What would the Republican tax plan do to tax-minimizing schemes used by wealthy people? It would make some irrelevant, kill off a few and leave many unchanged. Herewith, a survey of the damage.
It must be noted, first, that passage of the bill released Thursday morning is problematic. Its giant gift to the superwealthy means that no Democrat will vote in favor, and its mauling of taxpayers from California, New York and New Jersey means that a critical number of Republicans will balk as well.
The document is nonetheless a useful look at the thinking of loophole-closers. The techniques they want to eliminate are probably doomed—if not now, then a few years later in some other reform bill. The techniques they didn’t target may live on for quite a while.
The analysis here is based on a 76-page summary put out by the House Ways & Means Committtee. It may miss some subtleties buried in the 429-page bill.
Step-up. Under existing law, your family gets off scot-free on capital gains that remain unrealized at your death. The tax bill leaves this one in place. Somewhat remarkable, since the bill would also lighten the estate tax. (The exemption would double to $10 milllion immediately; in time, the federal death tax would disappear.)
Gifts of appreciated property. If you buy stock for $10,000 and give it to charity when it’s worth $26,000, you get a deduction for $26,000 and the $16,000 of gain is never taxed. This gimmie, of huge importance to charities, is left untouched.
Gifts to relatives. You give the $26,000 of appreciated Apple shares to your low-bracket daughter and let her sell it. Still works; the $14,000 gift tax exclusion (doubled for a couple) would remain in place and there seems to be nothing attacking intra-family transfers.
Like-kind exchange. You have an apartment building with a tax basis of $1 million that is now worth $3 million. You can swap it for a $3 million office building and postpone the capital gain tax. This gimmick, much favored by developers, would suffer a tiny nick by being disallowed on property other than real estate. But that won’t matter. How often do you want to swap an appreciated rail car for 12 vending machines?
Stretchout IRA. Now: You can leave your $100 million retirement account to your grandchildren, to be kept running over their lifespans. The bill appears not to adopt the recent proposal to cut this process short five years after you die.
Roth carve-up. Now: You can split up a pretax IRA and do Roth conversions on the pieces. You might, for example, carve a $100,000 IRA into two $50,000 accounts, investing one in a bullish ETF for Treasury bonds (TLT) and the other in a bearish Treasury fund (TBT). One goes up over the next year and the other down. You “recharacterize” the loser, turning it back into a pretax account.
The bill would end this game by repealing the right to recharacterize.
Dividends and capital gains. The bill leaves in place the top rate on dividends and capital gains, which is now 20% plus a 3.8% investment tax surcharge.
529s. College savings plans are a small benefit for the middle class and a large one for the rich. The bill summary makes no mention of putting an income limit on these accounts. It does include a lecture about the wickedness of abortion.
Strategic Rothification. Grandpa has $500,000 in a pretax IRA and is in a nursing home costing $120,000 a year. Every year his guardian does a $100,000 Roth conversion, absorbing a medical deduction that might have gone to waste.
The bill would kill this option by repealing the medical deduction. But stay tuned. Fans of the deduction might keep it alive.
Serial flipping. Now: If you have an eye for real estate values and some talent as a general contractor you can make $250,000 a year tax-free. Every two years you move, fix up the house you’re living in, and sell it for a $500,000 gain.
The bill would cut you way back. It would allow you that $500,000 home sale exclusion only once every five years, and it would haircut the freebie as your income climbs above $500,000.
Pease. Now: A convoluted surcharge that is disguised as a limit on itemized deductions can add 1.2 percentage points to your marginal tax rate. (Pease was a congressman who had it in for rich people.) The bill would repeal the surcharge. Not counting the 3.8% investment tax, the top rate would go from 40.8% to 39.6%.
HSAs. Now: You get a powerful deduction (one reducing your adjusted gross income) for contributions to health savings accounts. The money compounds tax-free and can be withdrawn tax-free, years later, to cover deductibles and other medical costs. The bill leaves this savings plan undisturbed. A good thing: You might spend several hundred thousand dollars on medicine in your old age.
AMT. The Republicans want to kill the alternative minimum tax. Giveaway to rich people? Not really. It would be more accurate to describe their tax bill as an extension of the AMT to everyone.
The plan is to almost eliminate the deduction for state and local taxes, just as now happens to people who fall prey to the AMT. (A token $10,000 deduction would remain but not many people would bother with it when the new standard deduction is going to be $24,000 for a couple.)
Some really rich people would benefit from the AMT repeal—Texans with oil wells, for example. But the upper middle class will not benefit if the bill is enacted as is. Among other things, the bill would apply the AMT’s tighter limits on mortgage interest to the regular tax.
Alimony shift. Now: Divorcees lower their combined tax bill by passing taxable income, in the form of alimony, from the high-bracket ex to the low-bracket ex. The bill would end this practice.
Share lots. Now: You can maintain separate costs for batches of stock bought on different dates. This feature of the code is sometimes useful in strategies to harvest capital losses. The bill appears not to alter it.
Borrowing a lifestyle. Say you inherit the Empire State Building when it’s worth $1 billion and has a $1 billion mortgage. After a time, the building appreciates to $1.3 billion so you are worth $300 million. How do you spend the money? If you sell the building, you owe capital gain tax. So you don’t do that. You just refinance, pulling out a little equity.
This classic technique explains how wealthy people can live well and pay no income tax. The proposed legislation wouldn’t change this.
Originally published at Forbes