TaxProf Blog

Paul L. Caron
Dean





Friday, March 1, 2024

Weekly SSRN Tax Article Review And Roundup: Speck Reviews Compliance And Anti-Abuse Reform To Tax The Rich By Fox, Liscow & Soled

This week, Sloan Speck (Colorado; Google Scholar)reviews new works by Edward G. Fox (Michigan; Google Scholar) & Zachary Liscow (Yale; Google Scholar), No More Tax-Free Lunch for Billionaires: Closing the Borrowing Loophole, 182 Tax Notes Fed. 647 (Jan. 22, 2024), and Jay A. Soled (Rutgers; Google Scholar), The Gift Tax and the Tax Gap, 182 Tax Notes Fed. 1047 (Feb. 5, 2024).

Sloan-speck

In the literature on taxing high-income and high-wealth individuals, loophole-closing and compliance loom large in enforcing equity across the tax system. And, under the Biden Administration, Congress and Treasury have given significant attention to enforcement and anti-avoidance initiatives aimed at the highest earners. In recent articles, Ed Fox and Zach Liscow detail the contours and stakes of closing the “borrowing loophole” for taxpayers with ultra-high net worth, and Jay Soled proposes enhanced information reporting—and associated penalties—for gifts to close the tax gap with respect to the federal gift tax. Taken together, these articles raise important questions about, first, which taxpayers matter when we talk about taxing the rich, and, second, how we should think about the intersections between tax compliance and anti-avoidance efforts, especially in the context of “simple reform measures” (Soled, 1047) that target current infirmities.

Fox and Liscow propose that, for households with net assets greater than $100 million, recourse and nonrecourse borrowings in excess of annual and lifetime exclusions would trigger gain with respect to the household’s “major assets” on a first-in, first-out basis (Fox & Liscow, 648–50). For example, Scrooge McDuck (transparently over the threshold) borrows $1 million cash from Chase Manhattan in excess of his exclusions. McDuck’s longest-tenured asset is a ludicrously large money bin with a basis of $1.5 million and a current value of $10 million. As a result of the borrowing, McDuck has $1 million in gain with respect to the bin, and his basis in the bin increases to $2.5 million. McDuck’s accountants hammer out some details about allocation of gain between land and improvements, redo depreciation schedules, and calculate McDuck’s tax due on the $1 million. Under current law, McDuck would receive his $1 million loan proceeds tax-free for any use, including personal consumption. Fox and Liscow’s proposal essentially would treat these types of borrowings as realization events.

Soled explores taxpayer noncompliance in a regime—the federal gift tax—with striking facial similarities to Fox and Liscow’s billionaire borrowing tax. Gift taxation involves wealthy households (though many below Fox and Liscow’s threshold), tricky valuation issues (that Fox and Liscow ably manage), and relatively generous annual and lifetime exclusions (for front-end administrative ease and back-end enforcement headaches). As Fox and Liscow note, the billionaire borrowing tax and gift tax operate as mutual backstops, since taxpayers can structure cash transfers as either gifts or loans. Of course, as Soled elaborates, gift taxation “is ravaged by taxpayer noncompliance,” leaving a significant but underappreciated “tax gap” (Soled, 1047), and one might worry whether the compliance problems Soled identifies will seep into a prospective billionaire borrowing tax.

The reasons for the gift gap stem, in part, from wealthy households’ social relationships and cultural norms. Soled points to two “likely scenarios” that lead to estate and gift tax evasion (id., 1048). Say Scrooge McDuck gives $50,000 each to his three great-nephews, presumably in the form of three hefty solid-gold coins from the money bin. Whether through inadvertence or malfeasance, no gift tax returns are filed, and no records of the gift are kept. After McDuck dies, nephew and executor Donald either (1) is unaware of the gifts or (2) intentionally neglects to report the gifts in McDuck’s estate tax filings. Imagine a tug-of-war between a kilted good duck and a pants-wearing evil duck. Regardless of which fictive duck wins, “the outcome is the same”: a tax savings of more than sixty cents on the dollar, including the generation-skipping transfer tax (id., 1048–49). To remedy this problem, Soled advocates requiring information reporting on both sides of the gift: donors would report gifts over the annual exclusion on their Form 1040s, and donees would file a separate form on the receipt of gifts in excess of the annual exclusion. Stiff penalties would apply to failures to report (and stiffer to collusion not to report), and Soled’s bilateral reporting obligations would increase Treasury’s odds of ferreting out bad actors.

