Super-rich: how does this tax avoidance strategy work?

Factual Questions
81

I think the idea is that if you were required to pay income taxes on the gold nugget the year you found it, then the law would almost force you to sell it to pay the taxes. And even if you had and used your savings to pay the taxes, what happens if you sell the gold in five years? If the price of gold has increased or decreased, then you either underpaid or overpaid in taxes. You can’t eat gold or pay for groceries with it, so it seems fair that you only pay taxes once you sell it and the tax bill can be both calculated and paid with the proceeds.

But I do wonder why this same principle isn’t applied if I win a car on a gameshow. I know the taxman wants his payment on the $40k value of the car and not the $500 when I sell it to the junkyard in 15 years, but what is the stated rationale for treating the two things differently?

ETA: But as to the first paragraph, I am remembering something from tax class in law school that income is realized once you have control over the item. So with respect to the gold nugget, I had the ability to sell it when I found it, so why isn’t it considered income in that year?

82

Thanks glowacks! It’s been a long time since I cared about the passive activity rules. One of my jobs in college was working for a broker-dealer that sold real estate LPs. Their primary market was old people still trying to write off passive activity losses they had accrued before the rules were changed in 1986(?). Some had hundreds of thousands in losses they could write off, if I remember correctly, at only $2500 per year against regular income.

In my hypothetical, Bezos is buying shares in an LLC with the proceeds of the loan, and the LLC invests solely in publicly-traded securities. I’m guessing the LLC interests would be subject to the passive activity rules. Since Amazon doesn’t pay dividends, Bezos could only deduct the interest expense for the passive investment if he took capital gains. Thus, to deduct the interest expense, he could sell shares over time, killing two bids with one stone - he could use the proceeds to retire some portion of the debt and cash in just enough to use up the passive activity interest expense each year. Again, I’m not sure this strategy actually works but it seems plausible.

83

That’s my point- until you sell it, it’s just a rock, not some sort of store of wealth that’s taxable.

84

In other words…
https://pics.me.me/haha-bro-im-smarter-than-you-13868169.png

85

A couple of points -

I don’t see a difference between digging up a gold nugget in your back yard, or having a house that is suddenly sitting where Goopple wants to build a new factory, and so is worth $20M instead of $10,000 you originally bought it for. It’s property, but it’s not more money in your pocket/bank account until you sell.

Just to clarify for those of us who don’t work for Goopple Unicorns Inc. - am I understanding this process correctly?

You get a stock option - “Stick around for 5 more years” (or “because you’ve stuck around for 5 years”) …“and we’ll let you buy our shares for $100 each 2 years from now.”
This is not income in any sense. Nothing went into your pocket.
“Vested” simply means you have that right to buy at stated price, they can’t rescind it.

The $15 discussion above was because someone out in Lala Land will say to you “I’ll give you $15 a share to take over those options” because they are speculating (gambling) that $15 today will gain them a lot more in 2 years when the stocks can be bought.
(Sort of like Wimpy’s “I will gladly pay you Tuesday for the price of a hamburger today.”)

If you sell those options, you see nothing more. How is that $15 income accounted for?
If the buyer exercises the option (assuming fine print allows selling the option) then is that considered your income, or is the real transaction presumed to be that you bought the stocks at the $100 and then sold them to the speculator for $100, no income for you?

“Exercise” means when you buy the stock at the option’s stated price?
So if the option said $100 and the stock is $140 market value when you exercise, then the government is considering/taxing the $40 as salary you earned. The other $100 - you are buying a stock so giving the company $100 in return for the (virtual) stock certificate.

You now own a stock that you “paid” $140 for. If you sell for $200 after this then you owe $60 capital gains when you sell.

As I understand it, the government couldn’t give a flying hoot (in general) what you used as loan collateral or how it was valued versus original purchase price, etc. the only question is - if you want to deduct the interest on a loan, the question becomes what was the money from the loan used for?

