As Congress advances Democrats’ tax plans, the wealthy eye loopholes

As Congress looks to advance its $1.75 trillion spending package this week, wealthy individuals are already planning ways to avoid paying for it.

Lawmakers are expected to vote on Democrats’ social spending bill in the US House of Representatives this week, laying the groundwork for the Senate to take it up.

The package would be the biggest expansion of the US safety net since the 1960s, and Democrats propose paying for it by levying a 5 per cent surtax on individuals with more than $10 million in annual income and an additional 3 per cent tax on individuals with more than $25 million in annual income.

While the White House says the new surtax could generate $230 billion to pay for the spending bill, experts and bankers say that many individuals will find ways to avoid it and that it will raise less than an earlier proposal for a billionaires tax.

“Even though on paper the bill looks like it increases sharply the taxes on ultra-millionaires, in reality, it’s not going to have as much bite,” said Emmanuel Saez, professor of economics at the University of California at Berkeley.

The proposed billionaires tax, targeting roughly 700 Americans, commanded headlines in recent weeks and elicited frustration from the world’s richest man, Elon Musk.

That proposal, which taxed unrealized share gains, was ditched after moderate Democrats opposed the plan, arguing it unfairly targeted wealth creators.

Despite that, Musk sought to get ahead of any future Democratic plans to hike taxes by selling $6.9 billion in Tesla Inc (TSLA.O) stock last week.

The exact details of the bill that the House will vote on are not yet known. Bankers, lawyers and academics expect it to include the White House’s proposal for the up-to-8 per cent surtax, but not the billionaires tax.

The surtax is straightforward for wealthy taxpayers to plan around, said Alvina Lo, chief wealth planner at Wilmington Trust.

“The goal is to get your modified adjusted gross income below the threshold and the tax does not apply,” Lo said.

The billionaires tax, in contrast, “would have been very difficult to avoid,” said Comerica Bank’s national director of wealth planning, Lisa Featherngill.

That levy would have applied to individuals with assets worth more than $1 billion or who earned more than $100 million for three years straight. To avoid paying the tax, individuals would have had to reduce their income or assets by at least half.

“If you have a billion in assets, getting to $500 million is not easy,” Featherngill said.

S CORPS AND C CORPS

Some wealthy people are looking to bring their personal income below the $10 million threshold for 2022 by shifting earnings they receive through so-called S corporations or pass through tax structures to C corporations.

S corporations are popular with Wall Street investors and owners of private equity firms and hedge funds. That is because the structure allows them to declare their earnings from the business as personal income – avoiding the additional layer of corporate income tax.

In the proposed bill, S corps are taxed at a top rate of 48.8 per cent at the federal level, and at over a 60 per cent rate in California and New York when adding state income taxes.

By switching their S corporation tax structures to a C corporation, wealthy individuals should be able to keep their annual personal income below the $10 million threshold – although the downside is those earnings must be retained in the business, where they will pay a corporate tax of 21 per cent.

STOCK SALES

Wealthy individuals are also selling stock this year before the surtax takes effect and planning to spread out future stock sales over several years to avoid hitting the $10 million-surtax threshold, bankers say.

Individuals will still pay capital gains and investment income taxes totaling up to 23.8 per cent, but that is less than the 31.8 per cent tax the highest income earners could pay next year overall if the spending bill is passed, Lo said.

It is not clear if Democratic lawmakers are aware of the potential loopholes.

Frank Clemente, executive director of Americans for Tax Fairness, said the tax surcharge was a “big improvement,” but not enough.

“The millionaires surtax does not fix the problem of unrealized capital gains,” he said. “The billionaires income tax, on the other hand, would solve the scandal of tax-free billionaires.”