The American income tax system is based on the principle that income derived from both work and wealth is taxable. Just as employees pay taxes on their wages, wealthy individuals should pay taxes on their investment gains.
The system works great for taxing employees. Not so much for the taxation of capital gains.
University of Southern California law professor Ed McCaffery describes how America’s rich avoid income taxes in three words: buy – borrow – die.
He’s right. Take Leona Lot, a fictional, super-rich real estate mogul. If she buys an asset, she doesn’t pay any income tax. This part makes sense. If the asset goes up in value and she borrows, Leona still pays no tax. This is where it starts to get a little crazy. But not as crazy as when Leona dies and all that appreciation for income tax purposes disappears. Leona’s kids can sell the asset, pay off the loan, and, well, really well, live off what’s left. Without paying a cent in income tax.
You can also use a portion of these sales proceeds to start the Buy-Borrow-Die process again. What if they die? Yes, more appreciation disappears for income tax purposes. You can leave even more untaxed profits to Leona’s grandchildren. Etc.
Congress has been observing this process for decades. And done nothing.
We’ve got to the point, writes McCaffery, where federal income tax is a tax only for the little people – you know, those who work for a living. It may work for Leona’s grandchildren, but it’s terrible for our country. If all that millionaire income is untaxed, wealth will be concentrated at the top. We now have about 650 billionaires – about 0.0005 percent of our households – sitting on over $ 4 trillion in assets.
One of the things they buy with just a tiny fraction of that trillion is access to our political leaders. That is why Louis Brandeis remarked a century ago, “We can have democracy in this country or we can have great wealth in the hands of a few, but we cannot have both.” Brandeis’ words are just as true today as they were when he spoke them.
But don’t despair. This madness could come to an end.
Senator Chris Van Hollen (D-MD) introduced a law, the Sensible Taxation and Equity Promotion (STEP) Act, that would put an end to Buy – Borrow – Die. Millionaires will still be able to die – we can’t stop that – but under the STEP Act, dying will no longer be an income tax godsend.
Under the STEP Act, when a rich person dies, his estate pays income tax on all of his previously untaxed profits, just as he would have sold his property a month before his death.
Leona’s grandchildren and the rest of the dynastic wealth crowd will no doubt squeal about it. “It’s double taxation!” You’ll scream because about 0.1 percent of American goods are subject to estate tax. But it’s not double taxation, even for this tiny group. The income tax paid on the estate on previously untaxed profits reduces the estate tax amount. Under the STEP Act, the tax treatment of a super rich person who sells assets before they die and someone who holds them until they die is the same.
What gives the STEP law something that our tax law currently lacks: fairness.
We will also hear screams about how the STEP Act will force the sale of family businesses and small businesses. This is nonsense. The STEP Act allows the first million dollars in valued assets to be passed on at death without incurring income tax. And family members who inherit farms or small businesses that they want to keep operating have 15 years to pay income tax.
The truth is that the fictional plight of farmers and small business owners is a red herring, an insincere distraction created by a group of millionaires and billionaires with an out-of-control sense of entitlement.
Our advice: ignore the squeaking of the super rich. But if you feel sorry for them, think this way: Since death is no longer an income tax avoidance event, our super-rich will have more reasons to live.
The STEP Act would also treat gifts of valued assets in the same way as sales for income tax purposes.
The STEP Act contains provisions designed to prevent the use of trusts in order to circumvent the requirement that profits from appraised assets must be taxed at least once per generation.
Will the STEP Act be the end of Buy – Borrow – Die? Yes, although we still have buy-borrowing. That’s a problem, but don’t fret. Help may be on the way here, too. Stay tuned.