How the ultra-rich avoid paying taxesPlay
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In the 1980s, a lawyer named Richard Covey devised a tax dodge that would save the ultra-rich millions.
In the 1990s, Congress stepped in to make the maneuver even more lucrative.
“The original one was kind of complicated and unwieldy and risky," Zachary Mider says. "There was a chance it wouldn't work. But the new one was like just basically free money.”
Today, On Point: How the ultrarich avoid paying taxes.
Zachary Mider, reporter for Bloomberg News. (@zachmider)
Bob Lord, senior advisor of tax policy at Patriotic Millionaires, a group of wealthy Americans advocating for more stringent taxes on themselves.
Richard Covey, senior counsel at Carter Ledyard & Milburn. He pioneered the grantor-retained annuity trust (GRAT).
Transcript: How the ultra-rich avoid paying taxes
MEGHNA CHAKRABARTI: It’s tax season. You’re standing at your mailbox, pulling out your W-2s, your 1099s.
You sigh. Because yes, taxes are the price we pay for a civilized society. Credit U.S. Supreme Court Justice Oliver Wendell Holmes for that one. It’s also carved over the entrance to the IRS’s HQ in Washington. But is everyone who’s enjoying the fruits of this civilization actually paying fairly for it? Democratic lawmakers don’t think so.
... But have you ever wondered how that happens? It’s not like there’s a paragraph on page 5473 of the United States Tax Code that says “to achieve the billionaire deduction do this.”
Nah. It’s way more interesting than that. You see, billionaire tax avoidance is, in its own way, a celebration of American ingenuity. Ideas are brainstormed in that laboratory of fiscal experimentation – the tax attorney’s office – and then unleashed into the wild.
And then, attorneys and their clients watch from behind their monied blinds. Will the new mechanism thrive in the real world? Will the IRS shut it down? Will Congress wipe it away? Will a court? And what happens when none of those things takes place? How many billions of dollars go unpaid, virtually forever?
Turns out, it’s a lot. And today, we’re going to show you how. This is On Point. I’m Meghna Chakrabarti.
This is Richard Covey. He served as special tax counsel to the American banking association for more than 25 years. Now, we couldn’t tell if it’s because he’s a generally happy guy, or the story he told is absurd, or if he can’t believe what he invented has been as successful as it is. But when we talked with him, Richard Covey laughed, a lot.
RICHARD COVEY: And to my surprise, continues to work today.
Richard Covey helped develop something called a GRAT. I’ll decipher that acronym a bit later. The story begins in the 1980s. But we’ll pick it up with what happened in 1993. Covey was going around the country discussing how GRATS might be used.
COVEY: At one of those speeches, a lawyer who came to it came up to me and he said, Would you be willing to work with me for one of my clients? And I said, Sure.
CHAKRABARTI: That client was Audrey Walton, of the Walmart Waltons. So what does a GRAT do?
COVEY: The result of that was you could retain 100% of the value of the trust. And that's what was behind the Walton case, which we won in the tax court. And as a result of that, people could create million-dollar trusts, they could create billion-dollar trusts, and there's still wouldn't be any tax when you use the Treasury table that wiped out the full value of the retained interests.
CHAKRABARTI: Yep, you heard correctly. ... The IRS did take Audrey Walton to court for using Richard Covey’s idea to shelter her assets. But the court decided with Audrey Walton.
COVEY: It's been accepted as of working and continues to work today. People had clients who wanted to reduce their taxes, and this was a great way to do it. It's that simple. It doesn't take long for those ideas to get around when you have a case right on point.
CHAKRABARTI: And that's exactly what happened. In the decades since, GRATS have become a beloved way of putting billions of dollars out of reach of the IRS and your U.S. Treasury.
COVEY: The GRAT concept works whether you put in $100,000 or you put it in $100 million. If you're successful, it works. And it just simply means that people who put in more are obviously more successful.
CHAKRABARTI: There's that laugh again. Now we're going to hear more from Mr. Covey in a bit. But we have to pause here for a moment because tax attorneys tend to speak in a somewhat rarefied language. But we have an interpreter here with us who's going to help us better understand the natural history of the grant. Zach Mider joins us. He's a reporter for Bloomberg News. Hello there, Zach.
ZACH MIDER: How do you do?
CHAKRABARTI: I'm doing well. So, first of all, tell us more about Richard Covey. Who who is he?
MIDER: So Richard is a long-time tax lawyer and who, you know, represents wealthy clients and helps them prepare their taxes. And he lives in this sort of world of tax planning, which is kind of to some degree a euphemism for figuring out how to avoid paying taxes or to pay as low as possible.
CHAKRABARTI: Pretty, pretty good line of work if you can get it here. So the story actually really begins, as I understand it, back in the 1980s, 1984, to be exact, because that's when Richard Covey just came up with this idea of something that was later known as a GRIT or a grantor retained income trust. And he told us about it.
COVEY: Common law GRIT was simply a person, creates a trust for himself, retains the right to keep the income for a number of years, retains a couple of other rights which have value for transfer tax purposes, and therefore he pays a gift tax when the trust is graded on only a portion of the trust.
CHAKRABARTI: So, Zach, decipher that for us. What is he talking about?
MIDER: Sure. So we're talking here about the estate and gift tax system, which is, you know, the estate tax is basically a special tax is different from the income tax that applies to kind of large fortunes when they pass down from one generation to generation. And what Covey developed was this kind of cool idea for how you could create a trust that would sort of appear to involve a very small gift to your ears, but in fact would transfer a large amount of money.
