ProPublica: How The Wealthy Save Billions In Taxes By Skirting Wash Sale Rules

ProPublica, How the Wealthy Save Billions in Taxes by Skirting a Century-Old Law:

Congress outlawed tax deductions on “wash sales” in 1921, but Goldman Sachs and others have helped billionaires like Steve Ballmer see huge tax savings by selling stocks for a loss and then replacing them with nearly identical investments.

At first glance, July 24, 2015, seems to have been a brutal trading day for Steve Ballmer, the former Microsoft CEO. He dumped hundreds of stocks, losing at least $28 million.

But this was no panicked sell-off. Among the stocks Ballmer sold were those of the Australian mining company BHP and the global oil giant Shell. Had Ballmer lost confidence in BHP’s management? Was he betting that the price of oil would not soon recover? Not at all. That very day, Ballmer also bought thousands of shares in BHP and Shell.

Why would he sell and buy shares in the same companies on the same day? The answer is counterintuitive to the average person but obvious to a sophisticated investor: A loss, for tax purposes, is valuable; a big one can wipe out millions in potential taxes. Ballmer’s two-step process allowed him to use the loss to lower his taxes, while the near-simultaneous purchase meant he effectively hadn’t changed his investment.

Since 1921, claiming tax losses from so-called wash sales — selling shares of a company then buying them again within a short period — has been forbidden. But Ballmer collected his losses anyway because, technically, the types of shares he bought and sold weren’t the same.

Both Shell and BHP offered two different versions of their common stock. For each company, the two stocks were legally distinct, but they performed very similarly because, after all, they were shares in the same company.

Ballmer’s not-so-bad day, in fact, was carefully planned, part of a strategy by Goldman Sachs, which conducted the trades on Ballmer’s behalf, to wield the stock market’s natural volatility to the billionaire’s advantage. At Goldman, the hundreds of stocks in Ballmer’s “Tax Advantaged Loss Harvesting” accounts were selected to follow the movement of the broader markets. Over time, the markets, as they had historically, would buoy Ballmer’s investments upward. When, inevitably, some of the stocks underperformed or the whole market dipped, Goldman was ready to pounce, selling off the losers and replacing them with equivalents.

Over and over, Ballmer sold and bought stocks in roughly equivalent amounts, as on that July day, when he swapped around $200 million worth. A month later, he did it again, landing at least $23 million in tax-reducing losses. Similar efforts that December brought $26 million more.

ProPublica estimates that from 2014 through 2018, Ballmer was able to generate tax losses totaling $579 million without changing his investment portfolio in a meaningful way. The tax savings from these losses amount to at least $138 million.

The scale of Goldman’s feat was remarkable, but Ballmer was just one client pursuing such a strategy. And Goldman was just part of an industry that helps the ultrawealthy report billions in losses — and save billions in potential taxes — even as their fortunes rise. ...

After inquiries by ProPublica, Goldman said it would halt transactions like Ballmer’s Shell and BHP trades. Goldman conducted a review, according to a statement by the bank, and found that a “very small percentage” of its “tax investment solutions” trades were “inadvertently made in a manner inconsistent with our strategy.” The bank said it strives “to provide best-in-class investment advice to clients, consistent with both the letter and the spirit of all applicable tax laws and regulations.” ...

For the rich, the “tax system is sort of like a rigged coin,” said David Schizer, a tax expert and professor at Columbia Law School: “If you win, you get to keep all of it, but if you lose, you can pass some of those losses on to the government.” The wash sale rule, he said, is easily skirted by “well-advised taxpayers.” ...

Is it OK to swap Vanguard’s ETF tracking the S&P 500 for Blackrock’s version of the same index? Some tax experts say yes, some say no. Besides the IRS’ vague guidance, there are few relevant court cases, and all are decades old. ...

At wealth management firms, loss harvesting accounts are often designed to work in tandem with other services, as a kind of knob to turn up or down, depending on the need. ...

To prevent the wealthy from easily skirting the wash sale rule, Congress would need to change the law, experts said. One fundamental, but long-shot, reform would be to automatically tax the annual fluctuations of investments’ value (called “marking to market”). That would prevent the wealthy from being able to defer taxes on gains forever — and also render tax-loss harvesting unnecessary.

But even narrower changes could have an impact. Steve Rosenthal of the Tax Policy Center suggested a law aimed at how products like direct-indexing accounts are marketed: If an asset manager touted the ability to replace securities with positions that were economically the same, then those losses could be deemed wash sales. This, he said, wouldn’t be a major change, “but it might slow people down.”

Schizer, of Columbia Law School, suggested a more comprehensive reform: Congress should replace “substantially identical” with “substantially similar,” a phrase that is used in some other areas of tax law. That could rule out some of the most common harvesting moves, he said. The rule, he said, “ought to be updated to reflect how people invest today instead of how they invested 100 years ago.”