The tax code is so horribly intricate, convoluted and difficult to follow that the Trump administration may have inadvertently just gifted those who store cash and investments offshore another major tax cut - allowing them to tap the 21% corporate rate - without even knowing it.
Not unlike the patchwork job that the Federal Reserve has been performing on the economy, the tax code has been constantly revised and re-written for years, although nobody has had the fortitude to realize that maybe just stripping a good portion of it away would do us a lot more harm than good. With this type of backwards thinking comes ridiculous mistakes, like the one unearthed recently. The nation's wealthiest can now potentially tap the 21% corporate tax rate for personal earnings offshore.
For years, the tax code has been laughed at due to its complicated nature and voluminous content. Year after year, election after election, politicians promise to try and clean up the tax code, making it easier for "the rest of us" to understand. It never happens.
The Trump administration has tried to take steps in simplifying things, recently releasing a postcard sized version of Form 1040 for most people who don’t have complicated returns.
But only now - months after Trump has signed his tax cuts into law - are accountants starting to realize that cutting the corporate tax rate may have inadvertently created a tax loophole that could allow some of the nation's wealthiest people - who are usually the ones with access to expensive tax accountants and experts anyway – to be taxed at the corporate rate. Bloomberg reported on the story:
An obscure tax provision from the 1960s that was left untouched by President Donald Trump’s overhaul could let wealthy individual investors seize for themselves the largest corporate tax cut in U.S. history.
The measure -- signed into law by President John F. Kennedy -- was designed to prevent Americans from indefinitely shielding themselves from taxes by keeping investments offshore. It forced them to pay taxes annually on these investments, but gave them the option to have that income taxed at the corporate rate instead of at individual rates.
Bloomberg noted that the provision was virtually never used as the highest corporate rate had traditionally been the same or higher as the highest individual rate, but that has now changed.
For the past few decades, investors have had little reason to pick the corporate rate, since it was nearly the same as the top personal rate. But that all changed in December, when Trump’s tax law slashed the corporate rate to 21 percent -- 16 percentage points lower than the top federal individual income tax rate.
One expert in the article is quoted as saying "...we just forgot about it."
As to how it will work specifically: Investors have to create companies offshore where they can stash their passive income generating investments. From there, they can choose to pay the corporate rate, instead of their regular income tax rate, on what they earn. The money is taxed a second time if its moved back into the U.S., but for investors with a longer term horizon, this loophole could still create a major tax break.
The potential corporate rate cash-in derives from a complicated and controversial part of the tax code known as Subpart F. Congress passed the section in 1962 in an attempt to prevent companies from deferring taxes in overseas subsidiaries by keeping the profits abroad. Despite the deterrent, researchers have estimated that U.S. companies stashed more than $3 trillion of their earnings overseas. The recent tax law creates a mandatory tax -- at a one-time low rate -- that applies to those offshore earnings.
Subpart F also includes a section, 962, that allows individual taxpayers to act as if a “phantom” domestic corporation stands between them and their foreign company. Congress created that section as a way to put individuals on equal footing with those who held actual domestic corporations that owned a foreign subsidiary.
That said, those who plan on taking advantage of this loophole likely should do so with some expedience, as it would seem doubtful that it is going to last, especially once there is a public backlash to this latest gift to the rich.
In general, this loophole can only be described as another typical piece of inefficiency from the countless layers of government bureaucrats who continue to believe that overregulation and putting Band-Aids on things is a favorable solution instead of simply reducing the amount of government in our lives. The constant patchwork job that the government and the IRS are doing on the tax code is now – clearly more than ever – counterintuitive. After an embarrassing error like this, will the government start to get the point? Probably not.