Updated: May 16
Asset Rich and Cash Poor, Not Just a Founder’s Dilemma
This is a follow up to my first blog post, Billionaire Tax Strategies to Help Your Divorce. In that post I wrote about ways in which you can benefit from simple, yet very effective tax strategies, whether in divorce or not, including avoiding the sale of appreciated assets, and applying various deductions to reduce reportable income. The good news is that you don’t have to be a business founder or an elite member of society to apply these tactics. In this post, we go into another efficient method to save you tax dollars, through the use of borrowed money.
USC tax law professor Edward McCaffery succinctly sums up a strategy for highly successful people as “Buy/Borrow/Die.” By using appreciated asset values as collateral to buy more assets, you are able to borrow vast sums, without ever having to pay the borrowed funds back, all the while avoiding capital gains taxes.
The truly rich do not have to pay any tax once they have their fortunes in hand. They can follow the simple tax planning advice to buy/borrow/die: Buy assets that appreciate in value without producing cash (like shares of Internet stocks), borrow to finance lifestyle, and die to pass on a "stepped up" basis to heirs wherein the tax gain miraculously disappears. (1)
Who’s Done it?
Tens of billions of dollars have been borrowed in this way from such American moguls as Elon Musk, Carl Icahn, and Larry Ellison. Icahn uses this strategy with the intent to boost his investment returns while also deducting the interest expense from his borrowings to lower reported income and reduce his tax bill. He uses a pass-through tax structure, reporting his business profits and losses on his personal tax returns. In some years, this results in negative reported income, avoiding federal taxation altogether. (2)
The strategy is not just an American one, and it can be a little easier to achieve in some locales where fewer disclosures are required. For instance, the founders of Alibaba, Jack Ma and Joe Tsai, have also done this in China. The benefits they received include gaining liquidity and diversification, as well securing business deals, and acquiring private jets and property.
Bankers say stock pledges are a common method for Chinese executives to raise cash without losing control of their companies or sending negative signals to the market by selling the shares. (3)
It’s Not Just for Founders
I frequently see clients use appreciated assets as collateral to boost the growth rate of their wealth. If you haven’t delved into this arena previously, you may be pleasantly surprised at the asset level required and just how low the interest rates can be. It can also be a sound option for providing needed liquidity with tax efficiency in divorce. The strategy isn’t without risk, however, and should be thoroughly discussed with professionals before implementing. You don’t want to wind up as the next Archegos. We are here to assist you in exploring this and other liquidity considerations that may be helpful, in your divorce or otherwise.
Citations and References:
1. “McCaffery: Mark Zuckerberg May Never Pay Taxes Again,” Paul Caron, TaxProf Blog, 4/10/13. Accessed 7/2/21. https://taxprof.typepad.com/taxprof_blog/2013/04/mccaffery-mark-zuckerberg.html
2. “The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax,” Jesse Eisinger, Jeff Ernsthausen, and Paul Kiel, ProPublica, 6/8/21. Accessed 6/9/21. https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax
3. “Alibaba founders secure loans from global banks backed by company stock,” Ryan McMorrow, Financial Times, 7/1/21. Accessed 7/2/21. https://www.ft.com/content/1efa8623-4e4c-435b-8195-26b3fb9839b9
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