Everybody’s heard of tax shelters, but few U.S. citizens could tell you what they are, how they operate or what they cost the U.S. every year in lost tax revenue. Which is curious. Current U.S. Treasury Department estimates place lost tax revenue from individual tax payers due to foreign tax shelters at $70 billion a year. By comparison, the Department of Defense spent about $80 billion last year on the wars in Iraq and Afghanistan. In other words, if the U.S. simply collected the taxes that the ultra-rich, who are the prime beneficiaries of these tax shelters, owed, we could pay better than 87 percent of the cost of the Iraq and Afghanistan conflicts without raising tax rates a single penny. Instead, we pay for them by borrowing money, mostly from China, and then paying our new Chinese masters interest on that debt. When it comes to class warfare, tax shelters are weapons of mass destruction.
So why don’t we hear more about the economic cost of tax shelters? I can’t say for sure, but I have a theory. We’ve all had the myth of the “liberal media” shoved down our throats for so long that much of the American public takes it on faith that there is a liberal bias to reporting in most mainstream media. And on social issues, even political issues, that may be true. The ultra-rich don’t have ideological hegemony on issues like gay marriage or abortion. But they do when it comes to protecting their wealth. So the billionaires who control the New York Times are no more interested in frequent reporting on tax shelter abuse than are the billionaires who control Fox News or the Wall Street Journal. On pretty much any other story having to do with $70 billion a year in lost federal revenue, I’m certain that one side of the spectrum or another would be banging the drum, loudly and often. But on the issue of tax shelters, they are strangely and unanimously quiet.
But I digress.
So how do these tax shelters work? They come in infinite and creative varieties, but essentially they do one of two things – they hide assets and/or income that would normally be subject to U.S. tax from the IRS or they create paper losses that offset real gains on which tax otherwise would be owed.
Tax shelters stem from the fact the any sovereign nation is allowed to create and enforce its own laws governing taxation. And what some nations choose to do is enact laws that place very low, or even no, tax rates on certain types of income or assets, on top of which they pass laws that shelter the owners of that income or those assets from inquiries from taxing authorities outside their borders.
If you’re a One Percenter in the U.S. (or more likely a one-tenth-of-one-percenter) with an estate of, oh, half a billion dollars, that estate is likely generating at least $50 million a year in taxable gains or income. So you transfer ownership of those assets to a shell corporation in one tax shelter nation, which in turn distributes those varied assets out to other shell corporations and trusts in other tax shelter nations; you drop a few hundred grand to get one of the Golden Circle firms in our country’s secretive but very lucrative wealth defense industry to write you up a nice mess of Tax Opinion Letters which wind their way in and out of a few hundred of the Byzantine nooks and crannies of our ridiculously over-complex tax code and swear that everything is on the up-and-up; and, if and when the IRS decides to take a peek at your arrangement, they conclude that they will only ever collect anything after a decade or more of incredibly expensive litigation, and even then they may lose, and so they either take a pass, or they settle with you for a tiny fraction of what you would have paid if you’d just left your assets in the good old U.S. of A., and then they put out a press release swearing they are cracking down on abusive tax shelters and touting the couple hundred grand they got you to cough up, never mentioning that you probably should have paid upwards of $10 million.
Or maybe you do this. You buy offsetting options for premiums in the same amount as the gain you want to eliminate. Say you’re going to owe taxes on $10 million in income. First, you pay $10 million in premiums for a put option on some not-particularly- volatile item, say a stable currency. Then, you pay $10 million in call options for the exact same item and with the exact same effective dates. Since the options offset each other, the net effect of the transaction is zilch – you come out of it right where you went in, minus negligible (too you) transaction costs.
Now comes the fun part. Your Golden Circle firm sets up a partnership, and you transfer your options into that partnership. Your Golden Circle buddies have Tax Opinion Letters that swear up and down that the value of your partnership interest is equal to the value of your contributed call option, or $10 million. So, you now don’t own the put or the call, you just own a partnership valued at $10 million, but for which you’ve paid nothing. The partnership executes the offsetting calls and puts, meaning your partnership earnings are zero, since the instruments exactly offset. So you sell that partnership interest, for which you paid zero, but which is valued at $10 million, for zip, zilch, nada. And then you claim a $10 million dollar loss on the value of your partnership – which offsets the $10 million in income you were worried about.
You’ve done exactly what you set out to do – engaged in a series of economically meaningless transactions that create an artificial loss. Technically, that’s tax fraud. But again, you’ve got documents from some really good lawyers citing dozens of odd little tax code sections – sections that some really high priced lobbyists probably worked very hard to get enacted and that generated very little attention at the time because most people couldn’t understand them and, since they could only every really apply to an infinitesimal number of taxpayers anyway, nobody cared.
So, again, the IRS takes a peek, does its cost/benefit voodoo, and shows its ass.
This kind of thing goes on all the time, year in and year out. And yeah, some smart guy out there is gonna say “No, the IRS has identified these sorts of shelters as abusive and requires that they be listed. You pull this kind of shit now, you are asking for trouble.” Yeah, right. The IRS declares a specific structure abusive, and the financial propeller heads devoted to helping the rich avoid taxes tweak it just a touch and write a new opinion letter, and the beat goes on.
What to do about it? Well, legislation like FATCA, which the Obama Administration pushed through as part of the HIRE Act in 2010 is a start. It requires U.S. taxpayers and many foreign financial institutions to report on their holdings. No doubt, however, the Golden Circle crowd is already hard at work finding ways around these requirements or is designing new schemes that operate outside its parameters.
The real cure relies on three things. One, slashing and burning the tax code. The tax code’s complexity favors only the wealthy. Regular folk simply can’t afford the kind of advice it takes to dig through its 5.6 million words to design avoidance schemes that work for them. You have to have a ton of money at stake before paying the kind money that type of advice takes makes economic sense.
Second, bite the bullet on enforcement. Where abuse is clearly expected, stop treating justice like an exercise in arbitrage by negotiating small settlements in order to avoid the cost of litigation and the risk of loss. The ultra-rich are using litigation to blackmail the IRS into settlements. Go to the matt. That means not just collecting the money owed, plus interest and penalties, that also means going for fraud convictions and jail time.
Third, revise the statutes to make the penalties fit the crime. The ultra-rich are willing to take abusive positions now because they have relatively little downside. The average bank robber gets away with about $2,500 and can face 20 years or more in prison. So how much should somebody who robs the U.S. of $10 million or more get? I bet if there was a mandatory 20-year sentence for tax fraud in excess of, say, $1 million, the ultra-rich would be less enthusiastic about their shenanigans. And make it mandatory for the IRS to pursue ANY case involving $5 million or more all the way to trial. Let the blackmailers know up front that negotiation will not be an option. If they want to play at the big table, then they are all in, and if they don’t win, they will be counting their losses in the big house.