A Clever Tax Strategy May Backfire – New York Times is an impressive reporting job by Flloyd Norris. I can only vaguely understand this tax-avoidance strategy but, regardless, who could possibly symphathize with the hunters as opposed to the hunted?
The Strategy as Norris presents it:
An investor with a large block of stock does an options collar transaction, in which he buys a put option, giving him the right to sell the stock, and sells a call option, giving someone else the right to buy the stock from him. That protects him from major price declines, in return for giving up possible additional gains.As long as there is a decent spread between the put and call exercise prices, leaving the investor with a chance for losses or profits, that is legal under the rules. Investors can get cash out by borrowing money secured by the stock. Then they can put the cash into other investments, like hedge funds, the current trendy investment for the wealthy.
In Wall Street jargon, the investor buys something called a prepaid variable forward contract that puts the whole transaction together.
This is popular because there are a lot of rich people with concentrated investments, including people who sold their family-run company to a publicly traded one and received stock. In many such cases, the tax basis of the stock is close to zero, so selling shares would mean paying tax on nearly all the proceeds. And you don’t get richer by paying taxes.
The strategy as described above is not challenged by the I.R.S. memorandum. The catch comes from the fact that the brokerage firm needs to hedge its exposure to a big drop in the price of the stock. It can do that by selling the stock short, but that means finding some stock to borrow, preferably from a lender who will not recall the shares at an inopportune time. So the contract may call for the customer to lend his shares. It makes things much easier.
But that, the I.R.S. memorandum states, is where the problem lies. As far as it is concerned, an investor who has given up most of the profit and loss potential and then lends out the shares has also given up the right to get the actual dividends, and risks losing the votes on the shares.
{ 10 comments }
When I was a kid my grandfather invested in well run companies that sold a good product at a reasonable price. I spent hours reading the glossy annual reports.
These days the stock market is a crap shoot. People buy stock because they think the price will be run up and they can sell it to someone stupider than they are. The mutual funds play “my computer is faster than yours.”
This is another resson why it will be disaster to replace SS (a successful universal welfare program) with deferred comp schemes. The Republicans (and libertarians) claim that the money going into the market will cause business expansion. Pure bull because the only new money that has a chance of going towards business expansion is IPOs and some new bond issues. The rest goes to a REAL Ponzi scheme.
billwald is quite mistaken. The real Ponzi scheme is Social Security, a socialist scam who’s mere existence should be an affront to any freedom lover. I wouldn’t invest in the stock market at this time because it’s going to go down and the managers and employees of most companies take advantage of the owners.
billwald, social security is not successful. It’s nearly bankrupt. The alleged “trust fund” has nothing in it but government debt, and it will need to be paid out of present taxes. Social security is doomed, no doubt about it.
Second, no sane libertarian supports Bush’s “privatization” scheme either. If it was really private, the government wouldn’t be involved at all.
Compulsory retirement plans are just another example of the government usurping the traditional rights and responsibilities of families. And then people wonder why many families seem so much weaker…
“Compulsory retirement plans are just another example of the government usurping the traditional rights and responsibilities of families.”
Edward,
To continue that thought, I think the stock market distortions Mr. Wald complains about are due in no small part to the government-defined tax shelters (IRA’s, 401k’s, ESA’s, etc.) we must use in an effort to preserve our savings. For that matter, the government’s own inflation chases money into the stock market as people try desperately to maintain their purchasing power. Wall Street has some very good friends in D.C.
Those who criticize tax avoidance and tax avoidance strategies in many instances believe that taxes are “the price we pay for civilization.” In complete contrast to this mindset, I and I believe most readers of this site would argue that civilization is the result of the market economy and civilization exists despite the imposition of taxes.
Dennis,
I’m one of those readers, and I heartily agree. Taxes are to civilization what ticks are to a dog.
Why bother at all about minor things like “tax avoidance strategies” when “no taxation without representation” principle is de-facto gone from our lives?
I’m rather pleased to see that the NYT has figured out that “… you don’t get richer by paying taxes.” Perhaps they will one day realize that this applies on a national level as well.
I’ve diversified myself out of the stock (and bubbled housing) markets entirely — anything that has seen a price rise based on the counterfeiting of Greenspan is not the safest bet for me.
There IS no growth of wealth without savings financed loans. Today’s loans don’t seem to be based on money people saved and expect to earn a real income from in interest. Stocks don’t pay profits (where do all those profits go?), bonds pay interest rates below true inflation, and housing profits come directly from the easy credit every American seems to love.
The crap shoot may never end — our government is POSSIBLY powerful enough to keep the economy growing through force. I don’t think that will be the case, though, which is why I’ve moved entirely to a gold standard for myself. Any “true” anarchocapitalist can do the same, and still feel safe for the future. If you’re a contractor rather than an employee, you have numerous loopholes already set up for how you tax your income, and you also have other options for working outside of dollar payment.
Don’t feel like you have to stick to the current system because you’re forced to. If you accept it, you’re reaping what you’ve sown. There are alternatives — and you don’t have to be a tinfoil hat wearing conspiracy theorist to take advantage of them.
The only thing that is “sucessful” about SS is its ability to steal from wage earners especially younger ones.
Billwald’s philosophy asserts that all the income I earn with my labor is really the governments. Because without a master institution that has the power to strip me of my life, wealth and dignity, no one could earn a living and that furthermore, if one did earn a meager sum, it would only be stolen seconds later by someone else. All the good we have comes from the existence of the state and nothing by self interest. Which of course is bunk.
Comments on this entry are closed.