The headlines are meant to grab your attention:
- Wealthy Clintons use trusts to avoid full estate tax they back
- After touting estate tax, Bill and Hillary Clinton seize on loopholes
- Bill and Hillary Clinton are dodging ‘death tax’ on their homes despite campaigning to raise it
- Clintons use loophole to avoid estate tax they helped create
Gasp. It appears that the Clintons don’t want to pay more in taxes than they have to. Newsworthy stuff, right?
Or maybe not.
We all want to criticize tax reduction strategies as somehow un-American until, of course, we want to take advantage of those same opportunities.
I said “opportunities” for a reason. I’ve been pretty outspoken about how I believe that the notion of a “tax loophole” has been mischaracterized in the press to paint a picture of taxpayers who are somehow gaming the system. We pretend that a loophole is kind of an “oops” – that it wasn’t really mean to exist and that somehow, someone has figured out a way to exploit it. But that’s not true.
Loopholes exist because it is impossible to imagine every response to the law. And a real loophole can be fixed.
But an accepted tax planning strategy – even if we don’t like it and even if we don’t think it’s fair – isn’t a loophole. It’s a carefully planned reaction to existing law.
It doesn’t matter whether it’s Apple or the Clintons: the law is the law. Whether and how often individuals and corporations take advantage of those laws may be a matter of choice – but let’s face it, when tax reduction strategies are available, most of us seize on them. You take the mortgage income deduction, right? You claim your dependents. You stash away tax-deferred cash in retirement plans. You write off business expenses. You do it because you can. Just like the Clintons. And just like Apple. The difference is that the notion that other taxpayers are somehow saving more than they are annoys other taxpayers.
So what kind of crazy tax planning are the Clintons accused of doing? They used a little something called a personal residence trust to potentially save a tidy little bundle in federal estate taxes. Here’s how it works: A personal residence trust (PRT) or qualified personal residence trust (QPRT) is an irrevocable trust created to hold ownership of a residence. Typically, a parent transfers the residence to the trust for a term of years: the transfer is considered a gift. The value of the gift depends on a number of things, including the age and health of the parent and the length of the term (the longer the term, the smaller the gift). If the parent survives the term, the child gets the house and the residence isn’t included in the parent’s estate for federal estate tax purposes. If the parent doesn’t survive the term, the gift bounces back to the trust and is generally includable for federal estate tax purposes. It’s a gamble. If it pays off, it can potentially result in some significant savings. If it doesn’t, you’re back to square one, albeit short some legal fees.
Realistically, it’s a fairly low pressure, low-risk estate planning strategy, and assuming that the parent has the resources to spare and the ability to give up control, it’s a pretty commonly suggested tack.
So why all the attention?
Politics. For one, the rise of personal residence trusts can be traced back to 1996, when one William Jefferson Clinton was in the White House. At the time, President Clinton wasn’t the populist that he’s painted as being today. He actually presided over increases in the federal estate tax exemption which, of course, disproportionately benefited the wealthy. Those increases were the first in ten years. To somehow suggest that Clinton was a champion of taxing the wealthy more in 1996 – but not so much now – is a bit misguided.
And it’s a fun message to say that the Clintons are using a tax strategy which benefits the top 1%… It’s also redundant: the top 1% are the only taxpayers subject to the federal estate tax anyway. Why would any of the 99% – who aren’t subject to the tax in the first place – even consider such a strategy? It’s pointless. But it makes a good talking point in the press, apparently. You know, for folks who aren’t quite sure what they’re talking about.
And yes, Hillary did go on a tear in the last presidential run as the people’s candidate. She touted tax reform aimed at the lower and middle classes, with increases at the top. Then again, a little context is needed. “The top” for politicians is not the same as “the top” for you and me. Even in 2007, at the Democratic primary debate at Drexel University, Hillary outlined her plan and it wasn’t to sock it to the rich. She actually agreed with keeping the estate tax in place but said, “I want to freeze the estate tax at the 2009 level of $7 million for a couple.” For the sake of comparison, the current exemption is $10.68 million for a couple.
The Clintons have long spoken out against disproportionate tax burdens for the lower and middle class. That’s what gets them votes. That doesn’t mean, however, that they have an obligation to pay more in taxes than they have to. Nobody does. Warren Buffett, for example, may decry a tax system that allows him to benefit from income tax breaks but he still takes them: he pays an effective federal income tax of around 11%.
And Romney? Remember the stink about his charitable trusts? Headlines like “Romney Avoids Taxes via Loophole Cutting Mormon Donations” were all over the place even though the mechanisms Romney used, like the personal residence trusts for Clinton, were pretty standard for high net worth individuals in estate and tax planning.
You don’t have to like Clinton or Romney or Buffett. And you don’t have to like their tax policy or their personal tax planning.
But let’s be very careful when we criticize the use of a legitimate and lawful (and indeed, common) tax planning strategy as somehow being inconsistent with tax reform. You can have both. You can want the law to be different but still honor the existing law.
I have a number of high net worth clients. None of them want to pay a dollar more than they have to pay in taxes. But just because they utilize strategies available to them – just like you do on a smaller scale – doesn’t make them bad people or hypocrites.
So, once more with feeling, here’s my unpopular advice: stop blaming big companies and rich taxpayers for not paying more in taxes. If you want change, advocate for change. But until that change happens – if it happens – we have the Tax Code we have. It’s the law, not a loophole.
