Middle class folks who are using the mortgage deduction generally use it exactly as intended. They don't have an army of accountants on retainer to figure out how to game the tax code and accomplish things that weren't really intended.
The example that always sticks in my head- maybe this isn't true, but I've heard there are strategies of buying failing companies for pennies, shuttering them, and then writing off their losses on your own taxes. You incurred no risk, you lost no money, and now you pay no taxes. Whether it's actually intended to happen that way, it doesn't seem right, and ordinary people can't do it.
Anyway, I'm not an accountant, but the upset over the tax exploits of the wealthy revolve around the concern that they are managing to exercise the tax code in a way that was never intended to pay less than they were meant to owe. Middle class folks don't wind up in the crosshairs because they generally file very ordinary returns, following both the letter as well as the spirit.
> The example that always sticks in my head- maybe this isn't true, but I've heard there are strategies of buying failing companies for pennies, shuttering them, and then writing off their losses on your own taxes. You incurred no risk, you lost no money, and now you pay no taxes. Whether it's actually intended to happen that way, it doesn't seem right, and ordinary people can't do it.
That's the problem with most of these situations -- people don't understand what's really happening.
Suppose you have a company that started off with $25 million thinking it would turn it into fifty million, but really it turned it into five million. Then the company is still worth $5 million dollars, right? Except that it has a $20M tax loss, which is worth something. When other people have profits they're paying a 35% tax rate on, the tax loss has a market value of $7M, so the company is actually worth $12M.
Which means that's what richie rich who wants to use the tax loss has to pay for it, since the seller can shop the tax loss to the highest bidder and get close to the full value for it. The money isn't going to the rich guy, it's going to the guy with the tax loss.
Which means it's a rule that helps the little guy. If you take a risk and fail, it allows you to at least recover as much of your investment as the big guy with diversified investments would have had as a tax deduction -- i.e. it prevents creating a disadvantage when the little guy takes a risk vs. the big guy. And if you have creditors, the buyer has to make them whole in order to take the tax loss, which makes them more likely to lend to you to begin with.
But people see the result that rich people are getting a tax deduction and clamor to get rid of the rule.
If it actually worked how you describe, it wouldn't happen. As the market value approaches the expected benefit, there becomes no point.
I gather it's a strong buyer's market, in which case this isn't really the saviour of the little guy.
Also worth considering, if these loss deductions always find their way to the guy with the highest marginal tax rate- is that really working as intended?
> If it actually worked how you describe, it wouldn't happen. As the market value approaches the expected benefit, there becomes no point.
If you pay $6.9M for $7M in lower taxes, you make $100,000 for free and the little guy recovers $6.9M. Then one of the other million companies with net profit realizes they can net $90,000 by offering $6.91M. This is not what a buyer's market looks like.
Obviously no one is going to offer exactly $7M because they have to cover the transaction costs etc., but that's not even profit -- if they offer $6.95M because they have $40,000 in transaction costs, they're only making $10,000, but they still do it because they're still making $10,000. Until someone else is willing to make $5000.
It's a seller's market because there are more companies with net profits than net losses.
> Also worth considering, if these loss deductions always find their way to the guy with the highest marginal tax rate- is that really working as intended?
This one of the many reasons why graduated tax rates are inefficient as compared with something like flat rate + UBI (which can be equally progressive but doesn't have this problem), because it works that way for everything. The same thing applies to losses incurred directly by the big guy. Or if you create a deduction for green cars, someone paying a 35% marginal rate gets more from buying the same car than someone paying 15%.
But that doesn't apply to corporations anyway. Corporate tax rates largely aren't based on income. If they were, splitting an operation into multiple corporate entities would lower the tax rate and then everybody would do that.
> But people see the result that rich people are getting a tax deduction and clamor to get rid of the rule.
The big problem is that people see and remember companies like Toys R US and Guitar Center that would be JUST FINE if companies like Bain capital hadn't loaded them with debt to pile in tax writeoffs.
> The big problem is that people see and remember companies like Toys R US and Guitar Center that would be JUST FINE if companies like Bain capital hadn't loaded them with debt to pile in tax writeoffs.
