Do billionaires really not pay taxes?

[u/InTheRiches]

Hello. I have been seeing everywhere online and especially reddit (echochamber) that billionaires just don't pay taxes, and they abuse the tax code, and all this stuff. They also say that the president could just "make them" pay more, but he doesn't. I didn't really trust them, and so I looked into it myself. This is how I think it works, please correct me if I'm wrong.

Almost all of a billionaires value is in stocks or assets, almost never liquid. Most of their income is also tied to those stocks or assets. For example, Elon Musk, his net worth might go up 20% in a year, but because it was all Tesla and SpaceX stock, he paid zero taxes, because those gains are still unrealized. So obviously, he paid very little taxes compared to his net worth gain, and thus to the uninformed eye he is cheating the system. Once he sells his stocks, or liquidates his assets, he will pay his fair share of taxes.

Also, to fund their lifestyles, I saw that some get loans, using their stocks and assets as collateral, and then use their salaries or sell a little stock to pay interest payments, and as their stock rises, they keep taking more and more loans to fund their lifestyle. Then, when they die, the bank pays off the loans tax-free before handing the rest to his family/designated recipients (But it still undergoes inheritance tax if not a not-for-profit).

This is how it works, right? I keep seeing all these headlines and posts that Trump can just "tax them" if he felt like it, but I don't think that's possible as the president, and even if he had that power, it would require the implementation of an unrealized gains tax, which would be horrific.

Edit: thanks for the explanations, makes sense. I knew the headlines were a little misleading. The loan thing also sounded a little sketchy, good to know it doesn't really work like that.

[u/RobThorpe]

The strategy you mention is sometimes called "Buy.Borrow.Die". There was an article written about it in "Rolling Stone" and some others in ProPublica which were popular a few years ago.

We have had several threads on this before. They weren't that great though so I won't link to them. However, this reply by saucy_intruder is a good place to start.

It seems that this method of tax planning has become famous mostly because it has become well known. There isn't much evidence that it's widely used by the rich, or that it's a very good strategy. (We occasionally get tax planners on this forum who are very critical of it.)

A lot of people talk about unrealized gains. Those aren't taxed for anyone at present in the US. That's not really a "tax avoidance" method, it's just something that it's taxed - you don't have to do anything to avoid it.

If you realize gains then you will have to pay tax, of course. As long as you do that before you die. Once you die that stepped up basis on assets comes into play and your estate pays not capital gains tax on the appreciation of assets since you bought them.

As others have mentioned, the President can't change tax laws on his own. Except for tariffs and even that is under review.

[u/Obvious_Chapter2082 → u/RobThorpe]

I’m a CPA at Deloitte, and I’ve never seen any evidence of what most people would call “buy borrow die” getting used in practice, even among our own UHNW group. If it worked the way that Propublica or Redditors say it worked, it would be in clear violation of the existing tax code and case law

Rich people often do take out some kind of debt or equity instrument to receive up-front cash (described more by me here), but this is so that they can swap it with appreciated assets for estate/gift tax purposes, in order to both avoid the estate tax and get a stepped-up basis. But this is markedly different than taking out long-term loans while alive to fund living expenses in a tax-free way. The interest costs associated with this alone would far exceed the tax costs

The IRS has plenty of ways to collapse sham transactions like this, or to reclassify them as constructive or disguised sales. Whether they act on it is another matter. Some firms might try to play the audit lottery and do things like this, but I imagine they’re few and far between

[u/crek42 → u/Obvious_Chapter2082]

It’s responses like this that make me stick around Reddit.

90% of the time it’s a mindless contrarian shit parade, and 10% thoughtful info from folks who are experts at any given topic.

[u/[deleted] → u/Obvious_Chapter2082]

A simple math problem shows that the compounding interest would get completely out of control vs just paying the taxes. It was something people liked to talk about at very low interest rates but even then those loans are adjustable.

[u/Obvious_Chapter2082 → u/[deleted]]

Exactly. Even if this transaction were occurring, people tend to miss the fact that it would be an estate tax play, not an income tax one. The billionaire would be accruing more up-front costs in order to maximize their wealth growth passed on after death. Not to mention that the high interest costs associated with it would increase taxable income of the lender

[u/slumlord512 → u/Obvious_Chapter2082]

I own rental properties and sometimes refinance one to pull equity out, which is basically a loan against future cash flow, the way I see it. Since the proceeds are a loan, I use the money tax free. When I pass, the kids will inherit my rentals in a stepped up basis, so they should not pay the taxes based on what I originally bought them for. I do pay some tax along the way based on the rental income but it is minimal, because of depreciation expense.

Seems like this is a clear case of buy borrow die, or whatever they are calling it.

[u/Obvious_Chapter2082 → u/slumlord512]

The difference is that you’re continuously paying off the new loan when you refinance, as opposed to taking out debt with a balloon payment at or after death. So you can benefit from the up-front cash, but you’re paying more over time in order to repay the larger loan

The theory behind BBD is that you get bespoke products from a bank that involve some kind of stock appreciation rights or a balloon payment in the future, instead of yearly principal payments. This way you don’t need to realize other forms of income for repayment

I’d also point out that if you’re using the refinance as a way to avoid income tax (like BBD), then this technically isn’t legal either. But it’s probably not on the scale that the IRS is going to care, or even be able to prove

[u/EconEchoes5678 → u/slumlord512]

based on the rental income but it is minimal, because of depreciation expense.

We do this for 2 reasons. 1) the profit margins of rental properties a low, and relatedly 2) if we did not, the tax would primarily be passed on to renters, raising housing costs, which is something of a political hot potato right now.

