$20-Billion Loophole Is Found in Tax Law : Officials Urge Change of Provision on Estates, Employee Stock Plans
Congressional tax writers, faced with a newly discovered $20-billion loophole inadvertently created by the new tax law, are being pressed to consider emergency legislation to eliminate the provision, officials said Friday.
The loophole stems from an obscure provision put into the tax law by former Sen. Russell B. Long (D-La.) during negotiations last August between Senate and House tax writers. It allows the estate of a wealthy individual to avoid estate taxes simply by selling the stock that it owns in a firm to that company’s employee stock-ownership plan.
The congressional Joint Committee on Taxation, which had earlier said the provision would have little effect on total government revenue, estimated this week that the revenue drain could reach $20 billion over five years, according to tax aides. That is most of the $25 billion that the estate tax, which generally applies only to individuals worth more than $1 million at death, had been estimated to raise during that period.
Earlier this week, the Internal Revenue Service moved to narrow the preference, but the IRS is likely to be challenged in court because its ruling goes well beyond the law’s actual wording and the congressional committee report explaining the bill.
“I would not be surprised to see legislative action soon,” said a senior aide to a tax-writing committee. “This was clearly not recognized at the time, but I’ve looked at the legislative language, and Treasury is definitely going to need some help on this one.”
Unless the loophole is closed, employee stock plans--called ESOPs--could be used as huge tax shelters by almost any wealthy individual to avoid estate taxes. The law contains practically no restrictions on using the provision, which would allow the trustees of an estate to deduct from the taxable value of the estate half the proceeds from any sale of stock to an ESOP.
ESOPs, which enjoy enormous federal tax advantages, are funds established to buy shares of a company’s stock on behalf of the firm’s employees. The money that feeds the fund may come from the employees themselves or from a loan from the employer, and the stock is typically distributed to the employees only when they leave the company.
The IRS, in its new guideline, attempted to rule out the most extreme uses of the new tax law’s provision allowing estates to use ESOPs. The guideline, “pending the enactment of clarifying legislation,” is designed to prevent an estate from buying stock in a company after a person’s death and then selling it to the firm’s ESOP to avoid estate taxes.
It would also require the ESOP to distribute to employees any of the stock it buys from an estate. That measure is designed to prevent ESOPs from becoming massive tax-shelter mills that buy stock from estates at a discount and then resell it at a profit.
Treasury officials are worried that the administrative ruling may not stand up in court. And even its narrow interpretation of the provision would allow individuals to buy stock while still alive with a stipulation that it be sold to the employee stock plan after their death.
“I won’t say there is a panic over here,” said one Treasury official, “but I would certainly say that there is a lot of consternation over this thing.”
Congress can approve a bill eliminating or modifying the provision retroactively. But Administration officials say they are reluctant to wait until tax writers get around to the expected technical corrections bill later this year because of the danger that large numbers of wealthy individuals could then be hurt by legislation retroactively revoking the newly discovered tax loophole.
The loophole was discovered by a handful of private tax lawyers, congressional aides said, and it came to the attention of government officials only recently. Tax writers say that the implications of the change were not understood at the time it was incorporated in the bill.