And the technical way it would achieve that is ... you wouldn't get the income, the expected income that this thing was going to generate, which was theoretically very large. But then you would actually invest in things that didn't produce any taxable income, say, for instance, stocks that didn't pay dividends. And so over time, that would kind of accumulate in the trust in a way that was kind of counter to what the IRS formula would have predicted. And so you would essentially find a way of making a large gift to your heirs appear very small.
MIDER: Yes. So that's exactly how Covey described it to us, that essentially the mechanism he created undervalued the remaining interest or value of the trust, which is why he got away with not paying as much or any taxes at all. Now, he also told us, Zach, he was frank about sort of the political climate at the time, which sort of helped him launch the concept of the grit into the world. And here's what he said.
COVEY: You started this movement, I would say, in the late '70s and early '80s, of using a trust ... to accomplish things that would save estate taxes. It's not only the common law GRIT and GRAT that did it. It was some other things that were mentioned in practical drafting. And then there were these family limited partnerships where people started to use a partnership as a way of reducing your estate taxes.
CHAKRABARTI: So, Zach, Covey described to us a shift in using trusts offensively rather than defensively to protect our assets. Do you think that's important?
MIDER: Yeah. So I think when a lot of people think about trusts, if they think about them at all, they think of maybe, you know, an heir who receives something, but they're too young to make good decisions about it. So they have an older trustee to kind of keep an eye on it until they come of age, things like that. There's all kinds of reasons why people have trusts.
They go back to the Middle Ages that have nothing to do with tax. But what Covey is talking about is sort of like using that mechanism to sort of, you know, offensively go out and achieve some tax goals of like, you know, essentially giving money to your heirs without paying the taxes that would otherwise be due on it. By, you know, kind of manipulating some aspect of the tax code to kind of, you know, slide it through.
CHAKRABARTI: Well so that's the real key thing as far as I understand it, that it's this idea that, okay, well previously we had thought that eventually when someone dies, some sort of tax will be paid to the federal government. But the offensive use of trust, as Richard Covey described, the point was to erase that eventuality. So we could talk a little bit more about how that happens, because the IRS eventually comes around and says, well, this whole GRIT idea, we don't like it, not a good idea, abusive use of it. And then Congress steps in. What does Congress do, Zach?
MIDER: Yes. So Congress, you know, recognized this was well publicized in the '80s, that people were we're doing this. I mean, Covey had, I think, published a paper to talk about how it could be done. And Congress stepped in and said, you know, we're going to have to change the law to make it so that that particular abuse is not possible. So they passed a law in 1990 that ended the GRIT as we know it. So it wasn't really possible after that to do the exact thing that Covey had come up with.
CHAKRABARTI: So, Zach, what happened after Richard Covey's original idea of the GRIT was basically shunned by Congress? What did Congress do?
MIDER: So Congress passes a law in 1990 that specifically targets the abuse that it saw in Covey's grit, which was the trust he came up with in the '80s. They said, you can't do that anymore. New set of rules. So that particular trick doesn't work anymore.
CHAKRABARTI: So here's what Richard Covey told us about what Congress made instead, right? Because they created a new option to replace the GRIT. Is that right?
MIDER: They basically said, if you want to do something like that, that's not an abuse of the tax code. We're going to invent our own sort of, you know, officially sanctioned thing called a GRAT, which doesn't have any of those abuse potentials that we were so worried about in the GRIT.
CHAKRABARTI: Okay. And so the GRAT is that grantor retained annuity trust. So Congress says here this is something that's legal, you can't abuse it. Go ahead and use it in your tax filings. Okay. But here's what Richard Covey told us about the problems with the GRAT.
COVEY: They made a very serious drafting error. They didn't realize that they were still permitting you to create a grant or retained annuity trust, let's say, of where you value the retained interest, that the full value of the trust virtually. And because of that mistake, the GRAT really grew up.
CHAKRABARTI: So Zach the who's the they? Who actually wrote or created the GRAT in Congress?
MIDER: You know, it ultimately comes down to some lawyers who work for the tax writing committees in the House and the Senate. And I spoke to a few of the folks who actually worked in those jobs in the lead up to the 1990 legislation. And, you know, some of them were pretty junior folks who've gone on to do other things outside of the tax world.
CHAKRABARTI: Junior folks, though, what does that mean, Zach?
MIDER: Yeah, I mean, they weren't that long out of law school, right? These were, you know, sort of like a chance to be a congressional aide for a few years, that kind of thing.
CHAKRABARTI: I don't mean to laugh, but what you're saying is congressional aides, you know, hardworking as they might be, are the ones who came up with the language on behalf of actual members of Congress saying, here's a legal way for a new form of trust for billionaires to use. So, again, might be just out of law school, might be super hard working, but it sounds like they didn't actually realize what they had done, which Richard Covey said they had given him and other tax attorneys a giant loophole to use. Now, with the GRAT and here's what he told us.
COVEY: The result of that was you could retain 100% of the value of the trust. And that's what was behind the Walton case, which we won in the tax court. And as a result of that, people could create $1 million trusts, they could create $1 billion trusts, and there still wouldn't be any tax when you use the Treasury table that wiped out the full value of the retained interests.
Bloomberg: "Accidental Tax Break Saves Wealthiest Americans $100 Billion" — "'How many times do you have to pay taxes on money?' the casino magnate asks, leaning on a blue cane on the cobblestones of Wall Street on a crisp October morning."
This program aired on February 9, 2023.