Let's Talk Taxes: IRS Looks To Fix Major Tax Loophole For The Rich

In 1789, Benjamin Franklin famously said, "In this world, nothing is certain except death and taxes." This underscores the inevitable nature of taxes. Regardless of whether one is an employee or a boss, taxes are a constant reality. Yet, despite their certainty, numerous wealthy individuals have managed to avoid them to varying degrees. The IRS now plans to close a major tax loophole for the wealthy, potentially raising over $50 billion in revenue over the next decade, according to the U.S. Treasury Department.

Tax Obligations for the Wealthy
Americans primarily face Income Tax and Capital Gains Tax. Although Inheritance Tax is not common nationwide, only being present in six states, it is another tax often evaded.
Income tax is calculated based on the formula:
(Income−Deductions) × Income Tax Rate = Income Tax Payable
With the highest income tax rate in the U.S. at 37%, billionaires are theoretically supposed to pay more than a third of their wealth in taxes. However, in 2021, ProPublica revealed in "The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax" that the top 25 richest people paid an average true tax rate of only 3.4% from 2014 to 2018.

The Plan to Close the Tax Loophole
The IRS's proposed rule includes plans to end “partnership basis shifting” — a tactic where assets are moved among related parties to avoid taxes. This practice is common among major corporations, which often establish headquarters in low-tax countries like Ireland (with a 12.5% corporate tax rate) and control operations through holding companies in tax havens like the British Virgin Islands or Cayman Islands, where the corporate tax rate is 0%.

Common Tax Avoidance Tactics

Income Tax Avoidance

1. Charitable Contributions: Wealthy individuals donate to donor-advised funds, where they control how the donations are used, effectively reducing their taxable income.
2. Corporate Earnings: By categorizing personal earnings as corporate earnings, individuals benefit from the lower corporate tax rate of 21%, compared to the personal income tax rate of up to 40%.
3. Offshore Holdings: Many corporations set up holding companies in tax havens like the Cayman Islands to benefit from 0% corporate tax rates.

Capital Gains Tax Avoidance

1. Share Loans: Instead of selling shares and realizing taxable gains, the wealthy use shares as collateral for low-interest loans.
2. Art Donations: Appreciated artworks are kept and not sold to avoid capital gains tax, or donated to charity for tax deductions.

Inheritance Tax Avoidance

1. Trust Funds: Trusts allow beneficiaries to inherit funds indirectly, avoiding inheritance taxes.
2. Charity Foundations: Setting up charitable foundations allows for tax deductions on donated funds, bypassing inheritance taxes.

Is This the End of Tax Avoidance?
While the new IRS rule may help recover some taxes from the wealthy, it won't entirely eliminate tax avoidance. What more can the government do to curb these practices?
The Global Minimum Tax at 15% is a promising strategy, as it sets a minimum global tax rate for large corporations, making it harder for them to use complex tax avoidance tactics. Additionally, lowering the Capital Gains Tax to a reasonable level could reduce the incentive for companies to set up operations in tax havens like Hong Kong or Singapore, known for their 0% Capital Gains Tax.

The Path Forward
Eliminating tax avoidance is a complex challenge requiring multifaceted solutions. The IRS's new rules are a step in the right direction, but broader measures like the Global Minimum Tax and more competitive tax rates may be necessary to ensure that the wealthiest individuals and corporations contribute their fair share to society.