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In America the rich can avoid taxes, Who A Thunk It.
QUOTE:
And if all investors were allowed to use exchange funds, government tax revenues would plummet, Mr. Neal said.
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A Tax Break for the Rich Who Can Keep a Secret
By DAVID CAY JOHNSTON
When most Americans sell stock they must pay taxes on their profits by the following April 15. But a few Americans are delaying taxes on their stock profits for years or decades — or, in some cases, never paying at all.
It's all perfectly legal — but only if you have $5 million of stocks and bonds. And only if you promise to keep it secret. It's one example of how the tax laws currently grant certain favors only to the very wealthiest.
The deals work this way: Executives and investors with $5 million of stocks and bonds contribute at least $1 million of their stock in a single company to a pool into which others in the same situation contribute their own shares. In return they receive shares of a partnership that owns the pool.
When they are ready to withdraw from the pool, the partnership gives them not their original shares or cash but instead shares of a variety of stocks held by the pool. As a result, someone with too much money in one stock can quickly diversify into a more balanced portfolio. But unlike other investors, who have to pay taxes on profits when they sell a stock, no taxes are owed on the profits of the shares contributed to the pool.
If investors stay in the pool for seven years, the stocks they get when they withdraw their investment do not incur the tax on investment profits that other investors must pay. Only if the investors then sell the various stocks they received from the pool are they supposed to pay taxes.
Those taxes are by law owed on their investment profits all the way back to the time they bought the stock that they put into the pool. But cheating is easy because the investors can merely report only the profit made since they took back the stocks from the pool. An Internal Revenue Service auditor would have to know about the pool, and do a lot of work, to determine the full profit made on the original stock contributed to the pool.
The Eaton Vance mutual fund company in Boston and the Goldman Sachs investment house are by far the biggest operators of investment pools based on this tax avoidance technique, with at least $18 billion of stocks in what are known in the investment business as exchange funds or swap funds. Smaller exchange funds are operated by investment firms that include the Bessemer Trust, Credit Suisse First Boston, Merrill Lynch and the Salomon Smith Barney brokerage unit of Citigroup.
To get in on these tax avoidance deals, investors must sign statements promising never to disclose the terms to anyone except their financial advisers.
But the confidential offering for one such deal was provided to The New York Times by one investor and separately by two Washington tax experts to whom the document was leaked. They said they were offended by tax avoidance available only to the very rich.
One of these people said he was also upset by advice in promotional literature for the Eaton Vance funds that shows executives how to disclose these transactions in a way that is legal but that investors who track sales by company executives are less likely to notice. Some investors pay close attention when executives buy or sell shares of their company as a signal for the likely direction of the stock price.
The confidential offering provided to The Times shows that investors have contributed to Eaton Vance's exchange funds pool shares of more than 700 corporations, including almost every company in the Standard & Poor's 500.
Fewer than one in 1,900 Americans qualify for exchange funds according to current rules, said Professor Edward Wolff, a New York University expert on wealth.
The exchange funds are but one of a variety of techniques available only to the very wealthy to delay or escape taxes on their investment profits. Other techniques include certain kinds of insurance and offshore trusts.
Exchange funds have been around for decades. But they used to be open to everyone. Congress tightened the rules in 1967, 1976 and 1997 to gradually exclude all but the wealthiest investors. The 1997 change, detailed partly in a tax bill and partly in a securities bill, created a new class of investors, known as qualified purchasers, whom the Securities and Exchange Commission defined as people with more than $5 million of investable assets.
To meet the 1997 requirements, the operators of exchange funds must form partnerships that are not offered to the general public, only to qualified purchasers. Other tax and S.E.C. rules require that the partnerships be treated as private placements, rather than a public offering to investors, so no advertising is allowed and prospective investors must sign confidentiality agreements.
Why limit qualified purchasers to people with $5 million in stocks and bonds? The rationale is that exchange funds are considered suitable only for people who do not need to touch the money for 7 to 15 years — in short, only for people wealthy enough to afford the risk of such a long-term investment. A lot of early withdrawals make the fund unmanageable.
Eaton Vance sells its exchange funds under similar names. One is called Belrose Capital and funds created since 1997 are called Belair, Belcrest, Belmart, Belport and Belvedere.
Most of the exchange fund investors are longtime shareholders, including heirs of families that own large stakes in a single company. About 10 percent to 15 percent are executives of the companies whose stock they are contributing to the exchange fund, investment executives at Eaton Vance and other firms said.
The funds benefit more than just their investors. They also generate lucrative fees for both the firms that organize them and the outside brokers who find investors for them.
Brokers who sell Eaton Vance funds are paid 2 percent of the value of shares their clients contribute to the exchange fund. Individual brokers typically share a portion of this fee with the firm that employs them. The brokers also get, and split with their firms, an annual fee of one-quarter of 1 percent of their client's investment. Because most clients stay in an exchange fund for seven years the broker and his firm stand to collect at least 3.75 percent of his client's account.
Investors pay Eaton Vance total annual fees of a little under 1 percent of their investment, about the same fee charged by a mutual fund that actively trades, even though exchange funds rarely incur commissions to buy or sell securities.
Some years ago the exchange funds came to the attention of Representative Richard E. Neal, a Massachusetts Democrat. He introduced legislation to stop them. But the legislation never went anywhere.
Eaton Vance, in a report to Mr. Neal last year, said its exchange funds "are not tax shelters" and "benefit our markets and our society" because they provide "risk reduction that otherwise would not be achieved."
Two Eaton Vance executives, in background talks, said that rather than further restrict or even shut down the funds, Congress should allow anyone to invest in them.
"Why should the guy with a $1,000 gain not be allowed in?" said one Eaton Vance executive, who the company insisted not be identified.
Not everyone agrees with that approach. Mark Seaman, a vice president with the Legg Mason Wood Walker brokerage firm in Baltimore, a securities dealer that markets the Eaton Vance funds, said that because people were expected to stay in an exchange fund for seven years the funds were not appropriate for people who might need access to their cash.
And if all investors were allowed to use exchange funds, government tax revenues would plummet, Mr. Neal said.
"We have individual retirement accounts where you can trade stocks without immediate taxes," he said, "but they are limited by Congress." Also, when investors in I.R.A.'s withdraw their money, they must pay taxes at ordinary income rates, which are higher than, and sometimes almost double, the capital gains rates on investment profits.
No one knows how much exchange funds cost the government in taxes because no official study of their costs has been made. But the Eaton Vance and Goldman Sachs exchange funds alone represent as much as $3.6 billion of deferred capital gains taxes at current rates.
The Congressional Joint Committee on Taxation, without any supporting data, has written Mr. Neal to say that no revenue would be raised by closing exchange funds because "the class of investors engaging in swap funds" would find other ways to avoid the tax.
Mr. Neal said he pressed Mark A. Weinberger, who until recently was the chief tax policy official at the Treasury Department, about why the Bush administration would not shut down exchange funds as loopholes, which the administration had said it opposed on principle.
Mr. Weinberger, the congressman said, replied that the Bush administration "is not for or against swap funds, but we are against taxes on capital gains in general and so we will not take any action against the funds."
Mr. Weinberger, who has returned to the Ernst & Young accounting firm, and is now its vice chairman, said that he recalled making much less-definitive remarks, but did confirm that he said that the administration had not developed a position on exchange funds.
A Treasury spokeswoman, Tara Bradshaw, said the Bush administration was not currently considering any action on exchange funds and therefore had no policy position on them.
Wait, let me compose myself a moment. 
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