Your Christmas gift to the richest people in the U.S.

If you’re concerned that you haven’t spent enough on Christmas this year, the Wall Street Journal reassures you that, via your federal income tax payments, you’re subsidizing some of America’s richest private equity partners, $1,500/hour lawyers, etc. “High-Income Business Owners Escape $10,000 Tax Deduction Cap Using Path Built by States, Trump Administration” (12/6):

More than 20 states created workarounds to the limit, and New York’s law firms and private-equity firms are signing up

Here’s how it works. Normally, so-called pass-through businesses such as partnerships and S corporations don’t pay taxes themselves. Instead, they pass earnings through to their owners, who report income on individual tax returns. That subjects them to state individual income taxes—and the federal limit on deducting more than $10,000, created in the 2017 tax law.

Details vary by state, but the workaround flips that concept. The states impose taxes—often optional—on pass-through entities that are roughly equal to their owners’ state income taxes. Those taxes then get deducted before income flows to the business owners.

The laws then use tax credits or other mechanisms to absolve owners of their individual income-tax liabilities from business income. Thus, they satisfy state income-tax obligations without generating individual state income-tax deductions subject to the federal cap.

In these systems, state revenue is virtually unchanged, because the entity-level tax replaces personal income taxes. Business owners win, because every $100,000 of state taxes that go from nondeductible to deductible yields up to $37,000 in net gain on federal income-tax returns. The federal government loses money.

In New Jersey, pass-through businesses reported $1.3 billion in entity-level liability for the tax’s first year in 2020, suggesting an equivalent amount of federal deductions that might have otherwise been disallowed. In New York, more than 95,000 pass-through entities opted into the tax for 2021 before the Oct. 15 deadline.

“It’s really a slam dunk,” said Phil London, an accountant and partner emeritus at Wiss & Co. in New York, who said he has seen the owners of one business save $1.5 million and expects law and accounting firms to use the workaround. “The larger-income entities and real-estate investors and real-estate operators, they’re going to benefit from it.”

Private-equity firms have been particularly interested, said Jess Morgan, a senior manager at Ernst & Young LLP. And some businesses have restructured themselves to take maximum advantage of the benefit, she said.

After rejecting other workarounds, the Treasury Department blessed these a few days after the 2020 election, citing a footnote in a committee report from the 2017 law and a handful of entity-level taxes that predated 2017. The Trump administration, which had pressed for the $10,000 cap, offered the path out of it.

In other words, many of the richest Americans in high-tax states will be able to deduct nearly all of what would have been their state tax liability, thus keeping the subsidies flowing from workers in low-tax states and from ordinary W-2 slaves who can’t work around what was advertised as the law.

8 thoughts on “Your Christmas gift to the richest people in the U.S.

  1. The relevant wording from the UBC CS job ad:

    In accordance with UBC’s CRC Equity, Diversity, & Inclusion Action Plan, and pursuant to Section 42 of the BC Human Rights code, the selection will be restricted to members of the following designated groups: persons with disabilities, Indigenous Peoples, women and gender minorities (transgender, gender-fluid, nonbinary and Two-Spirit people), and racialized minorities. Applicants to CRC positions are asked to complete this equity survey as part of the application, and candidates from these groups must self-identify as belonging to one or more of the designated equity groups to be considered for the position. Because the search is limited to those self-identifying as members of designated equity groups, candidates must also provide their name to be considered

    • Anon: Since the job is in quantum computing, it makes sense that they’re seeking “Two-spirit people”. Look at in which we learn that the qubit is a superposition of two basis states (each of which could be regarded as a “spirit”).

  2. Add this to the lengthy, and growing, list of ways the wealthy are advantaged in our society. Helping folks who need no help, at the expense of everyone else, is the new American way. Increasing disparities in income and wealth gaps directly correlate to and illustrate these advantages. The bottom line outcomes and trends over time break free of all the purposeful complexity, noise, confusion, obfuscation, political and philosophical posturing. The top 1% have not suddenly become able to work harder, and are no smarter, than their counterparts over the last centuries. All the gains in earning are attributable to an increase and snowballing of societal economic advantages.

  3. I think that if someone wants to live near their fetishes in deep blue states insane run cities or making money of state/city contracts but it makes no financial sense to hire $1,500/hour lawyers and is wealthy enough to be hurt by state tax above $10,000 deduction then extra tax is the thing that he/she supports or lives off. Most middle income people are covered by $10,000 deduction. If not in a particular state then it is enough of them there to vote for lower taxation, states with large state taxes are primarily Democrat – run and middle class votes for them.
    It is wrong to state that Trump devised exit strategy for rich to escape the tax.
    1) Rich did not donate Trump enough in 2020, unlike in 2016, I think it is due to state deduction elimination.
    2) Trump was too busy with investigations and big stuff to think of creating complex ways to reduce taxation. Even he were a financial genius it is US Congress who creates laws including tax laws or refuses to do so and relegates them in my humble view unconstitutionally to bureaucrats
    And the most important 3) Most large heuristic system have many loopholes and more rules create more loopholes. And US tax code is specifically designed to have special treatments. As Godel tell us, even simple arithmetic rules can not be explained from itself, loopholes are everywhere and thus smart and knowledgeable lawyers and a lot of data research and AI legal software can find and exploit loophole. The only way to stop this is legal tyranny and disregard for law made by legislature and rules unconstitutionally delegated by legislature to executive branch bureaucrats. But legal tyranny is a remedy which is much worse then the disease.

  4. Like most of the WSJ business articles that are not just human interest pieces this piece is incoherent. Pass through entities are typically not taxed at the entity level but here they are taxed at the entity level but “other mechanisms” ensure that the individual partner or shareholder is not taxed at the personal level or something like that. We dont know what these “other mechanisms” are and we dont know how this sorts out on someone’s tax return. And if it were true that through this kind of abracadabra you could deduct your SALT no problemo then you have to wonder why the Trump treasury first got rid of the SALT deduction and then reinstated it this way (Steve Mnuchin wasn’t exactly a dunderhead) and why the Blue State governors and senators are so excited about reinstating the SALT deduction — since this article seems to say it was never taken away in the first place. Would be nice if someone who knew something like a tax lawyer or tax accountant would coherently explain the issue — since the way things stand this piece seems to have been reprinted here primarily to stoke resentment — which is unfortunately a typical blog theme.

    • Jack: I thought I understood the article. Suppose that Mx. Rich is the sole owner of an LLC that generates $10 million/year in profit, ordinarily taxable to Mx. Rich as personal income (federal and state). California is mentioned in the article as one of the states that has implemented this scam, so let’s assume that Mx. Rich lives in California. Without the scam, he/she/ze/they would have had to pay $3.7 million in federal tax on the $10 million and $1.33 million in California state tax. With the scam, the LLC pays $1.33 million in tax to California, resulting in a pass-through profit of only $8.67 million. 37 percent of $8.67 million is $3.2 million (federal tax). So Mx. Rich ends up $0.5 million richer (his/her/zir/their personal state tax liability on the $8.67 million is zeroed out by a credit associated with the state-run scam).

    • Overall effect of this scheme for rich is unclear: it is helpful for big spenders, usually tax minimizing investment strategies are focused on reducing overall taxes. Philip’s hypothetical Californian with $10,000,000 in profits would pocket net excess profit that were enough to buy a Ferrari (not even new Cirrus), after paying $1,500 lawyers ( before current inflation started).
      But yes, it diverts $$$ from USA but is likely invest it directly into US economy

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