The Case For A Better Wealth Tax February 8, 2019February 7, 2019 Just delete two sections of the tax code and you’re done. As colorfully argued on Seeking Alpha by “Investment Pancake,” a retired American lawyer living in Lisbon: Summary Wealth taxes don’t work. The tax code currently exempts the really big amounts of income entirely from tax. Instead of adding more junk into the tax law, why not take out the two main pieces of junk that exempt all the big money income from tax? You might as well be ringing the dinner gong at the weasel farm. The accountants and tax lawyers come scampering across the linoleum floor, skidding out, claws scratching, as they all go careening around the corner towards the dinner plate. A new wealth tax. Just think of the planning opportunities… and the billable hours appurtenant therewith! Problem. Wealth taxes don’t work. Like estate and gift taxes, wealth taxes amount to little more than a government subsidy paid by wealthy clients to deserving tax planners. . . . Have you ever asked yourself “how does any billionaire with half a brain (or the means to hire someone else’s half a brain) elect to pay zero wealth taxes?” There are precisely three ways: (1) either don’t own the wealth in question; (2) make the wealth less valuable on paper so it draws less wealth tax; (3) or do a combination of both. The “not owning wealth” is the simplest of approach of all — transferring it into a trust or LLC might be a nice start. And then divvy up the ownership in mildly creative ways. Take the illustrative case of a Picasso bought at auction for around $28,000,000. Like many countries in Europe, France and Spain have pernicious-looking wealth taxes, and the owners of this painting [sit] straight in the crosshairs. The fact is, those wealth taxes are about as dangerous as a stuffed alligator. Give the granddaughter (then 2 years old) the right to use the painting in any way she wants for the rest of her lifetime… as long as she doesn’t sell it or rent it out for money. This sort of thing is called a “lifetime estate” in tax-engineering parlance. Then, give grandpa (or his estate) the unrestricted ownership of the painting following the death of the grandchild. You can impress your friends by calling this a “remainder interest.” It isn’t hard to understand why a remainder interest owned by a 68 year old in property currently subject to a life estate owned by a 2 year old is worth just slightly north of diddly squat. What’s the actuarial likelihood grandpa will ever see a dime out of that painting? His estate will get the painting at some point… maybe in a 100 years. Discount that remainder interest to present over a 100 year lifespan of a 2 year old and the value of that wealth is miniscule. And what of the value of baby’s lifetime right to look at the painting? I’ll put it to you this way. You can go to the National Gallery in Washington, DC (when there isn’t a government shutdown) and look at as many Picasso paintings as you like all day, every day… for free. So you get the picture. This $28,000,000 is now worth close to zero. Or should I say, the various ownership interests of the painting in the hands of various European taxpayers who might otherwise have had to pay wealth taxes on that painting is remarkable similar to the number zero. Plenty of billable hours, too, churning out all the relevant paperwork. Funny thing, but I think the legal bill was probably substantially higher than the wealth tax bill that actually got paid. Wealth taxes. Oh puuuuulease. What are you going to do? Tax people when the value of their stock portfolios are going up? What happens when the value of the portfolio drops? Do you give them a wealth tax refund? Do you really want Uncle Sam to be writing put options and handing them out to wealthy taxpayers? Here is a novel idea. Instead of taxing billionaires’ wealth, why not tax their income instead? Unlike we do now. Did you know that the really significant income earned by billionaires goes entirely and permanently and LEGALLY untaxed? I’m really not kidding. Look. You know how most billionaires make the big money. It isn’t salary. Not dividends. Not interest. It’s capital gains. If I buy (or start) a business for $100, and the value of my interest in the company explodes into the billions, I assure you that I am better off financially than I was back when I invested that $100. If I don’t want to trigger any capital gains tax, no worries. I can take loans out, secured by my highly appreciated stock. And when I die, what happens to the value of all that appreciation? It permanently escapes income tax, thanks to Section 1014 of the Internal Revenue Code. Section 1014 of the Internal Revenue Code provides what’s called a “step up” in the basis of that stock. So literally, that $999,999,900 of income I’ve enjoyed (and that my heirs will enjoy) is never going to draw one thin dime of income tax, ever. How does that make any sense? It doesn’t! It’s a gimme for rich people, plain and simple. So you don’t need a wealth tax. All you need is a dude with a red pen to come over and cross Section 1014 out of the Internal Revenue Code. And you’re done. And no, this isn’t some kind of complicated legal mumbo jumbo I’m suggesting. I’m simply saying to repeal one single section of the tax law so that you or your estate pay income tax on capital gains that you’ve enjoyed during your lifetime. [And now for the other simple tweak.] Hey, careful not to spit coffee out all over your diamond studded ascot while you read this, but I’ve got some great news for you. I am going to give you a free gift of $1,000,000,000. Hurray! So how does it feel to be a newly minted billionaire? Do you feel wealthier? Does it feel like you just got $1,000,000,000 of income? This is not a trick question. I won’t blame you if you think that you have “income” because your wealth increases. Wrong! You can thank Section 102 of the Internal Revenue Code, which provides that gifts and inheritances are…. get this…. not income. That’s right. That’s $1,000,000,000 tax-free for you, my friend. Don’t spend it all in one place. How does this even make sense? You win a $1,000,000,000 lottery, you pay income tax. You get dividends, you pay tax. Interest? You pay tax. You work your tail off and earn a salary that is a tiny fraction of $1,000,000,000, you pay tax. But you sit around doing nadda and you stumble into a gift of $1,000,000,000…. and pay no income tax????? Tell me why that makes any sense at all. So skip all this talk about wealth taxes that don’t actually work, shall we? Bring forth the dude with the red pen to cross out Section 102. It is not complicated tax law mumbo jumbo. If you get free money, you pay income tax on it — just like you pay tax on money that didn’t come free. I honestly can’t understand why anyone is talking about wealth taxes, and why nobody is talking about just taxing income, instead. They make it sound like you need some kind of a PhD in tax law to understand how and why billionaires pay little to no taxes, but as you now can see, that’s a lie. You know every single thing that you need to know about how to fix the tax code so everyone pays income tax on income. Repeal Sections 1014 and 102. Done. Simple. Voila. Have a great weekend!