If I have a share worth $200 and borrow $100 against it as collateral, then when I sell it the bank will want their money back. Since I paid $140 for it, I have to pay the government tax on $60 capital gains and then the bank $100 loan principal repayment?

86

It’s funny, if I worked my butt off to help make your business a rousing success, and you gave me a giant gold nugget instead of money, I’d have to sell it to pay tax. If, instead, I dig up a giant gold nugget, or get it willed to me from a rich aunt, it isn’t ‘fair’ to make me sell it to pay tax.

If I’m not rich, I’m forced to convert my windfall into something I can use to buy groceries, or a decent car, and will then pay tax. If I’m rich, I can keep it tax free for as long as I want, because making me pay tax isn’t ‘fair’.

It’s all a very logical financial set of rules that make sure rich people, and people that don’t work for their money, don’t get stuck paying tax.

87

In the infamous words of hotel-owner Leona Helmsley, “We don’t pay taxes; only the little people pay taxes.”

88

When something changes hands as value in lieu of money, it’s considered the equivalent of selling it and giving the money to the person.

I agree, the anomaly is when a not-yet-valued item like your nugget is inherited. If I inherit my aunt’s Van Gogh, do I have to pay taxes on it? If instead I have a valuable painting willed to me by a famous artist, do I have to pay tax on its fair market value? (I suppose the difference too, is like a professional treasure hunter, a professional artist is actually a business and his products are business output?

OTOH, if great-aunt Cuthberta wills me her mansion or her Amazon shares - then as I understand it. the estate (not me) is taxed on capital gains as if the property were sold at fair market value. The reason they often have to be sold is that the estate cannot come up with sufficient funds, nor can the recipient pay on behalf of the estate in order to keep the bequest intact.

Estate tax is just another extra similar burden, if applicable.

I read somewhere that so many of the magnificent estate manors of England had to be sold (or bequeathed to the National Trust) fo this same scenario - the family that owned them (more specifically, the estate of the dead peer) did not have sufficient funds to pay the inheritance taxes, so the property had to be disposed of.

89

You only pay a federal estate tax if the value of the estate is more than $11.58 million. As noted up-thread, people with that much money almost never pay estate taxes (they arramge things to make sure this does not happen…tax avoidance again).

If your aunt did not arrange things to avoid federal estate taxes and that Van Gogh (and all of the rest of her stuff) was worth more than $11.58 million then yeah…taxes would have to be paid.

If your aunt’s estate was worth $10 million then no federal taxes, enjoy the Van Gogh.

90

[Moderating]

There is no way to read that post, and the image in it, as anything other than a personal attack. This is an official Warning.

91

So what happens if I inherit a painting as part of an estate that everyone(including the IRS) thinks is worthless and don’t pay any estate taxes at that time. Then 10 years later I go get the painting appraised and it turns out to be some masterpiece and sells for $100 million. What taxes would I pay on it?

92

The taxes would be based on the difference between the value at the time you acquired it (worthless=$0) and the price you sold it for ($100M). So if you sold that worthless painting you were bequeathed 10 years earler for $100M, you’d owe taxes on $100M. But if it was valued at $5M when you acquired it, then you’d owe taxes on that $95M difference.

This more commonly happens with houses. You are bequeathed a house. Either you or the estate will need to have it appraised to find out its fair market value, which let’s say is $500,000. You take ownership of the house and don’t pay any taxes. You live in the house for 20 years and then sell for $3M. You would have to pay taxes on the difference between the sales price and the price it was appraised at when you acquired it. (3M - 500k = 2.5M). If instead you bequeath it to your child, the pattern is repeated. They get an appraisal for $3M and take the house without paying any taxes. If your estate is large than the estate may have to pay estate taxes, but the heirs get the property without having to pay taxes on the value.

93

This is why they have entire legal departments. They pay a lot of money for top flight legal services because it saves them way more than they spend. You buy “justice” in this nation, and it’s no different with the laws surrounding tax liability.