Taxes

Pensions May Make a Comeback. If You’re Rich.

JM Ashby
Written by JM Ashby

When former Kansas Governor Sam Brownback signed his grand, Norquist-inspired tax "experiment" into law, one of the immediate consequences was a wave of individual people declaring themselves businesses so they wouldn't have to pay any taxes under Brownback's zero-business-tax regime.

When congressional Republicans passed their tax cuts into law, there was a risk that we would see a similar scenario play out nationwide with wealthy individuals declaring themselves businesses so they could obtain lower tax rates.

The Treasury Department recently announced new regulations intended to prevent that from happening but, according to Bloomberg, the rich have found a new loophole that could allow them to obtain the lower tax rate: individual pension plans for themselves.

Pensions, also known as defined-benefit plans, can be used by doctors, law partners and wealth managers to stash hundreds of thousands of dollars in income a year. By doing so, they’ll get around the income limits Congress created to bar them from a generous new tax break for owners of pass-through entities, who report the firms’ income on their individual tax returns.

The Treasury Department proposed regulations last week specifying who qualifies for the 20 percent deduction, which effectively slashes the top tax rate to just under 30 percent from 37 percent. The rules also say that planning techniques such as the “crack and pack” -- where business owners split their firms into different entities to lower their tax bills -- are considered abusive.

“Doctors and lawyers got really annoyed when they were excluded from the pass-through deduction,” said Daniel Kravitz, president of retirement plan administrator Kravitz. “After tax reform, these plans become even more beneficial.” [...]

A cash balance pension is the “next logical step” for successful business owners who are already funding their 401(k) profit-sharing plans up to their limits and want to avoid taxes by deferring even more income, said Keith Steidle of Steidle Pension Solutions, a small plan administrator based in New Jersey.

A 61-year-old married doctor with a practice earning $650,000 a year could set up a defined-benefit pension to get his taxable income under $315,000. He could put $268,000 in a cash balance pension, in addition to putting money in his 401(k) and contributing to employee retirement accounts, and get down to an effective tax rate of 20 percent, according to Kravitz’s calculations.

To make a long story short, wealthy individuals could make it appear as if they're earning far less money than they really are by dumping large amounts of money into their own pension plan.

Making it appear that they're earning far less money will allow them to obtain the lower tax rates for pass-through income that would otherwise be unavailable under limits set by Congress and the Treasury Department.

They would have to pay taxes on the income if they withdraw it from their pensions, but they don't need to. They can let it sit there until they're old enough to enter a lower bracket and, in the meantime, they can pay lower rates on a yearly basis.

It's possible the Treasury could try to prevent them from doing this as well, but it's not entirely clear at this point if even the Treasury's initial actions will hold up when challenged in court. There's a line between the law as it was hastily written by our Republican-controlled Congress and the Treasury's interpretation of the law. Where exactly that line is hasn't been tested yet.

The heart of the problem is the GOP's decision to drastically cut tax rates that ultimately only apply to rich people. Tax cuts for corporation have been funneled into the pockets of executives and shareholders and new tax brackets for business owners are only applicable if you were wealthy to begin with.

  • muselet

    I’m pretty sure this is an unintended consequence of the tax deform legislation. A lack of time or focus or care or attention to detail led to weird distortions like this loophole.

    On the other hand, I’m also pretty sure the Rs are happy as Larry about the existence of such loopholes and distortions in the tax code. Those loopholes benefit the right people, after all.

    –alopecia