Embedded in these two articles are differing—but not necessarily inconsistent—visions of who the wealthy are and how they operate. Fox and Liscow focus on 35,000 households, of which 14,000 have current borrowing over the lifetime exclusion. Billionaires would contribute half of total revenue from the instrument. These taxpayers are almost uniformly well-advised and accustomed to intricate tax planning. By contrast, Soled’s target is broader. More than 200,000 gift tax returns are filed annually, which gives some sense of how far Soled’s information reporting requirements might reach. Furthermore, these filers’ principal mechanisms for avoidance or evasion are blunt. Failures of memory are not sophisticated tax planning. Alex Raskolnikov, among others, has addressed whether policymakers should address systemic reform to only the most well-heeled, or whether such reform also should incorporate the merely well-off. To the extent these two groups are different, however, narrow reforms may optimally or appropriately target one population or the other, even if the total effect violates some sense of holistic equity.

But the question of similarity and difference between the extraordinarily wealthy and the simply affluent is an empirical one—and likely tricky to tease out. Gift tax noncompliance, for example, probably extends to the top of the distribution. All families have secrets, and many of those involve money. Obfuscation and ignorance are not limited to households without ready access to more nuanced tax planning. Moreover, parsing individuals into wealth or income categories may be challenging. The rich are different from you and me, and not just because they have more money. The rich also control and benefit from more corporations, partnerships, trusts, and offshore entities, all designed to push and pull on various legal regimes of governance, succession, and taxation, and they operate within a network of financial, family, and banking relationships that rely on express and implied arrangements, norms, and quid-pro-quos. Planning occurs within these systems. For Fox and Liscow, this context, among other things, complicates the revenue raised by the retroactive part of the billionaire borrowing tax, which must account for the current landscape to effectively capture borrowing. For Soled, the result may be that only middle-class-ish families comply rigorously (or can be forced to comply rigorously) with bilateral information reporting for gifts, leaving the reporting initiative stranded between administrative costs imposed on taxpayers below the lifetime exemption and an inability to enforce against those more likely to pay estate tax. In either case, reform must account for the operational realities of the rich and affluent.

Further tensions between enforcement and anti-avoidance measures emerge in other contexts. For reasons developed in Soled’s article, the billionaire borrowing tax almost certainly would rely heavily on information reporting. Even if banks do not resist a new reporting obligation, untangling the names on the forms may prove difficult, and non-bank parties may provide no information at all. And if there’s not information, enforcement will be hard. This administrative wrinkle could hamper Fox and Liscow’s detailed efforts to prevent taxpayers from avoiding the borrowing tax through related party and other transactions. Furthermore, the billionaire borrowing tax introduces line-drawing issues, with a concomitant risk of taxpayer manipulation for any congressional or regulatory missteps. For example, the category of “major assets”—the assets on which tax is computed—may need to distinguish between personal use assets and investments. If Scrooge McDuck swims joyfully in his money bin, is the bin an easily valued business asset, or more like his second home—or maybe an esoteric adjunct to performance art? These latter categories are, under Fox and Liscow’s framework, excluded from potential tax. Enforcement seems likely to struggle with these types of questions, which has implications for the tax instrument’s efficacy.

Overall, the authors’ proposals—for loophole-closing and enhanced compliance—meet on particularly fertile ground for tax reform: both articles argue for well-developed, limited-scope reforms with significant potential in terms of revenue and equity. Scholars and policymakers, as well as taxpayers and their advisors, would be well-served to read these two articles.

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2024/03/compliance-and-anti-abuse-reform-to-tax-the-rich.html

Scholarship, Sloan Speck, Tax, Tax Daily, Tax Scholarship | Permalink