ProPublica, How a Decades-Old Loophole Lets Billionaires Avoid Medicare Taxes:

For most working Americans, paying their share of the taxes that fund Medicare is an unavoidable fact of life. It’s so automatic for many workers that they may not even realize it takes a bite out of every paycheck. In theory, everyone is required to contribute to the country’s health insurance program for seniors, no matter how poor or rich, from cashiers to CEOs.

Not on Wall Street. There, some of the most powerful people in finance found a way to opt out.

The trove of tax records behind ProPublica’s “Secret IRS Files” series contains plenty of examples of billionaire financiers who avoided Medicare tax despite earning huge amounts from their companies. In 2016, Steve Cohen, the owner of the New York Mets, paid $0. So did Stephen Schwarzman, head of the investment behemoth Blackstone. Bill Ackman, the headline-grabbing hedge fund manager, was able to shield almost all his income from the tax.

How do they do it? Business owners, like any self-employed person, whether they’re a freelance Uber driver or a hedge fund manager, have the responsibility to declare their self-employment earnings on their tax returns. Indeed, the vast majority of small-business owners have no choice but to do so and pay the same taxes that wage earners pay, including Medicare.

But high-priced tax advisers, wielding a once-obscure bit of the tax code, found a way to make that obligation vanish. By carefully channeling profits through a company in a way that invokes that obscure provision, even a Steve Cohen, with a tax return showing he received hundreds of millions in profits from his hedge fund, can exempt that income from Medicare tax.

The three billionaires contacted for this article said they followed the law as written. They also pointed to the fact that they paid substantial income tax, which for them carries a much higher rate. Medicare tax is 2.9% for most people and 3.8% for high earners.

But these maneuvers by the rich hasten Medicare’s future crisis. Sometime in the 2030s, the program’s trust fund is due to run dry. Closing the loophole, along with eliminating other ways around the tax for wealthy business owners, could raise more than $250 billion over 10 years for Medicare, according to recent government estimates.

Over the past three years, ProPublica has mined the tax records of the rich to detail the many ways they avoid taxes. We’ve focused on basic structural features of the U.S. system that advantage them. We’ve uncovered maneuvers of questionable legality that seem to have escaped the notice of the IRS. The Medicare tax loophole occupies a gray area. The IRS definitely knows about it, but it’s unclear if the agency will be able to stop it.

The potential of the loophole first surfaced in the 1990s, and the IRS soon expressed the view that active business owners shouldn’t be allowed to exploit it. It was only in recent years, however, that the agency got tough. Today, the IRS continues to battle what it considers a serious abuse, waging a rare, long-shot campaign to prevent some of the nation’s wealthiest citizens from using the loophole.

The story of how America’s richest financiers avoid paying Medicare tax gives unique insight into the peculiar, messy way taxes work in the U.S. No one set out to create the loophole when it first entered the tax code in 1977. But a series of seemingly unrelated policy changes, together with a revolution in how American businesses are structured, conspired to deliver a major tax advantage to the wealthy. On Capitol Hill, interest groups have successfully defended that advantage, branding any effort to close the loophole as a tax hike on Main Street businesses.

Approaching its 50th birthday, the loophole, for now, lives on.

ProPublica, How Billionaires Have Sidestepped a Tax Aimed at the Rich:

Fourteen years ago, Congress set out to remedy a basic unfairness in the tax code. The tax that funds Medicare, because it’s aimed mainly at wages, hits even the poorest American workers. But the wealthy could easily avoid paying their share. So lawmakers created a new type of Medicare tax to capture the kinds of income the rich often enjoy: interest, dividends and capital gains from investments.

A host of billionaires — sports team owners, oil barons, Wall Street traders and others — have managed to avoid paying it, ProPublica found.

To study who was actually paying the new tax, ProPublica analyzed its trove of IRS data containing information on thousands of the wealthiest Americans. We identified 17 people who, in the first six years of the law, 2013 through 2018, each shielded at least $1 billion in capital gains from the tax. Together, this small group, by collectively exempting more than $35 billion, saved about $1.3 billion in taxes.

Most members of the group were able to sidestep the tax because of a huge gap written into the law, which allows owners to exempt gains from the sale of their businesses. They include Donald Sterling, the disgraced former NBA team owner who avoided the tax when he sold the Los Angeles Clippers to Steve Ballmer for $2 billion in 2014.

But others eluded the tax in ways that raise questions about how the law is being enforced.

