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.
Getty Images (L) | CNBC (C) | CNBC (R)
Louis Moore Bacon (L), Daniel Loeb (C) and Steve Cohen (R).
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.
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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.
In the heat of the presidential race, the
influence of wealthy donors is being tested.
At stake are the Obama
administration's limited 2013 tax increase on high earners — the first
in two decades — and 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 taxpayers 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 past 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 income into another
type that's taxed at a lower rate.
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, 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
The rich want to stay rich
Global million dollar donations have dropped by nearly $3 billion in 2014.
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.
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 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 family — 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 past 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.
who the super rich want for
president
Robert Frank takes a look at
republican standings and top choice for president
based on survey results.
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 IRS 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."
http://www.cnbc.com/2015/12/29/for-the-wealthiest-a-private-tax-system-that-saves-them-billions.html
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