Nikki Spretnak loved working as an IRS agent. She loved being able to look at the books of different businesses and gain a deep understanding of the economy. Over the years, she became increasingly aware of the chasm between her auditing business owners and herself. It wasn’t so much that they were rich and she, a revenue agent in the IRS office in Columbus, Ohio, was not. It was their privileged lifestyle when it came tax time that they shared with her, a mere W-2 holder.
Along with a team, I have been working together for the past year. ProPublica, I’ve spent countless hours scrutinizing the tax information of thousands of the wealthiest Americans. Like Spretnak, I’ve seen behind the veil and witnessed the same chasm. Although doing my taxes myself was never an exciting experience, it was a great way to learn about the tax world.
Filing taxes is a simple task for me and most people. I have my W-2 form from the employer in my hand and I begin to enter my wages. Next, I need to fill out the 1099 forms listing my dividends and interest earnings. This tedious work is made somewhat easier by the fact that the IRS has a copy. At the end, you will see my income in black and clear.
It is difficult to define the financial reality of ultra-wealthy people. For one, wages are only a small percentage of their earnings. They have wide latitude in the way they account for their investments and businesses. Their incomes aren’t defined by a tax form. Instead, they represent the triumph of careful planning by skilled professionals who strive to deliver the most-advantageous-yet-still-plausible answers to their clients. A tax return is a bid to the IRS. It’s a kind of theory.
There is no limit to what you can do in this tax world. Stephen Ross is one of the world’s most successful real estate developers, a billionaire many times over, the owner of the Miami Dolphins. Ross, a former tax lawyer, once praised tax law as a particularly “creative” endeavor, and he is a master of the craft. His tax returns showed a total of $1.5 billion in earnings from 2008 to 2017, but he didn’t pay a dime in federal income taxes during that time. How? How? ProPublica reported. Look at Ross’s “income” for any of those years, and you’ll see numbers as low as negative $447 million. (He told ProPublicaHe observes the tax laws.
Kelcy Warren, a Texas billionaire owns a highly profitable natural gas pipeline company. But in an orgy of cake eating and having, he’s able to receive hundreds of millions of dollars from his company tax-free while reporting vast losses to the IRSHis records were made possible by tax breaks and energy-industry. (Warren didn’t respond to our questions.
Based on those reported “incomes,” both Ross and Warren received COVID stimulus checks in 2020. We counted at most 16 other billionairesYou are among hundreds of other ultrawealthy recipients of the stimulus checks, including hedge fund managers or former CEOs. This is how our system works. It’s why, in 2011, Jeff Bezos, then worth $18 billion, qualified for $4,000 in refundable child tax credits. (Bezos didn’t respond to our questions.)
A recent study by the Brookings Institution set out with a simple aim: to compare what owners of privately held businesses say they earn with the income that appears on the owners’ tax returns. The findings were stark: “More than half of economic income generated by closely held businesses does not appear on tax returns and that ratio has declined significantly over the past 25 years.”
That doesn’t mean business owners are illegally hiding income from the IRS, though it’s certainly a possible contributor. There are many legal ways to make income disappear. Depreciation and other tax perks allow owners to make tax losses while expanding their businesses. Real estate developers such as Ross can also claim losses on properties that appreciate. “Losses” from one business can also be used to wipe out income from another. Sometimes, spilling red ink can be a lot fun: For billionaires owning sports teamsAnd thoroughbred racehorsesAre exciting loss-makers
Congress larded the tax code with these sorts of provisions on the logic that what’s good for businesses is good for the economy. Although the evidence for a wider effect is often weak or nonexistent, it is clear that all of this is good news for business owners. Brookings’ study found that households worth more than $10 million saw the greatest benefits from being able make income disappear.
This isn’t just about a divide between rich and poor. Let’s say you have two people earning $1 million each, one via their salary, and the other via their business. Despite living in the same area and sending their children to the exact same private school, they do have different tax worlds.
Under the current system, said John Sabelhaus, a former Federal Reserve economist and one of the study’s authors, “if you’re getting a W-2, you’re a sucker.”
This basic divide can also be seen in how tax laws and regulations are enforced. The IRS considers the average worker an open book since all income is disclosed on W-2s or 1099s. A computer at the IRS can easily catch an error in a tax return.
But that’s generally not true for private businesses. These companies often become tangled up in interrelated partnerships, which can make it difficult to penetrate. Auditing businesses like these “certainly is a test of endurance,” said Spretnak, the former IRS agent.
She was able to solve the puzzle of income flow from one entity to the next, and she was ready for a more difficult challenge. It didn’t matter if what she saw made her jaw drop. She had to prove that the business’s tax geniuses had exceeded even what the generous tax laws allowed them to do. They had often done so, she discovered. Her final hurdle was to make her findings stand against a determined, well-funded opponent.
The IRS was no longer budget-constrained when Spretnak retired in 2018. budget-starved. Her successor will not replace the thousands of skilled auditors. Audits by the wealthy have fallen in value. Business owners still have reason to be bold.
On the other side of the chasm from the W-2er, there’s still another tax world, one that’s even more foreign than that of business income. It’s the paradise of unrealized gains, a place particularly enjoyed by the major shareholders of public companies.
If your company’s stock shoots up and you grow $1 billion richer, that increase in wealth is real. Banks will lend you money with this much collateral. Magazines will cover you. But if you simply avoid selling your appreciated assets (that is, realizing your gains), you haven’t generated income and therefore owe no tax.
Economists have argued for a long time that to exclude unrealized income from the definition is to draw an arbitrarily drawn line. The Supreme Court, as far back as 1940, agreed, calling the general rule of not taxing unrealized gains an “administrative convenience.”
Forbes reports that the wealthiest 25 Americans have risen to $400 billion in value between 2014 and 2018. While this is income to economists, it is irrelevant under tax law. So this group, which includes Warren Buffett and Elon Musk, was formed. paid federal income taxes of about 3.4% on the $400 billion, ProPublica reported. We called this the group’s “True Tax Rate.”
Recently, the Biden administration took a major step toward the “True Tax Rate” way of seeing things. It was a major step towards the “True Tax Rate” way of looking at things. proposedA Billionaire Minimum Income tax for the ultra-wealthy, which would treat unrealized gains and tax them at 20%.
To say that the idea’s fate in the Senate is uncertain would probably be overstating its chances. It is nonetheless a landmark proposal. Instead of talking about increasing income tax rates for the rich, the Biden proposal encourages a fundamental rethinking.
In the tax system we have, billionaires who’d really rather not pay income taxes can usually find a way not to. They can use tax losses to wipe out any taxable income and bank their accumulating gains. They can also look forward to receiving a few thousand dollars from the government to help with their children’s education or to assist them in a national emergency.
You could think of the fight to change this system as a struggle between the wealthy and everyone else. Yes, it is. But it’s also an effort to pull those other tax worlds down to the terra firma of the wage earner, to make it so a W-2 isn’t the mark of a sucker.
