Wealthy already lining up ways to skirt Buffett rule

The highest-earning U.S. households have ways to escape President Barack Obama's Buffett rule with tax-planning techniques that would limit their liability and undermine the proposal's purpose. Those affected taxpayers -- the fewer than 0.5 percent of Americans with annual incomes exceeding $1 million and tax rates of less than 30 percent -- could take advantage of tax-free investments such as municipal bonds to escape the Buffett rule's bite. They also could time asset sales for maximum tax benefits, engage in transactions that don't result in taxable income and make charitable contributions that yield deductions. “Largely, the Buffett rule is going to be manageable,” said David Miller, a partner at Cadwalader, Wickersham & Taft LLP in New York. “That is, with tax planning, people will be able to avoid it.” The proposal would deny high-income taxpayers many deductions and other breaks they use to drive down their average tax rate without closing out the tactics employed by the wealthiest, most sophisticated taxpayers. The Buffett rule, named for billionaire investor Warren Buffett, would require that taxpayers with at least $2 million in adjusted gross income pay a minimum rate of 30 percent and would impose the increase on a sliding scale for those with income between $1 million and $2 million. Buffett Rule Calculator Obama has been campaigning for the proposal in advance of an April 16 procedural vote in the U.S. Senate. He had television interviews yesterday in four states with one Republican senator. Also, the White House website posted a Buffett rule calculator with which taxpayers can compare their tax rate to millionaires' rates. Republicans are expected to block the Buffett rule bill, which requires 60 votes to advance in the Senate. Democrats will continue to campaign on the issue of tax fairness. Preferential tax treatment for capital gains and dividends is among the reasons why some high-income households have relatively low effective tax rates, and one result of the Buffett rule would be to raise effective tax rates on capital income. Of the top 1 percent of households, 10 percent have effective tax rates of 8.7 percent or less, including income, payroll and corporate taxes, according to the 2012 Economic Report of the President. Generating Revenue The Buffett rule measure, sponsored by Democratic Senator Sheldon Whitehouse of Rhode Island, would generate $47 billion for the government over the next decade, according to the Joint Committee on Taxation, whose estimates incorporate projected behavioral responses by taxpayers. That estimate assumes that income tax cuts expire as scheduled at the end of 2012; if those cuts are extended, the bill would generate about $162 billion, according to Whitehouse's office. Under current law, capital gains and dividends are taxed at a top rate of 15 percent, compared with 35 percent for wages, some business profits and other ordinary income. A 3.8 percent tax on the unearned income of the highest earners takes effect in 2013. The U.S. taxes capital gains only when assets are sold, letting taxpayers realize gains when they choose, and they sometimes make those decisions based on tax rates. This feature of the tax code has caused spikes in capital gains realizations -- most notably after the 1986 overhaul of the tax code before an increase in the capital gains rate took effect. ‘Delay Selling' “The tax on capital gains is only collected when you sell your asset,” said Jon Bakija, an economics professor at Williams College in Massachusetts. “So one way to respond to that would be delay selling your assets.” One of the clearest examples of this phenomenon is Buffett, whose estimated $44.8 billion fortune as of yesterday places him third on the Bloomberg Billionaires Index of the world's richest people. The value of Buffett's stock in Berkshire Hathaway Inc. (BRK/A) appreciates with gains in the company's stock price. He doesn't pay taxes on the higher value of his assets unless he sells them. Taxpayers can avoid the capital gains tax entirely by donating assets with low cost basis to charity. Another way to escape the tax is to keep such assets until one dies, when they would be passed onto heirs with a cost basis of their value at death. For the very wealthiest, the estate tax would capture some of those gains. Investment in Capital The higher taxes on capital gains and dividends would reduce the after-tax return on investment in capital, causing some taxpayers to make shifts in their portfolios. In some cases, income being taxed at the individual level has already been taxed at the corporate level at rates of up to 35 percent, so the combined rate could exceed 50 percent. “The evidence suggests that individuals, and particularly high-income individuals, are responsive to tax rates,” said Adam Looney, a senior fellow at the Brookings Institution in Washington. He said those effects are more modest than some analysts suggest. By raising tax rates on capital income, the Buffett rule would reduce investment, said Douglas Holtz-Eakin, former director of the Congressional Budget Office and a White House economist during the George W. Bush administration. “You affect all their investment decisions,” he said. “Less overall, but also reallocated to make sure it doesn't show up in a year when you're liable to be over a million bucks, so you start getting into games.” Timing Changes Beyond timing changes, taxpayers can rearrange their portfolios to earn income in forms that don't show up as part of adjusted gross income. For example, interest on municipal bonds and employer-provided health insurance are both tax free, and would become more attractive. Taxpayers who want to avoid selling appreciated assets and still enjoy their economic benefits can take out margin loans against the value, Miller said. Dividend taxes are tougher to avoid if the dividends flow from companies that the taxpayer doesn't control. Still, the higher dividend tax rates on large shareholders might prompt some companies to reduce payouts. Also, the Buffett rule proposal allows deductions for charitable contributions, so taxpayers could accelerate future donations, especially if they think Congress might repeal the Buffett rule or otherwise lower taxes in the future. Miller said taxpayers anticipating capital gains could move to a low-tax state. Because the Buffett rule would effectively deny the benefits of the state and local tax deduction, it would create a greater-than-usual incentive to move to a state such as Florida with no income tax. “I promise you, the one thing this is is a full employment law for tax lawyers,” Holtz-Eakin said. “They will love it.” --Bloomberg News--