One clear target of the new tax was investment professionals who rack up capital gains. Yet ProPublica found examples in the IRS data of financiers who claimed outsize profits but did not pay the tax. Tax experts contacted by ProPublica said they couldn’t think of a legitimate reason why those individuals were exempt. …

Both Medicare tax and its twin, the Net Investment Income Tax, as the new levy was called, are easily avoided by business owners. Last week, ProPublica revealed how some of Wall Street’s most powerful people use a loophole to avoid paying Medicare tax on their share of their firms’ profits. Eliminating these ways around the taxes, as House Democrats proposed to do in a 2021 bill, would raise an estimated $250 billion over 10 years. Medicare, the federal program that provides health care for some 68 million seniors, is projected to run short of money in 2036. …

The NIIT, together with its holes, entered the tax code as part of the Obama administration’s push to pass the Affordable Care Act. In need of ways to help pay for a major expansion of government health care subsidies, Democratic lawmakers embraced the idea of this new tax on investments. …

Owners of passthrough businesses with significant revenue already enjoy plenty of tax perks, as ProPublica showed in previous stories. The NIIT carve-out added to that list. The carve-out meant that when they sold their businesses, or portions of them, they’d be spared any extra charge beyond income tax on their capital gains. They’d pay a lower tax rate on those gains than on virtually any other form of investment.

“What we’re left with in terms of these gaps are nonsensical results,” said Steve Rosenthal of the left-leaning Tax Policy Center.

Prior TaxProf Blog coverage:

• ProPublica: America's Richest People Pay Little To Nothing In Federal Income Taxes (June 8, 2021)
• ProPublica: How Peter Thiel Turned $2,000 In A Roth IRA Into $5,000,000,000 (June 28, 2021)
• ProPublica: Why You Can’t Turn Your Roth IRA Into a Billion-Dollar Tax Shelter (July 1, 2021)
• ProPublica: The Billionaire Playbook — How Sports Owners Use Their Teams To Avoid Millions In Taxes (July 12, 2021)
• ProPublica: The Number Of People With IRAs Worth $5 Million Or More Has Tripled, Congress Says (July 29, 2021)
• ProPublica: Secret IRS Files Reveal How Much the Ultrawealthy Gained by Shaping Trump’s “Big, Beautiful Tax Cut” (Aug. 11, 2021)
• ProPublica: How The Trump Tax Law Created A Loophole That Lets Top Executives Net Millions By Slashing Their Own Salaries (Aug. 20, 2021)
• ProPublica: House Bill Would Blow Up The Massive IRAs Of The Superwealthy (Sept. 22, 2021)
• ProPublica: More Than Half Of America’s 100 Richest People Exploit GRATs To Avoid Estate Taxes (Sept. 30, 2021)
• ProPublica: 18 Billionaires Received Taxpayer-Funded Stimulus Checks During The Pandemic (Nov. 4, 2021)
• ProPublica: How These Ultrawealthy Politicians Avoided Paying Taxes (Nov. 5, 2021)
• ProPublica: More Billionaire Tax Games (Dec. 9, 2021)
• ProPublica: How Three Families Shielded Their Fortunes From Taxes For Generations (Dec. 15, 2021)
• Wall Street Journal Editorial, The Internal Revenue Leak Service (Dec. 15, 2021)
• ProPublica: When Billionaires Don’t Pay Taxes, People 'Lose Faith In Democracy' (Mar. 4, 2022)
• ProPublica Names The 15 Americans Who Reported The Most Income And Reveals Data For The Top 400 (Apr. 14, 2022)
• ProPublica: If You’re Getting A W-2, You’re A Sucker (Apr. 19, 2022)
• ProPublica: The Tax Scam That Won’t Die (June 22, 2022)
• ProPublica: The Billionaire GOP Mega-Donor Who’s Gaming The Tax System (June 22, 2022)
• ProPublica: Ten Ways Billionaires Avoid Taxes On An Epic Scale (June 27, 2022)
• Wall Street Journal Editorial, Comey|McCabe IRS Audits AND ProPublica Tax Leak Should Be Investigated (July 8, 2022)
• Wall Street Journal, Citadel’s Ken Griffin Sues IRS Over Leak Of Tax Return Info To ProPublica (Dec. 15, 2022)
• ProPublica: How The Wealthy Save Billions In Taxes By Skirting Wash Sale Rules (Feb. 13, 2023)
• ProPublica: Wealthy Executives Make Millions Trading Competitors’ Stock With Remarkable Timing (Mar. 18, 2023)
• Hedge Fund Billionaire Ken Griffin Subpoenas ProPublica Over Unlawful Disclosure Of His Tax Returns (Sept. 19, 2023)
• Hedge Fund Billionaire Ken Griffin And IRS Settle Lawsuit Over Tax Returns Leaked To ProPublica (June 25, 2024)

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