Loss-Making Strategies Of The Ultrarich Save Them Billions

At first sight, Steve Ballmer, the former CEO of Microsoft, appears to have had a terrible trading day on July 24, 2015. He sold thousands of equities, incurring a loss of at least $28 million.

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But, this wasn't a frantic sell-off. BHP and Shell, two major international oil companies, were among the equities that Ballmer sold. Had Ballmer lost faith in BHP's leadership? Was he making a wager that the price of oil wouldn't rise quickly? In no way. Ballmer also purchased tens of thousands of shares of BHP and Shell on that same day.

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Why would he trade shares in identical businesses on the same day? The solution defies common sense, but it is clear to a knowledgeable investor: A loss is valuable for tax purposes; a sizable one can eliminate millions in possible taxes. Ballmer's two-step strategy enabled him to use the loss to reduce his taxes, and because the purchase happened almost simultaneously, he had essentially not modified his investment.

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Since 1921, it has been illegal to claim tax losses through so-called wash sales, in which shares of a corporation are sold and then quickly purchased again. Although technically the types of shares Ballmer bought and sold weren't the same, he nonetheless collected his losses.

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The common stock was available in two separate forms from Shell and BHP. The two stocks were legally separate for each company, but because they were shares of the same business, they traded quite similarly.

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In reality, Ballmer's favorable day was carefully planned as part of a scheme by Goldman Sachs, which executed the trades on Ballmer's behalf, to take advantage of the stock market's inherent volatility. Ballmer's "Tax Advantaged Loss Harvesting" accounts at Goldman were filled with hundreds of equities that were chosen to track the direction of larger markets. As in the past, the markets would eventually support Ballmer's investments in an upward trend. When the inevitable happened and some of the stocks underperformed or the market fell, Goldman was ready to seize the opportunity by offloading the losers and substituting counterparts.

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In some cases, such with Shell and BHP, the replacement securities were essentially identical ones. Most of the time, they weren't. Yet with the correct tools, the right stocks might be easily found to keep the accounts monitoring the market. Ballmer was prepared to avenge his losses after having his losses covered.

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Ballmer frequently exchanged almost equal amounts of stocks for sales and purchases, such as the day in July when he did so for about $200 million. He repeated it a month later, resulting in tax losses of at least $23 million. Similar initiatives in December raised an additional $26 million.

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According to Trade Algo, Ballmer was able to produce tax losses totaling $579 million between 2014 and 2018 without significantly altering his investment portfolio. These losses resulted in at least $138 million in tax savings.

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Although the scope of Goldman's achievement was impressive, Ballmer was merely one of several clients who used this tactic. And Goldman was merely a part of a sector of the economy that assists the really affluent in concealing billions in losses in order to avoid paying billions in taxes even as their wealth increases.

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Using a wealth of Internal Revenue Service data that served as the foundation for "The Secret Internal Revenue Service Files" series, ProPublica was able to reconstruct the tax-loss strategies of a number of the nation's wealthiest individuals, including Ballmer and Facebook co-founders Mark Zuckerberg and Dustin Moskovitz. This collection includes extensive trading records as well as almost two decades' worth of tax filings for thousands of the richest people in the country.

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Following questions by ProPublica, Goldman declared it would stop dealings similar to those between Ballmer and Shell and BHP. The bank said it strives "to provide best-in-class investment advice to clients, consistent with both the letter and the spirit of all applicable tax laws and regulations" and that a "very small percentage" of its "tax investment solutions" trades were "inadvertently made in a manner inconsistent with our strategy."

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"Steve takes his responsibilities to pay taxes extremely seriously," a Ballmer representative stated. Steve has just received updated loss reporting data from Goldman Sachs for earlier years. Steve will promptly make any necessary filing amendments and pay any applicable tax, interest, or penalty.

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According to Goldman, however, only a small portion of its loss-generating trades—those involving two different types of stock from the same company—are being stopped. The bank will keep up its larger approach of looking for stocks with comparable results.

