There’s More To Tax Avoidance Than Deductions

Larry Summers had a great column over the weekend about how the really juicy tax loopholes aren’t the income tax deductions that have dominated the fiscal cliff debate, it’s stuff like this:

Why do current valuation practices built into the tax code make it possible for investment partners to end up with $50 million or more in entirely tax-free individual retirement accounts when the vast majority of Americans are constrained by a $5,000 annual contribution limit?

A simple calculation shows that our estate tax system is broken. Assets that are passed to relatives or other personal relations are often badly misvalued relative to what they cost on an open market. The total wealth of American households is estimated at more than $60 trillion. It is heavily concentrated in very few hands. A conservative estimate given the lifespans of Americans would be that 2 percent ($1.2 trillion) is passed down each year, mostly from the very rich. Yet estate and gift taxes raise less than $12 billion, or just 1 percent of this figure each year.

See, a run of the mill prosperous person faces the problem that his financial assets are all going to be obvious things like cash or mutual funds or publicly traded stocks. You can only put $5,000 a year away in an IRA that way. But if you’re a partner in a private equity company that’s just taken over a troubled enterprise somewhere you can stuff your IRA with shares of the company valued by Calvinball rules. Then when six years later your “$5,000” worth of company stock ends up being worth $5 million once the company’s back out in the open you’re just a guy who’s made some very fortunate investments. Similar antics can happen in estate planning.