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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.”
This may be a bit academic but might be useful to some.
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.
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.
Good point. Also, I long thought we should have one and only one tax-advantaged retirement plan with one set of limits and using the Roth model. Eliminate everything else.
It could be private or employer sponsored with match.
For most middle income and lower workers the pre-tax contribution is not a big deal anyway and Roth accounts during retirement probably have more value.
What about carried interest that the hedge fund big wigs earn? Instead of calling it wages it’s taxed at lower capital gains rates. Loophole?
That is debatable as the fees earned are fees or a share of the profits, but it’s not a loophole if the IRC permits the profit interpretation, but I could see changing the the way it’s viewed.
Yup!
When I retired at 62 before Medicare & SS I was able to keep my MAGI so low that I paid $7 monthly for a great Bronze plan. That $7 covered both wife and I. I never thought it was fair because I had over $2M in TIRAs, ROTH and Brokerage accounts, but I planned or it and didn’t hesitate to take advantage of “the loophole.”
Not a loophole as assets are not income. I am not taxed on SS or pay IRMAA premiums based on net worth, but income. I don’t even get property tax rebates based on networth.
Was a MAGI that low fun to live on? It wouldn’t pay my bills.
My lifestyle never changed. It was easy to calculate to keep MAGI at the number you want. I did plan and saved up a good chunk of cash for the years before Medicare kicked in. At 62 we paid $7 for our Bronze plan, at 63 it was $19, 64 was $39. Never made an IRA or brokerage withdrawal. We took SS at our FRA.
“It was easy to calculate to keep MAGI at the number you want.”
That was the key, knowing what was the maximum MAGI to avoid paying premiums. In our case we used inherited Roths above the MAGI, the MAGI funds came from our IRAs.
Had a similar experience with ACA, 7 figure portfolio & able to manage MAGI with regular brokerage a/c. A Silver plan with yearly premium calculated to equal the health plan reimbursement for gym membership & attendance. Felt kinda, well, healthy. And just received a Blue Cross/Blue Shield settlement past week. Winner, winner.
Income to live on that was not income. Pretty clever I would say.
I have a similar example. In the four years between when we retired and qualified for Medicare we had Affordable Care Plan policies. I studied how the subsidies worked an realized that I could utilize IRA income up to a certain limit to qualify for essentially a 100% subsidy, then utilize inherited Roth funds to cover the rest of our expenses. We never paid more than a token amount for a bronze plan since we were healthy but one year did pay 5K in deductible due to an ER visit, but still it was a bargain.
We certainly could have paid more in premiums, but because I educated myself on how the finances worked I was able to pay next to nothing for healthcare expenses for four years.
Was that a loophole? Others can decide.
What you did is called, “winning.”
Yes, contributions to my SEP and HSA, and Chris’s 401k, lowered our AGI enough to make us both eligible for contributions to our traditional IRAs. Allowing contributions to tax qualified savings accounts to enable even more contributions to the same type of accounts didn’t seem quite right to me, but hey, they said I could, so I did.
I think you make a valid argument that most tax loopholes come with a (potential) downside. Therefore I’m more concerned about antiloopholes such as the Foreign Tax Credit, IRMAA and that only $3,000 of tax losses can be carried forward.
I think you meant only 3k can be applied to ordinary income. There’s no such limit on how much can be carried forward.
Michael2, Good point, though what I really mean is that after an investor sells his 1000 shares of GE in 2020 that he bought in 2000, he can look forward to 86 years of tax losses carried forward.
i think you shouldn’t ignore that many well intentioned tax loopholes are abused. An example, is a politician who buried an ex-wife on his golf course and received a special cemetery tax reduction on the property. Here is the Chat-GBT summary on these:
The most frequently cited and widely debated US tax loopholes primarily benefit high-net-worth individuals and large corporations, often by reclassifying regular income or avoiding capital gains taxes. [1, 2, 3]
Prominent Individual Loopholes
Thanks, B, all good examples.
Sorry, I don’t see these as anything other than smart use of the tax code as written and the fact high net worth individuals figure it out is not meaningful. How many on HD talk about Roth conversion and using them to avoid IRMAA?
There is a community in Nj made up mostly from individuals of one religion. They routinely set up a religious school in their homes for a few children and claim the property is a religious house thus avoiding property taxes.That is not only a loophole, but abuse IMO.
You give a good definition of “loopholes”. I think they’re real. I sort of think that excluding Roth distributions from AGI may have been unintended, and therefore a loophole. Also, those back door Roth conversions probably fit the definition of loophole. But what politician has the guts to close them.
There are other loopholes, but that kind of thing is way above my pay grade. I bet the CPAs could add a thing or two.
All those other credits and deductions you list seem to work as intended, so I wouldn’t consider those loopholes.
Here’s an interesting loophole I came across on the internet. The Augusta Rule, (Section 280A(g)). It allowed people in Georgia to rent out their home for up to 14 days (during the golf tournament) without having to declare the income on their taxes. The unintended part happens when the owner of an S-Corp rents his personal home to the corporation for the annual board meeting, or maybe a personal retreat. He gets the tax free income, The S-Corp gets the tax deduction.
Do you think the IRC favors one income level over another or is it fairly progressive?,