The Tax Law’s Big Winner Is the Millionaire CEO

(Bloomberg Businessweek) -- By the time you read this, most Americans will have already filed their first returns under the 2017 Tax Cuts and Jobs Act. A Reuters/Ipsos poll last month said a majority of them think the new law didn’t save them a dime, but they’re wrong: The Urban-Brookings Tax Policy Center estimates that average Americans saw a 1.8 percentage point reduction in their effective tax rate. The actual effect—an average savings of $1,610—was simply so slight and so spread out that they didn’t notice.

The rich noticed. The top 1 percent of income earners saved 2.3 percentage points, according to Urban-Brookings, or $51,140. The top 0.1 percent, who make more than $3.4 million a year, saved the same amount in percentage terms as the average Joe, but in dollar terms made out with $193,380.

There’s a particular type of rich person, probably living somewhere in Florida, Texas, or another low-tax state, who did even better. This person runs his own company or companies, likely in the real estate business. Because men run about 80 percent of businesses in the U.S., this person is probably male. Sure, he cares about individual income tax rates, but he doesn’t make most of his money as a wage earner. He’s an owner.

The first tax break he probably spotted was the decline in his marginal tax rate, from 39.6 percent on every dollar above $470,700 to 37 percent past $600,000 if he’s married and filing jointly. That’s not the most important cut he received by any stretch—he makes too much money elsewhere—but it’s the one most Americans understand.

He got his first windfall from the new tax law back in 2017, before it even passed. As Republicans floated their proposal for a massive cut to the corporate tax rate, from 35 percent to 21 percent, investors began buying corporate shares in anticipation of its passing, says Todd Castagno, an analyst for Morgan Stanley. “Ultimately, investing in stocks is buying future earnings,” he says, and lower taxes mean better quarterly numbers.

In a report released last year, Morgan Stanley estimated the tax bill bolstered the stock market by 8 percent to 10 percent. “Corporate shareholders made out like bandits,” says Steven Rosenthal, senior fellow at the Tax Policy Center. Take investor and Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett: In last year’s annual letter to shareholders, he reported that in 2017, Berkshire’s shareholder equity grew by $65.3 billion, to $348.3 billion.

Our hypothetical rich person’s businesses are probably in commercial real estate. Those are most often structured as pass-throughs, such as LLCs or other partnerships, which are taxed not at the corporate level but at their owners’ marginal tax rate, and the new law lets their owners shield 20 percent of their business income from any taxes at all. This deduction was intended to benefit small businesses. Congress blocked high-income owners of some service providers from taking the break in most cases, including lawyers, doctors, and athletes. But lawmakers gave it to commercial real estate developers regardless of income.

Real estate dodged other bullets, too. For most businesses, Congress killed so-called like-kind exchanges, which let sellers of certain property such as machinery or artwork avoid capital-gains taxes so long as they reinvested the proceeds in similar property. But the provision was preserved for real estate. If our rich person invests in property in a “qualified opportunity zone,” a designation created by the new tax law to encourage investment in low-income areas, he’ll be able to avoid some capital-gains taxes and defer the rest for years. Many opportunity zones are indeed in low-income areas, but others include fast-gentrifying neighborhoods such as Long Island City in Queens, N.Y., where the developer stands to make a much larger return.

Our wealthy developer has likely already called his estate planner and received welcome news: His heirs will get to keep more than $4 million extra when he dies. That’s because the law roughly doubled the amount of his estate that’s tax-exempt, raising it to $22.8 million in 2019 for a couple; because the estate tax rate is 40 percent, that’s $4.56 million now going straight to the kids. The exemption reverts to the lower level at the end of 2025, but our rich person won’t need to die by then for his estate to benefit from the higher limit, says Mitchell Gans, a tax law professor at Hofstra University Law School. That’s because the lifetime ceiling on tax-free gifts is set at the same level as that of the estate tax exemption. When a wealthy individual makes a large gift, it’s counted against the exemption when he dies. Even though the estate tax limit is scheduled to fall by 2026, as long as he makes the gifts by then, Gans says, the Internal Revenue Service likely won’t penalize him if his largesse exceeds the lower limit. The merely rich person whose estate totals less than $22 million will of course have to hold on to some money to live on. “It’s going to be so much easier for the superwealthy than the modestly wealthy,” says Gans.