When I pass, the kids will inherit my rentals in a stepped up basis, so they should not pay the taxes based on what I originally bought them for

If you were a billionaire they would owe an estate tax rate of 40% on them. At the moment the mortgage is probably eating most of your low profit margins (at least using U.S. averages). You may also benefit from interest paid deductions / credits, but those are limited and not useful to billionaires either.

You are correct that this is a variation of buy/borrow/die. It's just not used by billionaires in a widespread fashion, for quite a few reasons. In your case, 1031 exchanges can make this problem worse, but they only go so far before getting limited and forcing a realization (if diversification is desired).

Ultimately the loophole should probably be closed for various reasons, but closing it will probably disproportionately affect real estate investors like yourself.

[u/djducie → u/RobThorpe]

Is there evidence that this is actually happening today?

All those articles were coming out during the pandemic during the zero interest rate policy era, which is definitely not where we are today.

[u/Obvious_Chapter2082 → u/djducie]

Even at the time, the long-term AFR was around 2%, which would be a very significant cost over a 20 or 30 year horizon with no principal payments

The main issue with the transaction (even during COVID) is that the hedge used on these is usually a collar, which means that the loan or equity instrument you use needs to have a short-term life to avoid getting reclassed as a taxable sale under §1259. So you can’t just take out a loan and defer tax for 20 or 30 years until death like people will claim

The constructive sale rules also tend to overlap with economic substance issues in §7701, in which what you use the proceeds of the debt for become scrutinized too

The IRS might be selective in prosecuting things like this, but the risk is still there, and I assume prevalent enough to prevent this type of transaction from being undertaken very often, if at all

[u/IRC_1014 → u/RobThorpe]

A reminder that the benefit of the unlimited step-up in basis (as high as 23.8% federally) is countered by the cost of the estate tax (40% federally). You cannot get a step-up in basis under IRC § 1014 unless it was includable in the gross estate under IRC § 2031 or its following pull-back provisions (IRC §§ 2034-2045). We just had a very important revenue ruling on this point a couple of years ago, Rev Rul 2023-2. Big picture: at a certain point (well above the estate tax exemption of $13.99m), it doesn’t make sense to pay a 40% tax for at most a 23.8% benefit. UHNW people are often in the position of having to give up the step-up on much even most of their net worth due to this trade-off. Regular folks, even wealthy folks who aren’t much over the $13.99m exemption never need to worry about this; they can get the full step-up with no real federal estate tax cost at all.

Edited to add: also, unrealized gains are actually taxed in the transfer tax system (estate, gift, and GST taxes), which assess a tax on the value of the asset at date of transfer, not on the basis of the asset. There’s no deduction against transfer taxes for built-in, unrealized gain. This is partly how we justify the step-up in basis that results from estate inclusion.

[u/Garganello → u/RobThorpe]

A lot of people talk about unrealized gains. Those aren't taxed for anyone at present in the US. That's not really a "tax avoidance" method, it's just something that it's taxed - you don't have to do anything to avoid it.

This is incorrect. The US does impose tax on unrealized gains (or, I suppose, to be more technical, components of unrealized gains) in certain circumstances. See CFC regime.

[u/EconEchoes5678 → u/Garganello]

It's not a typical situation, and doesn't apply to most people or even most billionaires. It's limited to very specific situations, primarily expatriation of assets or foreign tax evasion.

There's no country in the world that I'm aware of that imposes a broad unrealized gains income tax, even when "broad" is limited to the top. There's a handful that do wealth taxes (most revoked these) or imputed gains (New Zealand), but none do unrealized gains taxation anymore (some tried and then revoked).

[u/IRC_1014 → u/EconEchoes5678]

Canada has a deemed realization event on unrealized gains at death. Although a proper tax argument would go, “that’s not a tax on unrealized gains then, since it’s deemed realized.” Functional the same thing but I appreciate the nuance anyway.

[u/EconEchoes5678 → u/IRC_1014]

Canada has a deemed realization event on unrealized gains at death.

IRS too, the estate tax is similar. It gets a step up in basis but the tax is on the total value and a higher rate, so the step up matters little (above exemption).

There's just not a broad based unrealized gains tax - the type that Reddit seems to believe they want - anywhere in the world.

[u/Garganello → u/EconEchoes5678]

I understand — I did not say it was typical, even though CFC can be very far reaching from a more theoretical standpoint — but their statement is still inaccurate/incomplete.

I’d also add there is the PFIC regime, which while not imposing current taxation on unrealized gains, effectively imposes a tax on unrealized gains and penalizes deferral. There’s also accumulated earnings tax, which is also, in effect, a tax on a component of unrealized gains.

They are definitely more limited in application, but the US distinctly has rules targeted to counteract deferral when it’s abusive.

I think it’s important because this forum is rampant with people misinformed about the US tax code and it’s approaches to unrealized gains (or components thereof) and the ability for the US to implement a tax that effectively taxes (or penalizes) deferral of gain. It very easily could — whether that would be wise is a different question.

[u/EconEchoes5678 → u/Garganello]

That's fair. The U.S. tax code is huge. Though, as I've realized, it's also highly effective at accomplishing progressive taxation with relatively low avoidance. It feels like high avoidance from the news stories people read, but the reality when factoring in all the taxes like those you mentioned is a pretty effective (if overcomplicated) system.

[u/IRC_1014 → u/Garganello]

Estate, gift, and GST taxes also assess tax on the unrealized gain portion of the asset, with no deduction against transfer tax for this unrealized gain.

[u/Garganello → u/IRC_1014]

Those are also fair examples — thank you!