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There is no such thing as a tax loophole, but here they are anyway

My opinion is that there is no such thing as a tax loophole. Plus it has a negative connotation I don’t think is accurate. In addition, there is a tendency to apply the word to others – mostly the wealthy, but not ourselves

Look up the word and you likely see something like “ A tax loophole is a provision, ambiguity, or gap in tax law that allows a person or business to legally reduce the amount of taxes they owe — often in ways lawmakers may not have originally intended.”

Long term gains are taxed at lower rates to make investing attractive. Municipal bond interest is tax-free to allow municipalities to raise funds at lower interest rates.  This goes back to 1913.They are not loopholes.

Are Roth accounts loopholes? How about Roth conversions? Nope, but perhaps excluding Roth withdrawals from MAGI, especially related to IRMAA premiums may be considered as such. Ask yourself this. Who can better afford higher premiums, the person withdrawing $75,000 from a taxable IRA or the one taking $75,000 from a Roth tax-free.  Seems like the logic is backward. If a person lives on $75,000 in municipal bond interest, is that not the same income level as Roth income?

Are QCDs a loophole, they certainly apply mostly to higher income Americans? They are a clear tax advantage that also helps society. 

Why is it a loophole if stock compensation is favored over salary? Stock compensation contains risk and sooner or later it will be taxed. Not unlike a 401k taxed as ordinary income decades after a contribution is made, when the earnings portion is actually capital gains. 

Receive non-qualified stock options and they are not taxed until exercised and value is achieved, then it’s ordinary taxable income and if the exercise is taken in stock shares, the gain above exercise price is taxed again as a capital gain. That’s what I did twenty years ago and still hold the shares. When my family inherits them, the basis will be reset and eventually they will pay capital gains –  intentional part of the IRC which benefits many average Americans with modest estates even while benefiting the super wealthy.  No actual gain is realized until a sale is made. 

Around 60% of CEO compensation is equity, not cash. Generally, when this compensation vests, it is taxed as ordinary income. For example, when restricted stock units (RSUs), vest they are taxed as ordinary income first, then capital gains or losses on later sale. This is sometimes called a loophole, but why? Stock compensation is intended as an incentive and the value is at risk. 

Is the mortgage interest deduction a loophole given it favors homeowners over renters? 

I don’t see any of this as loopholes. Every taxpayer seeks to minimize their taxes, hopefully legally and the tax code applies to everyone. The fact more money is involved for the super rich, doesn’t change that in my opinion. 

There are currently sixteen tax credits in place, all but one directly benefiting individual Americans. Are they loopholes if many of us are not eligible? 

So, keep trying to legally minimize your income taxes and avoiding IRMAA and take advantage of every “loophole.” 

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ram bala
4 months ago

This may be a bit academic but might be useful to some.

  1. Tax planning opportunities (whether you call them a loophole is semantic) when there is a difference in tax rates across time periods (IRA vs taxable account) / types of income (income, dividends, gains, etc.) / jurisdiction (MA vs. FL) / object of tax (married vs. single) / other factors. Within each cut, effective tax planning seeks to move money from a category with a higher tax rate to one with a lower tax rate.
  2. We create a mess (and opportunities for tax planning by creating the above wedges) when we comingle social / economic policy with tax policy. A progressive tax rate is a simple example … it implicitly assumes that richer people ought to pay more. Likewise, why seek to favor investments via a lower rate on LT capital gains rate? Why promote marriage with a higher slab for married filing jointly versus two people living together and filing as individuals? In my view, every attempt to alter behavior via tax policy has unintended consequences which has created the “tax planning” industry.

Having said this, I think divorcing the social / economic and tax policy is not that easy or straightforward. So, I think we are stuck in this mess for the long haul. And, as a rational person, it makes sense to tax plan as much as possible.

Last edited 4 months ago by ram bala
DrLefty
4 months ago

I have no problem ethically with the legal use of tax “loopholes.” If it’s legal and you’re smart enough to take advantage, good for you.

I’ve thought for a long time that things like mortgage interest deductions and sizable above-the-line deferrals for retirements savings (401Ks, or my case, 403B/457) are a form of government handouts for the more privileged. Not everyone can afford a home with a big mortgage deduction. We maxed out all of our deferred comp accounts, plus the 50+ catchup, for nearly two decades, and that’s a big part of our net worth now. Yes, we (and in due course our estate) will have to pay up eventually, but most people can’t do what we did.

I don’t feel guilty about that at all, but I think it’s hypocritical when wealthier people sneer about people getting “handouts” and being “takers” when they’ve been “taking” in ways that the less wealthy folks cannot afford to pursue.

Nick Politakis