Except that their strategy had nothing to do with tax write offs.
In theory what they were doing is borrowing money to buy an ailing company and turn it around, and as long as they succeeded they could have serviced the debt.
What they actually did was fail to turn the company around while charging it hundreds of millions in consulting fees, until it finally collapsed.
The way things were set up, if they succeeded in turning the company around, they would get the profit in excess of the interest. If they failed, they still get all their consulting fees and the lenders are stuck trying to recover their loan principal in bankruptcy.
That situation creates terrible incentives. Either they can be lazy and just collect consulting fees for doing nothing, or they can take big risks with house money and cash in if it pays off or walk away if it doesn't. The people who lent them the money were nuts. They would have been better off buying the company for themselves.
It was an obscure part of the tax code that was never intended to be a tax-deferred saving vehicle until some guy named Ted Benna figured it out. He even suggested it to other clients and they said "no, the IRS will never buy it".
So is your argument that anyone using a 401k is a "greedy tax cheat"?
> They don't have an army of accountants on retainer to figure out how to game the tax code and accomplish things that weren't really intended.
Even that doesn’t sound that bad to me. All of those people have a job, are being paid and are also paying taxes.
Also that sounds like a tax code bug and not a rich people problem. The government is allowed to collect exactly the minimum required by law and nothing more.
>>Also that sounds like a tax code bug and not a rich people problem. The government is allowed to collect exactly the minimum required by law and nothing more.
Not to be "that guy" but who do you think is writing the tax code, if not rich people and the government officials they help fund? Of course it's a rich people problem, or rather a rich people solution.
That strategy works in some countries, not in others. Not sure about the US. In certain countries a profitable company can acquire a company with carry forward tax losses, and by merging both you can offset profits from the profitable company with the losses of the unprofitable one.
Not exactly extreme tax avoidance I'd say. This is quite a well known mechanism.
i'm also curious. unless i'm not understanding something, your tax writeoff could not exceed your cost basis on the purchase of the business, making the maneuver a net loss.
Tech startup A is capitalised with $1m. Burns through $1m, left with $0 in the bank, now has a million dollars in carry forward tax losses. That means you can make a million dollars without paying taxes. At a 21% corporate tax rate, that's $210,000 in taxes you'd pay on a $1m profit if you didn't have the carry forward loss.
How much are the shares of that shell worth if you can use the tax losses to offset profits of a different, profitable business? Somewhere between $0 and $210,000.
it looks like in your example you end up with $1mm, since you didn't have to pay tax on the profits of company B. but if you had just kept the original million and paid tax on B's profits, you would have ~1.8mm? or are you implying that you can buy company A for less than the market cap in the first place?
Yes, the owners of company A can sell their shares to profitable company B for an amount between $0 and $210,000. Obviously you wouldn't burn a million to create tax losses.
Remember: this company has $0 in the bank. It's essentially the same as a newly incorporated company, but with tax losses. There would generally be a discount on the value of the tax loss due to historical liability risks of the previous operating business.
The things written above are highly simplified though, and might not give a completely accurate reflection of the situation. There are likely some anti avoidance rules in place to stop this behavior. But this again depends on the country.
"There are some catches here. To use the NOLs (net operating losses), Sirius can't undergo a full change in control for three years. So Malone has to bide his time with his 40% for three years before scarfing up the rest of the company."
This is one such anti avoidance mechanism.
By being smart about taxes, he essentially got that business for free.
The example that always sticks in my head- maybe this isn't true, but I've heard there are strategies of buying failing companies for pennies, shuttering them, and then writing off their losses on your own taxes. You incurred no risk, you lost no money, and now you pay no taxes. Whether it's actually intended to happen that way, it doesn't seem right, and ordinary people can't do it.
Anyway, I'm not an accountant, but the upset over the tax exploits of the wealthy revolve around the concern that they are managing to exercise the tax code in a way that was never intended to pay less than they were meant to owe. Middle class folks don't wind up in the crosshairs because they generally file very ordinary returns, following both the letter as well as the spirit.