TW/CW: meansphobia, landphobia

Background

Whenever the topic of the tax burden currently falling on billionaires comes up, the immediate instinct of people is to go "umm, sweetie, actually did you know the rich can avoid taxes by taking up loans, using their stocks as collateral, and perpetually rolling them over"—the so-called "buy, borrow, die" method, apparently unpatched by US tax law. (Maybe this supposed commonness is just warped perception, but I've definitely internalized it—before people cancel me, I've already apologized to the PoM and PoL I've harmed, although I know that is not enough✊. Capital Forever!) So blatant an injustice is apparently committed by such an accounting trick that redditors have begun defending taxing collateral as a realized gain (how would mortgages work? lmao), among other nonsense. Below, I propose a simple solution. (Much simpler than what weird succish think tanks can propose). Note also that I am unconvinced this supposed cheat code is even prevalent (and hence I question whether it needs "solving"). I found one FT article mentioning a Peloton founder using it (linked below somewhere), but not much else.

Also, Stiglitz has a paper on this (and related accounting tricks).

Problems with the strategy

One extremely obvious problem is tail risk. If you realize your gains, and put them into safe bonds, you will have a lot more liquidity and a lot less risk. But for those who adopt the "buy, borrow, die" strategy, if things go awry (exposure to bad tail risk), it often becomes a "buy, borrow, pray" (as the Financial Times put it): their collateral is exposed to the same risks as their overall financial health. So, simply realizing your gains mitigates tail risk, and is therefore (often) advantageous.

Furthermore, this effect leads to a high(er) interest rate under the "buy, borrow, die" strategy. Indeed, if the situation at which you are most likely to default is when your stocks (put up as collateral) have a low value, potential debtors will ask for a higher interest rate R than if you had a less risky (or, at least, something less correlated with you being in a bad financial situation) asset as collateral. This higher interest rate R will become relevant later on.

The tax law, and a solution

My solution: abolish the step-up basis. If you don't know what that is (to the succs: take accounting), read about that before proceeding. (Note: I am not a lawyer. If you are a lawyer, and I am wrong about something, please don't correct me. I don't want to be embarrassed. Thanks!)

The "buy, borrow, die" method merely postpones payment of taxes after the step-up basis has been abolished. Indeed, suppose you die (morbid, isn't it?). Your estate must pay off all outstanding debts. And so when you've taken out loans, your estate has to find a way to pay them. That includes realizing gains by selling your former assets (and not at the stepped-up basis, but as if you were actually alive and were the executor this whole time). Furthermore, the government gains more capital gains under the "buy, borrow, die" strat than they otherwise would have (in terms of net present value): to make up (money received by you from the debt holder) times (1+R)^(time of death minus time of buying your stocks), the executor has to sell off more stock (realizing more capital gains) than if they had to make up (money received by you from the debt holder) * (1 + risk free rate)^(time of death minus time of buying your stocks). (Note: I assume here that debt is structured as a zero-coupon bond. Something something Modigliani-Miller theorem.)

In the current system, such a sell-off doesn't incur much capital gains, since the capital gains only applies to the following:

(number sold) times ((stock price at time of sale by the executor) minus (stock price at time of your death))

This number is probably small (the time between the date of sale by the executor and time of death will be relatively small compared to a whole lifetime). But under the reformed system, without a stepped-up basis, the change in stock price would be measured relative to the time of purchase, not date of death.

In other words: once the reform is made, using the BBD just defers capital gains taxes to death.

The estate tax

I don't really mention the estate tax in the above analysis, but it does also lead to a pretty substantial taxation of the estate (and not on a stepped up basis). This isn't directly relevant to the strategy, since the tax would have been incurred anyways (and you get a deduction = your borrowing, see 26 U.S.C. § 2053). As the comments have pointed out, there are ways to avoid paying it (via trusts). However, when you put your money in a trust, it no longer gets a stepped up basis.

Also, apparently, "just tax death lmao" works.

TLDR:

the "buy, borrow, die" strat carries lots of risks. furthermore, abolishing the stepped-up basis would make it so that the "buy, borrow, die" strat just defers capital gains (and at a higher NPV to the government than if not). furthermore, your estate is already taxable.

Silicon Valley and the nativist right worked together to elect Trump. Now the infighting has begun.

Subreddits Against Malaria 2024. Friday January 10th to Friday January 17th... 2025

Over budget and behind schedule, but it's happening. Are there any subreddits or other communities you're a part of that might be interested? Are there any new incentives you'd like to see? Let me know

We might hit the $1,000,000 mark this year 👀

Copy/pasted from /u/jenbanim, if you message me about this I won’t read it and I might ban you.

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