House ready to feed Wall Street bull

Tax loop­holes for Wall Street’s wealth­i­est loom in House bill

Sunday Star - - BUSINESS -

NEW YORK (TNS) — Law­mak­ers who sped a bill through the U.S. House last week may have handed a few more good­ies to Wall Street’s wealth­i­est than they re­al­ize.

In­vestors in bil­lion-dol­lar hedge funds might be able to take ad­van­tage of a new, lower tax rate touted as a break for small busi­nesses. Pri­vate equity fund man­agers might be able to side­step a new tax on their earn­ings. And a com­bi­na­tion of pro­posed changes might al­low the chil­dren and grand­chil­dren of the very wealthy to avoid in­come taxes in per­pe­tu­ity.

Th­ese are some of the quirks that tax ex­perts have spot­ted in the bill passed by the House on Nov. 16, just two weeks af­ter it was in­tro­duced. Whether they were in­ten­tional or ac­ci­den­tal, it will be up to con­gres­sional tax writ­ers to keep or re­vise them be­fore a fi­nal bill makes it to Pres­i­dent Don­ald Trump’s desk — as­sum­ing both cham­bers can work out a com­pro­mise. Se­nate lead­ers plan to vote on their own ver­sion of tax leg­is­la­tion by the end of this month.

“There sure are a lot of glitches and loop­holes, in large mea­sure be­cause there’s so much com­plex­ity in this bill that’s be­ing raced through,” said Steven Rosen­thal, a se­nior fel­low with the Ur­ban-Brook­ings Tax Pol­icy Cen­ter, a Wash­ing­ton pol­icy group.

Loop­holes aside, the big­gest fea­tures of the Repub­li­can tax plans in both cham­bers bear a mix of news for wealthy in­vestors.

The good: a po­ten­tial cut in the top mar­ginal in­come tax rate; big cuts in busi­ness taxes; an end to the al­ter­na­tive min­i­mum tax; and a cut or re­peal of the es­tate tax. The bad: lim­its or the out­right end of in­di­vid­ual de­duc­tions for state and lo­cal taxes and tax hikes on the debt fi­nanc­ing that fu­els pri­vate equity deals. The loop­holes are deep in the de­tails. The House bill con­tem­plates a ma­jor shift in how most Amer­i­can busi­nesses are taxed. Right now, prof­its from “pass-through” en­ti­ties, like sole pro­pri­etor­ships and part­ner­ships, show up on their owners’ in­di­vid­ual in­come taxes. The House bill re­places that with a new, 25 per­cent top tax rate on pass throughs’ busi­ness in­come. Sup­port­ers de­scribe the change as a boon for small busi­ness owners, a way to keep them rel­a­tively even with cor­po­ra­tions, which stand to see their tax rate drop to 20 per­cent from 35 per­cent.

The bill’s drafters prob­a­bly didn’t mean for in­vestors in part­ner­ships like hedge funds to use the new pass-through rate, ac­cord­ing to David S. Miller, a tax part­ner at Proskauer Rose LLP in New York. Cap­i­tal gains, the kind of in­come th­ese funds tend to gen­er­ate, would be ex­cluded.

But there may be a workaround. In a note pub­lished on Nov. 13, Miller high­lights what he calls “an un­usual set of draft­ing glitches.”

Here’s how it would work, ac­cord­ing to Miller: A fund could choose to be taxed the same way a se­cu­ri­ties dealer is. It would have to mark its port­fo­lio to mar­ket reg­u­larly and record any prof­its as or­di­nary in­come. Do­ing so would al­low it to char­ac­ter­ize the money it makes as “busi­ness in­come” rather than in­vest­ing in­come, and qual­ify for the pass-through rate.

For a hedge fund that gen­er­ates short­term cap­i­tal gains, this strat­egy could have the ef­fect of drop­ping an in­vestor’s tax rate to 25 per­cent from 39.6 per­cent. The man­ager of the fund prob­a­bly wouldn’t get the full ben­e­fit, Miller said.

