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Originally published January 15, 2014 at 3:32 PM | Page modified February 13, 2014 at 10:08 PM

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Accidental tax break saves wealthiest Americans $100 billion

The shelter, known as the Walton grantor retained annuity trust, or GRAT, shows how easy it is for the wealthy to bypass estate and gift taxes. Even the lawyer who pioneered the practice, which involves rapidly churning assets into and out of trusts, says it makes a mockery of the tax code.

Bloomberg News

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Sheldon Adelson makes no secret of his disdain for the estate tax.

“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.

A gravel-voiced man whose accent recalls his blue-collar Boston roots, Adelson, 80, has just rung the bell at the New York Stock Exchange. Shares of his Las Vegas Sands Corp. are at a five-year high, making him one of the world’s richest men, worth more than $30 billion.

Federal law requires billionaires such as Adelson who want to leave fortunes to their children to pay estate or gift taxes of 40 percent on those assets. Adelson has blunted that bite by exploiting a loophole that Congress unintentionally created and that the Internal Revenue Service unsuccessfully challenged.

By shuffling his company stock in and out of more than 30 trusts, he’s given at least $7.9 billion to his heirs while legally avoiding about $2.8 billion in U.S. gift taxes since 2010, according to calculations based on data in Adelson’s U.S. Securities and Exchange Commission filings.

Hundreds of executives have used the technique, SEC filings show. These tax shelters may have cost the federal government more than $100 billion since 2000, says Richard Covey, the lawyer who pioneered the maneuver. That’s equivalent to about one-third of all estate and gift taxes the U.S. has collected since then.

The popularity of the shelter, known as the Walton grantor retained annuity trust, or GRAT, shows how easy it is for the wealthy to bypass estate and gift taxes. Even Covey says the practice, which involves rapidly churning assets into and out of trusts, makes a mockery of the tax code.

“You can certainly say we can’t let this keep going if we’re going to have a sound system,” he says with a shrug.

Covey’s technique is one of a handful of common devices that together make the estate-tax system essentially voluntary, rendering it ineffective as a brake on soaring economic inequality, says Edward McCaffery, a professor at the University of Southern California’s Gould School of Law.

Since 2009, President Obama and some Democratic lawmakers have made fruitless proposals to narrow the GRAT loophole. Any discussion of tax shelters has been drowned out by the debate over whether to have an estate tax at all, McCaffery says.

Facebook Chief Executive Mark Zuckerberg and Lloyd Blankfein, the CEO of Goldman Sachs Group, are among the business leaders who have set up GRATs, SEC filings show.

JPMorgan Chase helps so many clients use the trusts that the bank has a special unit dedicated to processing GRAT paperwork, says Joanne Johnson, a JPMorgan private-wealth banker. “I have a client who’s done 89 GRATs,” she says.

Goldman Sachs disclosed in a 2004 filing that 84 of the firm’s current and former partners used GRATs. Blankfein has transferred more than $50 million to family members with little or no gift tax due, according to calculations based on data in his SEC filings.

Charles Ergen, chairman of Dish Network, and fashion designer Ralph Lauren passed more than $300 million each, calculations from SEC filings show.

Blankfein, Ergen, Lauren and Zuckerberg declined to comment.

Devising strategies

Congress enacted the estate tax in 1916 to apply to large fortunes at death. Eight years later, it added the related gift tax to cover transfers made before death. Both rates are now 40 percent, and the first $5.25 million of an individual’s wealth is exempt; the amount is $10.5 million for couples.

For as long as such levies have been on the books, lawyers have been devising strategies to get around them.

Congress created the GRAT while trying to stop another tax-avoidance scheme that Covey developed. In 1984, Covey, a lawyer at Carter Ledyard & Milburn in New York, publicized an estate-tax shelter he’d invented called a grantor retained income trust, or GRIT.

Covey figured out how to make a large gift appear to be small. He would have a father, for example, put investments into a trust for his children, with instructions that the trust should pay any income back to the father. The value of that potential income would be subtracted from the father’s gift-tax bill.

Then, the trust could invest in growth stocks that paid low dividends so that most of the returns still ended up going to his kids. Six years after Covey started promoting this technique, Congress termed it abusive and passed a law to stop it.

The 1990 legislation replaced the GRIT with the GRAT, a government-blessed alternative that allowed people to keep stakes in gifts to their children while forbidding the abuse Covey had devised.

Covey studied the law and found an even bigger loophole. “The change that was made to stop what they thought was the abuse, made the matter worse,” he says.

Fredric Grundeman, who helped draft the bill while he was an attorney at the U.S. Treasury Department and is now retired, says the framers didn’t recognize the new law’s potential for abuse.

“How do I say it?” Grundeman says. “When Congress enacts a law, it isn’t always well thought out.”

Covey, 84, a Missouri native and former U.S. Marine Corps basketball player who earned a law degree from Columbia Law School in 1955, uses the words “romantic” and “beautiful” to describe the most elegant tax maneuvers.

Covey recognized that a client could use the 1990 legislation to avoid gift taxes if he did something that would otherwise make no sense: put money in a trust with instructions to return the entire amount to himself within two years. Because he doesn’t have to pay tax on a gift to himself, the trust incurs no gift tax. Covey calls the trust “zeroed out.”

Because the client isn’t paying any tax upfront, the transaction amounts to a can’t-lose bet with the IRS. If the trust’s investments make large enough gains, the excess goes to heirs tax-free. If not, the only costs are lawyer’s fees, typically $5,000 to $10,000, Covey says.

Three years after the new law took effect, Covey created a pair of $100 million zeroed-out GRATs for Audrey Walton, the former wife of the brother of Wal-Mart Stores founder Sam Walton. The IRS, which had banned such GRATs through regulation, demanded taxes and took her to court.

In 2000, the U.S. Tax Court found in Walton’s favor, determining the 1990 law didn’t ban a “zeroed-out” GRAT. Covey had won a rare prize: an official seal of approval for a tax shelter.

Adelson’s scheme

Two years after Covey’s court victory, Adelson set up a GRAT called the “Sheldon G. Adelson 2002 Two Year LVSI Annuity Trust,” Adelson’s SEC filings show. By 2009, he was juggling chunks of his fortune in as many as 10 GRATs at a time, filings show.

Adelson once discussed his approach to inheritance taxes in a legal deposition.

“Listen, the law says you can avoid taxes but you can’t escape taxes,” Adelson testified as part of a 1997 lawsuit over an unrelated business dispute. “We just want to do what is right, but it is prudent and it’s wise to prepare your estate to save taxes.”

The son of a cabdriver from Lithuania, Adelson got rich in the 1980s as the owner of a company that organized computer trade shows. Later, he bought the Sands Hotel and Casino in Las Vegas.

A globe-spanning casino and resort empire followed. He drew national attention in 2012 by donating more than $90 million to groups that supported Republican candidates, including Mitt Romney, the presidential nominee and an estate-tax opponent.

In all, Adelson and his wife, Miriam, have created at least 25 GRATs.

Committees in the House and Senate are working on what they call comprehensive tax-overhaul bills. Neither plans to address estate or gift taxes.

Covey suggests one reason for the lack of action: Wealthy donors to politicians, both Democratic and Republican, want to keep the loophole in place.

“I’ve done a lot for Democratic contributors,” he says with a smile.

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