The Man Who Saves CEOs Billions in Taxes

Date: Dec 24 2013

Filed under: Family Money, Estate Tax, Tax Deductions, Tax Laws, Financial Education

InfoGraphic IRS -Tax Time
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If populist propaganda is to be believed, the true power brokers in this country reside not in Congress or the White House, but in the executive suites of America’s largest corporations. CEOs are currently seen as the modern-day equivalent of “The Great Oz,” pulling the levers and turning the dials that drive policy, law and the economy, all while shielded from view — the oak walls of the boardroom their green curtain.

Their power in the mortal world seems endless; however, with the exception of Walt Disney, they haven’t yet figured out how to cheat death. But thanks to one man, Richard B. Covey, they’re now able to avoid that previously unavoidable consequence of death: the estate tax.

The concept of an estate tax, or death tax, can be traced to Egypt as early as 700 B.C., and was used by Caesar Augustus nearly 2,000 years ago to finance the Roman Empire’s imperialist policies.

The precursor to the estate tax arrived in the United States in the form of the Stamp Tax of 1797, which required federal stamps on wills offered for probate. Not unlike the Roman tax, this tariff was used to raise revenue in order to underwrite naval expansion and engage in the Pirate Wars with France.

For the next 120 years, estate taxes were approved and repealed in lockstep with periods of war and peace until the the Revenue Tax of 1916, which created a transfer tax on wealth from an estate to its beneficiaries, ushered in the era of the modern estate tax. Assuming you’re still awake, you’ll be glad to know that reading this last paragraph counts as one college credit toward a degree in finance.

Despite the relatively modest 10 percent top rate of the inaugural estate tax, newly wealthy industrialists, undoubtedly sporting stovepipe hats, soon figured out that they could avoid the tax altogether by transferring their wealth to their heirs during their lifetimes.

In response, Congress began a long campaign aimed at closing inheritance loopholes and, in the process, raised the top rate to 77 percent, where it remained until 1977 when it began a gradual decline, leveling off to 55 percent during most of the 1980s and 1990s. And this is where Covey enters the picture, creating a tax-avoidance strategy in 1984 that began his assault on the estate tax code.

Covey, an attorney with New York powerhouse law-firm Carter, Ledyard & Milburn, created a revolutionary type of tax shelter he called a “grantor retained income trust,” or GRIT. A GRIT was created when an individual put investments into a trust, and then the income generated by those investments was used to pay back the individual, thus lowering his gift-tax bill.

Congress deemed GRITs abusive and replaced them in 1990 with GRATs, or grantor retained annuity trusts.

Though usually known for their efficient, thoughtful, and well-reasoned legislation, in establishing the GRAT, Congress actually created a larger loophole in the tax code, which Covey exploited with great success.

However, it was a tax-avoidance strategy that he employed with a client in 1993 that, to this day, is still spoken of in hushed tones and with high reverence wherever tax advisers gather.

Covey’s client was the son of a wealthy industrialist who had died and left half his fortune — in the form of his family owned company’s stock — to his wife; and half to a trust, the beneficiaries of which were his children.The problem was that both the value of the stock left to his widow — and the stock in the trust — would be taxed at the then 55 percent estate-tax rate, necessitating the sale of significant amounts of the stock in order to pay the tax bill, causing the family to lose control of their company. But Covey, a graduate of Harvard and Columbia Law School and a former Marine, was not about to give in so easily.

Instead, he proposed that the widow purchase from her children their right to inherit the trust, in essence handing over her share of the inherited stock as payment for the future rights to her children’s stock. Though not a tax-free transaction — both the widow and her children would be subject to the standard 28 percent capital gains tax, and still subject to challenge from the IRS — Covey’s client elected to go forward with the plan. The IRS did ultimately challenge the move, but ended up settling for an amount that Covey anticipated would save his client millions.

According to a recent report by Bloomberg, SEC filings show that since then, hundreds of executives have used the techniques pioneered by Covey, including Las Vegas Sands (LVS) CEO Sheldon Adelson, Facebook’s (FB) Mark Zuckerberg, Goldman Sachs (GS) CEO Lloyd Blankfein, as well as heirs of the Walmart (WMT) fortune. According to that same report, Covey himself estimates that his tax shelters have cost the IRS more than $100 billion in lost revenue since 2000.

I recently spoke by phone with Covey, who at 84 and semi-retired, still serves as senior counsel for Carter, Ledyard & Milburn. He speaks in a convivial manner, and it’s immediately obvious that his mind is still sharp as a tack. I asked him what his personal feelings were about the estate tax, and though I expected a hard-line, somewhat dogmatic reply; with a chuckle in his voice that suggested the answer was common sense, he simply said, “There’s got to be a better way to extract wealth from a society.”

No man is an island, or even a peninsula, so I encourage you to give me your feedback in the comments below. I also want to hear what else you’d like me to write about, so please let me know either via Twitter or email.

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