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.
By
Noam Scheiber and Patricia Cohen
The New York Times
DEC. 29, 2015
Moreover, each has exploited an esoteric tax
loophole that saved them millions in taxes. The trick? Route the money to
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
The ultra-wealthy “literally pay millions of
dollars for these services,” said Jeffrey A. Winters, a political scientist at
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.
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 substantial
increase in two decades — and an I.R.S. initiative to ensure that, in effect,
the higher rates stick 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 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
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 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
underpaid 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
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
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
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
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 almost $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 — has been decimated.
Groups like FreedomWorks and Americans for
Tax Reform, which are financed partly 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
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
In June, Mr. Yass donated more than $2
million to three super PACs aligned with Senator Rand Paul of
Mr. Paul, also a presidential candididate,
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.”
Nicholas Confessore contributed reporting and
Kitty Bennett contributed research.
A
version of this article appears in print on December 30, 2015, on page A1 of
the