. The agency is not allowed to
collect taxes directly from these partnerships, even those with several
hundred partners. Instead, it must collect from each individual partner,
requiring the agency to commit significant time and manpower.
The
wealthy can also avail themselves of a range of esoteric and customized
tax deductions that go far beyond writing off a home office or dinner
with a client. One aggressive strategy is to place income in a type of
charitable trust, generating a deduction that offsets the income tax.
The trust then purchases what’s known as a private placement life
insurance policy, which invests the money on a tax-free basis,
frequently in a number of hedge funds. The person’s heirs can inherit,
also tax-free, whatever money is left after the trust pays out a
percentage each year to charity, often a considerable sum.
Many
of these maneuvers are well established, and wealthy taxpayers say they
are well within their rights to exploit them. Others exist in a legal
gray area, its boundaries defined by the willingness of taxpayers to
defend their strategies against the I.R.S. Almost all are outside the
price range of the average taxpayer.
Among
tax lawyers and accountants, “the best and brightest get a high from
figuring out how to do tricky little deals,” said Karen L. Hawkins, who
until recently headed the I.R.S. office that oversees tax practitioners.
“Frankly, it is almost beyond the intellectual and resource capacity of
the Internal Revenue Service to catch.”
The
combination of cost and complexity has had a profound effect, tax
experts said. Whatever tax rates Congress sets, the actual rates paid by
the ultra-wealthy tend to fall over time as they exploit their numerous
advantages.
From
Mr. Obama’s inauguration through the end of 2012, federal income tax
rates on individuals did not change (excluding payroll taxes). But the
highest-earning one-thousandth of Americans went from paying an average
of 20.9 percent to 17.6 percent. By contrast, the top 1 percent,
excluding the very wealthy, went from paying just under 24 percent on
average to just over that level.
“We
do have two different tax systems, one for normal wage-earners and
another for those who can afford sophisticated tax advice,” said Victor
Fleischer, a law professor at the University of San Diego who studies
the intersection of tax policy and inequality. “At the very top of the
income distribution, the effective rate of tax goes down, contrary to
the principles of a progressive income tax system.”
A Very Quiet Defense
Having helped foster an alternative tax system, wealthy Americans have been aggressive in defending it.
Trade
groups representing the Bermuda-based insurance company Mr. Loeb helped
set up, for example, have spent the last several months pleading with
the I.R.S. that its proposed rules tightening the hedge fund insurance
loophole are too onerous.
The major industry group representing private equity
funds spends hundreds of thousands of dollars each year lobbying on
such issues as “carried interest,” the granddaddy of Wall Street tax
loopholes, which makes it possible for fund managers to pay the capital
gains rate rather than the higher standard tax rate on a substantial
share of their income for running the fund.
The
budget deal that Congress approved in October allows the I.R.S. to
collect underpaid taxes from large partnerships at the firm level for
the first time — which is far easier for the agency — thanks to a
provision that lawmakers slipped into the deal at the last minute,
before many lobbyists could mobilize. But the new rules are relatively
weak — firms can still choose to have partners pay the taxes — and don’t
take effect until 2018, giving the wealthy plenty of time to weaken
them further.
Shortly
after the provision passed, the Managed Funds Association, an industry
group that represents prominent hedge funds like D. E. Shaw, Renaissance
Technologies, Tiger Management and Third Point, began meeting with
members of Congress to discuss a wish list of adjustments. The founders
of these funds have all donated at least $500,000 to 2016 presidential
candidates. During the Obama presidency, the association itself has
risen to become one of the most powerful trade groups in Washington,
spending over $4 million a year on lobbying.
Buying Power
Articles in this series examine America’s growing concentration of wealth and its consequences for government and politics.
And
while the lobbying clout of the wealthy is most often deployed through
industry trade associations and lawyers, some rich families have locked
arms to advance their interests more directly.
The
inheritance tax has been a primary target. In the early 1990s, a
California family office executive named Patricia Soldano began lobbying
on behalf of wealthy families to repeal the tax, which would not only
save them money, but also make it easier to preserve their business
empires from one generation to the next. The idea struck many hardened
operatives as unrealistic at the time, given that the tax affected only
the wealthiest Americans. But Ms. Soldano’s efforts — funded in part by
the Mars and Koch families — laid the groundwork for a one-year
elimination in 2010.
The
tax has been restored, but currently applies only to couples leaving
roughly $11 million or more to their heirs, up from those leaving more
than $1.2 million when Ms. Soldano started her campaign. It affected
fewer than 5,200 families last year.
“If anyone would have told me we’d be where we are today, I would never have guessed it,” Ms. Soldano said in an interview.
Some of the most profound victories are barely known outside the insular world of the wealthy and their financial managers.
In
2009, Congress set out to require that investment partnerships like
hedge funds register with the Securities and Exchange Commission, partly
so that regulators would have a better grasp on the risks they posed to
the financial system.
The
early legislative language would have required single-family offices to
register as well, exposing the highly secretive institutions to
scrutiny that their clients were eager to avoid. Some of the I.R.S.’s
cases against the wealthy originate with tips from the S.E.C., which is
often better positioned to spot tax evasion.