While Congress’s Joint Committee on Taxation and think tanks such as the Tax Foundation and Tax Policy Center continue to generate estimates about how much each type of taxpayer will gain from the law, the true size of the benefits might not be apparent for years, as tax attorneys delve deep to find loopholes for their clients—attorneys such as Jonathan Blattmachr.

Blattmachr, who’s now mostly retired, is like Neo in The Matrix: He can bend or get around rules to save clients potentially millions of dollars. “For a lot of accountants, the law has been a real godsend,” he says, precisely because it’s so complicated. Take state and local income and property taxes. The new law capped the amount of those that Americans can deduct from their federal taxes at $10,000 a year—that’s why the tax winner probably lives in or is planning to move to a low- or no-tax state such as Texas or Florida, where the state and local tax (SALT) cap matters less.

The summer after the law passed, Blattmachr recommended to his wealthy clients that they split the ownership interests in their properties among several Alaskan non-grantor trusts that could let them avoid the cap. Non-grantor trusts are treated as individual taxpayers, so each one could potentially take advantage of the $10,000 SALT deduction; in a no-tax state such as Alaska, that would go extra far. Confused? Don’t think your storefront tax preparer or downloaded software would have come up with that? For sophisticated tax lawyers like Blattmachr, that’s the point.

It wasn’t the point for Treasury Secretary Steven Mnuchin, or at least so he said in an interview on CNBC shortly after Donald Trump was elected president. Any reduction in the highest tax rates would be offset by loopholes and deductions that would be closed or eliminated, he promised, resulting in no absolute tax cut for the wealthy. During his confirmation hearing before the Senate Finance Committee, Oregon Senator Ron Wyden, the panel’s top Democrat, dubbed this the Mnuchin Rule.

That wasn’t going to work, tax attorney Dana Trier remembers thinking while watching the hearing on TV. Trier previously worked on tax issues at the Treasury Department for Presidents Ronald Reagan and George H.W. Bush. The summer after Mnuchin was confirmed, the department hired Trier as deputy assistant secretary for tax policy to help write the new law.

As Trump’s signature legislative achievement made its way through Congress, Mnuchin asked his staff to run the numbers over and over, reacting with disappointment every time they showed a huge benefit for the wealthy, says Trier, who left the government in February 2018. “I personally don’t think he was the most competent tax policy leader in the world,” he says of Mnuchin. “But the one thing for sure is he was not out to benefit the rich.”

If that’s the case, he failed completely. “At the end of the day, when your central policy calls for lowering maximum rates, it’s not going to be easy not to benefit rich people,” says Trier. “It’s just a fact.” He says the IRS will surely stamp out, or at least deter, gamesmanship of the law—it’s already issued guidance to try to eliminate the Alaskan Trust loophole, which Blattmachr acknowledges. But Trier also says that 20 percent to 25 percent of the unintended loopholes the IRS kills will end up surviving court challenges that will likely play out over the course of years.

In a statement, a Treasury spokeswoman said the 2017 tax law “cut taxes across the board, with the particular aim of providing relief for hardworking, middle-income families.” She added that aspects of the new law, including the doubling of the standard deduction and an “enhanced” child tax credit, helped low- and middle-income Americans in particular.

It’s not lost on Trier that the winner of the 2017 law probably looks a lot like President Trump. That wasn’t on purpose, he says, adding that he thinks the law still did many things that helped American growth and competitiveness. “I detected a lot of intelligent, well-meaning people making mistakes,” he says. “Maybe you don’t believe this, but I didn’t detect people trying to help out specific lobbyists a whole lot.”

The idea that the White House engineered it all? “I think that’s crazy,” Trier says. “The president and his team in honesty did not have the sophistication and competence to lead this legislative effort. That’s the reality here.”

To contact the editor responsible for this story: Jillian Goodman at jgoodman74@bloomberg.net

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