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The capacity of Goldman to provide tax losses to its clients won't be severely hampered. This is due to the fact that investment has changed over the previous 25 years, rendering the legislation barring wash sales meaningless. The primary components of the transformation include better computing, new financial products, lower trading costs, and a move away from picking stocks to passively following the whole market.

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These innovations have been exploited by asset managers to create loss-harvesting accounts with assets worth hundreds of billions of dollars. Generating a tax loss without significantly altering the investment is increasingly typical, which is what the rule aimed to prevent.

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Even novice investors have access to such capability; they can imitate the methods employed by Goldman on their own or choose from the products provided by large brokerages like Vanguard and Charles Schwab. Nevertheless, the majority of Americans cannot use the method since very few of them own stocks or mutual funds outside of tax-protected retirement accounts.

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The richest people get the most. Any number of investment gains can be eliminated by using the losses. Ballmer, who has substantial Microsoft holdings, can simply use $100 million in losses to offset a $100 million gain by selling part of those shares. Wages and other sources of income, of which only $3,000 can be offset, are a very different matter. In 2018, only the top 0.001% of taxpayers, on average, received the majority of their income from investment gains, according to Trade Algo data that is available to the general public.

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Such profits are typically the result of deliberate preparation, just like many other elements of rich Americans' tax returns. Even the wealthiest Americans are capable of having years when they paid no taxes at all because earnings aren't taxed in the US system until they are sold.

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With investment losses, the narrative is quite the contrary. Ballmer increased his wealth by $22 billion between 2014 and 2018, however this information is missing from his tax forms. Goldman, meanwhile, saw to it that even temporary losses were catalogued in the thousands.

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According to tax expert and Columbia Law School professor David Schizer, the wash sale rule is easily circumvented by "well-advised taxpayers." Schizer compared the tax system to a "rigged coin" for the wealthy: "If you win, you get to keep all of it, but if you lose, you can pass some of those losses on to the government."

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The Federal Tax Service data demonstrates how frequently investment losses are used by the wealthiest Individuals. In the US, short-term gains—those sold less than a year after purchasing—are taxed at a rate that is roughly twice as high as long-term gains—around 40% in the highest band. Short-term losses are therefore more valuable since they lower income subject to a higher tax rate. The majority of Americans with incomes over $10 million in 2018 experienced net short-term losses, or over two-thirds of them. That was the largest portion of any income slice, and surprisingly, higher income led to greater losses, at least in terms of their taxes. Long-term losses, however, were uncommon for them.

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A tax-loss harvesting account at Northern Trust, a bank that specializes in managing the assets of the wealthy, allowed Jim Walton, the youngest son of Walmart founder Sam Walton and the 10th-wealthiest American, to incur years of short-term losses. Walton increased his wealth by $10 billion between 2014 and 2018, but only disclosed $111 million in long-term profits on his taxes (a spokesman for Walton declined to comment). He didn't pay any taxes on those earnings because his losses considerably outweighed those gains.

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A reader who went by the name RHT wrote to Trade Algo. It was a moment similar to today's in that the stock market had fallen after reaching highs during a pandemic (then the Spanish flu). The portfolio of RHT had decreased by roughly $50,000 ($7.5 lakh in current currency).

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RHT commented, "I do not want to sell these equities in the current market." "Even though I bought them back the same day, would it be permissible for me to sell these stocks and deduct the loss from this year's income? The Newspaper replied, "Yes, the transaction was legal and allowed.

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According to Duke Law School's Lawrence Zelenak, who also wrote a history of the early income tax, "basically, the strategy went viral."

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In response to "evasion through the means of wash sales," as described in a 1921 Senate conference report, lawmakers resolved to take action. They established a rule that made it illegal to claim a tax benefit if a buyer of a security that was "substantially identical" to the one sold within 30 days of the sale or within 30 days after it was sold.