By
the summer of 2009, several family office executives had formed a
lobbying group called the Private Investor Coalition to push back
against the proposal. The coalition won an exemption in the 2010
Dodd-Frank financial reform bill, then spent much of the next year
persuading the S.E.C. to largely adopt its preferred definition of
“family office.”
So
expansive was the resulting loophole that Mr. Soros’s $24.5 billion
hedge fund took advantage of it, converting to a family office after
returning capital to its remaining outside investors. The hedge fund
manager Stanley Druckenmiller, a former business partner of Mr. Soros,
took the same step.
The
Soros family, which generally supports Democrats, has committed at
least $1 million to the 2016 presidential campaign; Mr. Druckenmiller,
who favors Republicans, has put slightly more than $300,000 behind three
different G.O.P. presidential candidates.
A
slide presentation from the Private Investor Coalition’s 2013 annual
meeting credited the success to multiple meetings with members of the
Senate Banking Committee, the House Financial Services Committee,
congressional staff and S.E.C. staff. “All with a low profile,” the document noted. “We got most of what we wanted AND a few extras we didn’t request.”
A Hobbled Monitor
After
all the loopholes and all the lobbying, what remains of the
government’s ability to collect taxes from the wealthy runs up against
one final hurdle: the crisis facing the I.R.S.
President Obama has made fighting tax evasion by the rich a priority. In 2010, he signed legislation making it easier to identify Americans who squirreled away assets in Swiss bank accounts and Cayman Islands shelters.
His
I.R.S. convened a Global High Wealth Industry Group, known colloquially
as “the wealth squad,” to scrutinize the returns of Americans with
incomes of at least $10 million a year.
But
while these measures have helped the government retrieve billions, the
agency’s efforts have flagged in the face of scandal, political pressure
and budget cuts. Between 2010, the year before Republicans took control
of the House of Representatives, and 2014, the I.R.S. budget dropped by
nearly $2 billion in real terms, or nearly 15 percent. That has forced
it to shed about 5,000 high-level enforcement positions out of about
23,000, according to the agency.
Audit
rates for the $10 million-plus club spiked in the first few years of
the Global High Wealth program, but have plummeted since then.
The
political challenge for the agency became especially acute in 2013,
after the agency acknowledged singling out conservative nonprofits in a
review of political activity by tax-exempt groups. (Senior officials
left the agency as a result of the controversy.)
Several
former I.R.S. officials, including Marcus Owens, who once headed the
agency’s Exempt Organizations division, said the controversy badly
damaged the agency’s willingness to investigate other taxpayers, even
outside the exempt division.
“I.R.S.
enforcement is either absent or diminished” in certain areas, he said.
Mr. Owens added that his former department — which provides some
oversight of money used by charities and nonprofits to further political
campaigns — has been decimated.
Groups
like FreedomWorks and Americans for Tax Reform, which are financed by
the foundations of wealthy families and large businesses, have called
for impeaching the I.R.S. commissioner. They are bolstered by
deep-pocketed advocacy groups like the Club for Growth, which has aided
primary challenges against Republicans who have voted in favor of higher
taxes.
In
2014, the Club for Growth Action fund raised more than $9 million and
spent much of it helping candidates critical of the I.R.S. Roughly 60
percent of the money raised by the fund came from just 12 donors,
including Mr. Mercer, who has given the group $2 million in the last
five years. Mr. Mercer and his immediate family have also donated more
than $11 million to several super PACs supporting Senator Ted Cruz of Texas, an outspoken I.R.S. critic. and a presidential candidate.
Another
prominent donor is Mr. Yass, who helps run a trading firm called the
Susquehanna International Group. He donated $100,000 to the Club for
Growth Action fund in September. Mr. Yass serves on the board of the
libertarian Cato Institute and, like Mr. Mercer, appears to subscribe to
limited-government views that partly motivate his political spending.
But
he may also have more than a passing interest in creating a political
environment that undermines the I.R.S. Susquehanna is currently
challenging a proposed I.R.S. determination that an affiliate of the
firm effectively repatriated more than $375 million in income from
subsidiaries located in Ireland and the Cayman Islands in 2007,
activating a large tax liability. (The affiliate brought the money back
to the United States in later years and paid dividend taxes on it; the
I.R.S. asserts that it should have paid the ordinary income tax rate, at
a cost of tens of millions of dollars more.)
In
June, Mr. Yass donated more than $2 million to three super PACs aligned
with Senator Rand Paul of Kentucky, who has called for taxing all
income at a flat rate of 14.5 percent. That change in itself would save
wealthy supporters like Mr. Yass millions of dollars.
Mr. Paul has suggested going even further, calling the
I.R.S. a “rogue agency” and circulating a petition in 2013 calling for
the tax equivalent of regime change. “Be it now therefore resolved,” the
petition reads, “that we, the undersigned, demand the immediate
abolishment of the Internal Revenue Service.”
But even if that campaign is a long shot, the richest taxpayers will continue to enjoy advantages over everyone else.
For
the ultra-wealthy, “our tax code is like a leaky barrel,” said J. Todd
Metcalf, the Democrats’ chief tax counsel on the Senate Finance
Committee. ”Unless you plug every hole or get a new barrel, it’s going
to leak out.”
Geen opmerkingen:
Een reactie posten