The Se­nate plan, which is still un­der dis­cus­sion and hasn’t yet been put into leg­isla­tive lan­guage, would over­haul taxes for pass-through busi­nesses in a com­pletely dif­fer­ent way.

An­other pro­vi­sion in the House bill is aimed squarely at fund man­agers. It tar­gets the so-called car­ried in­ter­est tax break that Trump called for end­ing dur­ing his cam­paign when he said “hedge fund guys are get­ting away with mur­der.”

Hedge fund and pri­vate equity man­agers typ­i­cally get some of their pay in the form of car­ried in­ter­est — a per­cent­age of their in­vestors’ prof­its. Un­der cur­rent law, if those

un­der­ly­ing prof­its stem from in­vest­ments held for more than a year, the man­agers en­joy the same pref­er­en­tial, lower rate on the car­ried in­ter­est that their clients pay on their in­vest­ments.

The House bill pre­serves this break, but lim­its it by ex­tend­ing the hold­ing pe­riod from one year to three.

Even that tax hike might be avoid­able, ac­cord­ing to Monte Jackel, a se­nior coun­sel at Akin Gump Strauss Hauer & Feld LLP. Jackel notes that the pro­vi­sion doesn’t ap­ply to cor­po­ra­tions that hold car­ried in­ter­est. So a fund man­ager could col­lect his car­ried in­ter­est through a type of cor­po­ra­tion that doesn’t it­self pay taxes.

“It looks like that’s what they’ve writ­ten,” Jackel said, adding that it’s the type of dis­crep­ancy that’s likely to get fixed once some­one no­tices it. The Se­nate is work­ing on a sim­i­lar change in car­ried-in­ter­est tax­a­tion, but hasn’t re­leased de­tailed lan­guage.

An­other quirk in the House bill is so glar­ing that Richard Levine, a spe­cial coun­sel at Withers Bergman LLP in New Haven, Con­necti­cut, says he can’t be­lieve it was ac­ci­den­tal. This one in­volves the es­tate tax, a 40 per­cent levy that ap­plies to the es­tates of a few thou­sand of the rich­est Amer­i­cans each year.

The House bill would limit the tax to even fewer es­tates right away, and then elim­i­nate it en­tirely in 2025. But it leaves in place a re­lated mea­sure that al­lows heirs to sell as­sets with­out hav­ing to pay in­come tax on the ap­pre­ci­a­tion that took place be­fore they in­her­ited them.

Taken to­gether, that means that a fam­ily whose for­tune de­rives from a longheld as­set — think War­ren Buf­fett’s Berk­shire Hath­away Inc., or the Wal­ton fam­ily’s Wal­Mart Stores Inc. — might never have to pay tax on the bulk of that wealth at all. The found­ing gen­er­a­tion could bor­row against the stock to meet ex­penses, and the next gen­er­a­tion could sell it in­come tax-free.

The last time the es­tate tax was re­pealed, dur­ing the sin­gle year of 2010, Congress changed the rules on in­her­ited as­sets to avoid this re­sult, said Robert Gor­don, who ad­vises clients on the tax im­pli­ca­tions of in­vest­ments at Twenty-First Se­cu­ri­ties Corp. in New York.

He pre­dicted the same thing will hap­pen this time, but that it’s be­ing held back as a ne­go­ti­at­ing tac­tic. (The Se­nate bill would limit the es­tate tax to fewer peo­ple but not re­peal it.)

Levine helps wealthy in­di­vid­u­als with tax plan­ning, and he said the House pro­posal is “very wel­come for my clients.”

“As a mat­ter of tax pol­icy it’s com­pletely in­de­fen­si­ble,” he said. “It per­mits in­come that is ob­vi­ously in­come, in a con­sti­tu­tional sense, to go en­tirely un­taxed.”


The Wall Street Bull, lo­cated in the fi­nan­cial dis­trict.

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