The loophole language of the ‘Swiss cheese’ tax code could benefit from an overhaul
Last December, I chaired a hearing of our Ways and Means Oversight Subcommittee on Hidden Wealth in America. I was shocked by what I heard.
The Pandora Papers investigation revealed the secret assets of 130 billionaires in 45 countries. Building on this landmark work, our hearing further unmasked a vast network of shelters used by America’s wealthiest families. We have shown that they do it here, on our shores.
It was once a caricature that huge fortunes were deposited exclusively in remote places like Zurich and the Caribbean islands. But today the United States has become a magnet for the same people trying to hide their millions. That the United States has become an international tax haven is a stunning indictment of our own laws, both federal and state.
At the federal level, outrageous loopholes exploited by the wealthy have not been closed by Congress. At the state level, some states have gone to great lengths to craft laws to attract hidden money.
Sparsely populated states like South Dakota and Wyoming have become the Grand Cayman of the prairie by enacting laws that are nothing less than open invitations to wealthy families to hide their money in the Great Plains. My fear is that more states will seek to emulate these outliers while facilitating the titanic tax avoidance of our wealthiest citizens. And there is no doubt that our federal government’s inaction makes it easier for states and citizens to build tax shelters.
Unfortunately, there is no single way that well-to-do Americans avoid paying their tax bills; the arsenal of tools at their disposal is vast and varied. Taken in broad strokes, the tax code can look like a block of Swiss cheese.
I have been a member of the tax drafting ways and means committee for 15 years. I know the best and worst aspects of code, and there are a few doozies. But for my money, the worst loophole in the entire federal tax code is the so-called hard base loophole. Often the opaque names used by politicians and economists don’t adequately reflect the importance of a topic, which is why I call this loophole the billionaires’ bonanza.
In a nutshell, this loophole is the first choice of wealthy families to protect their gigantic inheritances from taxes. The Reinforced Foundation is the means for families to continuously pass prosperity from one generation to the next without touching it. Because it avoids the payment of a gain on asset appreciation, inherited wealth grows exponentially.
The strengthened base is a key factor in the growing chasm between the top 1% and everyone else. This Congress, I have been the main sponsor of legislation (HR 2286) to close the loophole. I will continue to offer it until Congress finally passes the reform.
But even as we wait for Congress, the executive can act to limit abuses of the hard base. The Treasury Department can use existing law to take targeted action to close the preferred loophole of wealthy Americans.
Item 1014 of the Internal Revenue Code provides that the basis of property acquired from a deceased parent or grandparent, for example, is the fair market value at the death of the deceased. Property is eligible for this treatment if it is acquired by bequest, will or inheritance. Assets included in a deceased’s estate for federal estate tax purposes are also eligible for intensified basic treatment. Thus, under the language of the code, assets outside of an estate in an irrevocable trust do not qualify for intensified basic treatment.
Nonetheless, evidence on record at our hearing revealed that aggressive estates circumvent legal language and exploit billionaire windfalls by arguing that the termination of an irrevocable trust on the death of the settlor should be treated as a “legacy”. or “design” under Section 1014.
It seems surprising that it worked, but the use of this technique is successful because the Treasury has not issued regulations explicitly prohibiting abuse of the loophole. Refusal to enact regulations means that taxpayers do not have to disclose that they have taken an enhanced base. Therefore, the IRS is unable to know whether a trust or its beneficiaries who sell their assets claim the benefit, allowing them to pocket even more. So, I’ve asked Treasury Secretary Janet Yellen to proactively issue regulations that put an end to this abuse of the code.
It wouldn’t require much – just a clarification by the Biden administration that the phrase “bequest, bequest, or inheritance” in section 1014(b)(1) does not apply to termination of trust status. of the settlor on the death of the settlor or the transfer of the property of an irrevocable settlor trust on the death of a settlor. It’s a small measure, and it’s incumbent on us in Congress to completely close tax loopholes so that tax evaders have no wiggle room. But it’s a way that can have a big impact in forcing monetized tax evaders to light.
Stopping tax evasion gimmicks may seem like a molehill, but that doesn’t mean we should give up and give up. America can’t survive long with a two-tier tax code that has one set of rules for the top and another for the rest of us. The wealthiest families cannot be allowed to grow their wealth without paying their fair share.
We must ask ourselves: as Americans, do we want our country to be a model of justice and fairness? Or do we want to become just another parking lot for buried billionaire treasure?
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Bill Pascrell Jr. is a member of the ways and means committee of the tax writing house and chair of its oversight subcommittee. A longtime resident of Paterson, Rep. Pascrell represents Bergen, Hudson and Passaic counties in northern New Jersey.
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