A Tax Break for the Rich Who Can Keep a Secret New York Times September 10, 2002 By DAVID CAY JOHNSTON
When most Americans sell stock they must pay taxes on their profits by the following April 15. But a few Americans are delaying taxes on their stock profits for years or decades - or, in some cases, never paying at all. It's all perfectly legal - but only if you have $5 million of stocks and bonds. And only if you promise to keep it secret. It's one example of how the tax laws currently grant certain favors only to the very wealthiest. The deals work this way: Executives and investors with $5 million of stocks and bonds contribute at least $1 million of their stock in a single company to a pool into which others in the same situation contribute their own shares. In return they receive shares of a partnership that owns the pool. When they are ready to withdraw from the pool, the partnership gives them not their original shares or cash but instead shares of a variety of stocks held by the pool. As a result, someone with too much money in one stock can quickly diversify into a more balanced portfolio. But unlike other investors, who have to pay taxes on profits when they sell a stock, no taxes are owed on the profits of the shares contributed to the pool. If investors stay in the pool for seven years, the stocks they get when they withdraw their investment do not incur the tax on investment profits that other investors must pay. Only if the investors then sell the various stocks they received from the pool are they supposed to pay taxes. Those taxes are by law owed on their investment profits all the way back to the time they bought the stock that they put into the pool. But cheating is easy because the investors can merely report only the profit made since they took back the stocks from the pool. An Internal Revenue Service auditor would have to know about the pool, and do a lot of work, to determine the full profit made on the original stock contributed to the pool. The Eaton Vance mutual fund company in Boston and the Goldman Sachs investment house are by far the biggest operators of investment pools based on this tax avoidance technique, with at least $18 billion of stocks in what are known in the investment business as exchange funds or swap funds. Smaller exchange funds are operated by investment firms that include the Bessemer Trust, Credit Suisse First Boston, Merrill Lynch and the Salomon Smith Barney brokerage unit of Citigroup. To get in on these tax avoidance deals, investors must sign statements promising never to disclose the terms to anyone except their financial advisers. But the confidential offering for one such deal was provided to The New York Times by one investor and separately by two Washington tax experts to whom the document was leaked. They said they were offended by tax avoidance available only to the very rich. ... Fewer than one in 1,900 Americans qualify for exchange funds according to current rules, said Professor Edward Wolff, a New York University expert on wealth. The exchange funds are but one of a variety of techniques available only to the very wealthy to delay or escape taxes on their investment profits. Other techniques include certain kinds of insurance and offshore trusts. ... Some years ago the exchange funds came to the attention of Representative Richard E. Neal, a Massachusetts Democrat. He introduced legislation to stop them. But the legislation never went anywhere. Eaton Vance, in a report to Mr. Neal last year, said its exchange funds "are not tax shelters" and "benefit our markets and our society" because they provide "risk reduction that otherwise would not be achieved." ... No one knows how much exchange funds cost the government in taxes because no official study of their costs has been made. But the Eaton Vance and Goldman Sachs exchange funds alone represent as much as $3.6 billion of deferred capital gains taxes at current rates. The Congressional Joint Committee on Taxation, without any supporting data, has written Mr. Neal to say that no revenue would be raised by closing exchange funds because "the class of investors engaging in swap funds" would find other ways to avoid the tax. Mr. Neal said he pressed Mark A. Weinberger, who until recently was the chief tax policy official at the Treasury Department, about why the Bush administration would not shut down exchange funds as loopholes, which the administration had said it opposed on principle. Mr. Weinberger, the congressman said, replied that the Bush administration "is not for or against swap funds, but we are against taxes on capital gains in general and so we will not take any action against the funds." Mr. Weinberger, who has returned to the Ernst & Young accounting firm, and is now its vice chairman, said that he recalled making much less-definitive remarks, but did confirm that he said that the administration had not developed a position on exchange funds. A Treasury spokeswoman, Tara Bradshaw, said the Bush administration was not currently considering any action on exchange funds and therefore had no policy position on them. ****** End of article. I've left some paragraphs out so if anyone wants the entire article, let me know and I'll send it privately. Debra Shea
