Paul L. Caron

Wednesday, December 29, 2021

NY Times: Section 1202 Qualified Small Business Stock — A 'Preposterous' Tax Dodge For The Ultrawealthy

New York Times, The Peanut Butter Secret: A Lavish Tax Dodge for the Ultrawealthy:

A tax break aimed at small businesses has become a popular way for Silicon Valley founders and investors to avoid taxes on their investment profits.

This is the story of the incredible cloning tax break.

In 2004, David Baszucki, fresh off a stint as a radio host in Santa Cruz, Calif., started a tiny video-game company. It was eligible for a tax break that lets investors in small businesses avoid millions of dollars in capital gains taxes if the start-ups hit it big.

Today Mr. Baszucki’s company, Roblox, the maker of one of the world’s most popular video-gaming platforms, is valued at about $60 billion. Mr. Baszucki is worth an estimated $7 billion.

Yet he and his extended family are reaping big benefits from a tax break aimed at small businesses.

Mr. Baszucki and his relatives have been able to multiply the tax break at least 12 times. Among those poised to avoid millions of dollars in capital gains taxes are Mr. Baszucki’s wife, his four children, his mother-in-law and even his first cousin-in-law, according to securities filings and people with knowledge of the matter.

The tax break is known as the Qualified Small Business Stock, or Q.S.B.S., exemption. It allows early investors in companies in many industries to avoid taxes on at least $10 million in profits.

The goal, when it was established in the early 1990s, was to coax people to put money into small companies. But over the next three decades, it would be contorted into the latest tax dodge in Silicon Valley, where new billionaires seem to sprout each week.

Thanks to the ingenuity of the tax-avoidance industry, investors in hot tech companies are exponentially enlarging the tax break. The trick is to give shares in those companies to friends or relatives. Even though these recipients didn’t put their money into the companies, they nonetheless inherit the tax break, and a further $10 million or more in profits becomes tax-free.

The savings for the richest American families — who would otherwise face a 23.8 percent capital gains tax — can quickly swell into the tens of millions.

The maneuver, which is legal, is known as “stacking,” because the tax breaks are piled on top of one another. ...

The story of the tax break is in many ways the story of U.S. tax policy writ large. Congress enacts a loophole-laden law whose benefits skew toward the ultrarich. Lobbyists defeat efforts to rein it in. Then creative tax specialists at law, accounting and Wall Street firms transform it into something far more generous than what lawmakers had contemplated.

“Q.S.B.S. is an example of a provision that is on its face already outrageous,” said Daniel Hemel, a tax law professor at the University of Chicago. “But when you get smart tax lawyers in the room, the provision becomes, in practice, preposterous.”

Manoj Viswanathan, who is a director of the Center on Tax Law at the University of California, Hastings, estimates the tax break will cost the government at least $60 billion over the coming decade. But that doesn’t include taxes avoided by stacking, and so the true cost of the tax break is probably many times higher.

(Hat Tip: Deborah Schenk)

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