Strategic Communications and Marketing News Bureau

Are the ultrawealthy breaking the law in avoiding taxes?

Reporting from ProPublica put the spotlight on the ultrawealthy’s stealthy ability to avoid taxation on their vast fortunes. Richard L. Kaplan is the Guy Raymond Jones Chair in Law at the University of Illinois Urbana-Champaign and an internationally recognized expert on U.S. tax policy. Kaplan spoke with News Bureau business and law editor Phil Ciciora about the legality of such financial legerdemain.

Based on the reporting, did the ultrawealthy do anything illegal to avoid taxes?

Probably not. All sorts of assets – stocks, bonds, real estate, Bitcoin – fluctuate in value, some days up, other days down, but the U.S. Supreme Court in the Eisner v. Macomber case of 1920 determined that mere fluctuations in an asset’s value do not constitute income. When the asset is sold or exchanged, the gain or loss at that point is said to be “realized” and subject to taxation, but not until then.

Those rules apply to everyone, but the ultrawealthy have the ability to obtain vast sums of cash from their assets without selling them. They can simply borrow and use those appreciated assets as collateral. The U.S. Supreme Court in the famous 1947 Crane v. Commissioner case declared that borrowed funds do not constitute income because they must be repaid and therefore do not represent an increase in wealth. The same principle applies to ordinary people who borrow against their home equity, or who borrow to buy a car or pay for college costs.

Bottom line: Unsold assets and borrowed money do not generate taxable income.

As far as I can tell, the only person who did anything illegal is the person who leaked the tax documents used in the news story.

What implications, if any, does this reporting have for the Biden administration’s tax proposals?

For the most part, the Biden administration’s tax proposals would not affect the results reported in this news story very much. Taxing capital gains as ordinary income would raise the tax rate paid by these billionaires but only to the extent that they sold any assets. No capital gains tax is owed on unrealized profits.

President Biden wants to raise the top income tax rate from 37% to 39.6%, but the Elon Musks and Jeff Bezoses of the world don’t have much income that is subject to tax. Like Steve Jobs, they often take a salary of $1 or some other nominal amount. Raising the top tax rate would hit high-income CEOs, athletes and entertainers, as well as some professionals, but not the people featured in the ProPublica news story.

On the other hand, the Biden administration has resurrected a proposal from the Clinton and Obama administrations to eliminate the so-called “step-up in basis” at death to counter intergenerational wealth inequality. This provision currently allows an heir to treat inherited property as if the heir purchased it for its fair market value when the decedent died. As a result, any gains that accrued during the decedent’s lifetime are never subjected to income tax. The decedent did not sell the asset while alive, and the heir starts with a new stepped-up basis.

Even this proposal, however, would not affect the ultrawealthy who donate their appreciated property to charities, including their private foundations.

The only proposal that would make a serious dent in the results reported by ProPublica would be an annual wealth tax as proposed last year by Sen. Elizabeth Warren, D-Mass. That tax would reach appreciated but unsold gains, but it comes with its own batch of administrative problems and – so far, at least – hasn’t garnered much popular support. That could change, however, as a result of this new report.

Is there any low-hanging administrative fruit that could gain bipartisan support?

The Biden administration’s proposal to boost IRS compliance efforts by giving the agency an additional $80 billion to enforce current tax laws has some serious bipartisan support. Republicans, it should be noted, may dislike enacting new taxes and raising tax rates, but often favor enforcing current law.

Nevertheless, if it turns out that the person who leaked the tax documents works at the IRS, that might change everything. After all, Congress has not funded the IRS at appropriate financial levels for many years following allegations of politically biased audit practices involving tax-exempt organizations. If the leaker worked at the agency, that would further erode trust in the IRS and make increased funding much less likely.

Editor’s note: To contact Richard L. Kaplan, call 217-300-7973; email rkaplan@illinois.edu.

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