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Investors continued to discover strategies to collect losses that would lower their taxes in the decades that followed. In many cases, the amount of selling at year's end was sufficient to temporarily lower stock prices.

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Investors may sell their losers and try to buy equities with better prospects, but there were substantial hazards to what was frequently called as "tax-loss selling" with the wash sale rule in place. This frequently resulted in "regret" when an abandoned stock went to the moon, as The New York Times noted in 1983. Investors would need to find a way to get around the 60-day restriction if they intended to hold onto a stock. That required either purchasing the same shares after they had sold (a process known as "doubling up") or before. Both possibilities involved risk. Their losses multiplied if the stock fell further while they were doubled up, and if it rose before they could buy back in, they would have missed the gain.

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New methods were developed in the middle of the 1990s to cater to a new generation of super-rich Americans during a period of historic market growth. Post-tax returns become more important to asset managers. The chief investment officer of JP Morgan's worldwide private bank, Jean Brunel, stated in the journal Trusts and Estates in 1997 that "tax-aware investing is the problem of the present." He noted that the "tax-sheltering volatility" of stock movements gave investment managers a "free alternative" and urged them to "make a stronger effort to find 'harvestable' tax losses."

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A trend away from stock selection and toward passive products, such as funds that track the Standard and Poor's 500, has made it possible for this new strategy of "tax-loss harvesting." The wash sale rule continued to restrict simple fixes to the issue of replacing a particular stock. Yet it become easier and easier to switch out an investment in something as wide as the Standard and Poor's 500 with anything else. It is becoming simpler for investors to discover a close double for practically any portfolio, according to a 1998 Times article.

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Exchange-traded funds, which first appeared in the 1990s, are ideal for this use. They could be exchanged like stocks, unlike mutual funds, which made loss-harvesting transactions easier to employ.

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Think about a transaction made by a billionaire in the 2015 summer. Market declines following issues with the Chinese economy gave investors with exposure to Asia the chance to profit from losses.

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One of those investors was Brian Acton, a co-founder of WhatsApp, which had been bought by Facebook for $19 billion a year earlier. He had shares of the emerging markets exchange-traded fund offered by Vanguard, which follows an index of Chinese and international corporations.

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According to Trade Algo, Acton sold $17 million worth of shares at the end of August 2015, incurring a $2.9 million loss. He invested $17 million in the Blackrock emerging markets exchange-traded fund that day.

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The two funds share significant interests in a number of the same Chinese companies and only have minor differences. The two funds perform similarly, as expected.

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Acton made the same transaction backwards when developing markets fell even worse before the end of the year: He sold Blackrock and repurchased Vanguard. He was able to bank another $6 lakh in tax losses as a result.

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In order to claim tax losses in 2015, well over 100 affluent Individuals in ProPublica's database shifted from one company's exchange-traded fund for developing markets to another.

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Acton responded to ProPublica's inquiry concerning loss-harvesting transactions by saying, "To be honest, I'm not really aware of any incidents like that."

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Acton, who has donated to ProPublica, said in a brief conversation over the messaging service Signal, where he is now temporary CEO, "Broadly, my fortune is managed by a wealth management firm and they manage all the day to day transactions." He was asked a long list of questions, but he didn't reply.

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Why wasn't Acton's trade, or any of the several others, a wash sale?

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The overlap between the stocks in two distinct funds could theoretically be so great that the Internal Revenue Service would classify them as "essentially identical" and deny any tax loss on such a trade.

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The wash sale rule, however, is only regularly used in one situation in practice. In accordance with Internal Revenue Service standards, brokerages must mark a transaction as a wash sale if the investor purchases the same security in the same account within 60 days after the transaction (with the same ID, called a CUSIP number). The amount of the prohibited loss is subsequently recorded on a 1099-B document that brokerages annually send to the Federal Revenue Service detailing stock trades.

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The Internal Revenue Service hasn't offered any additional guidelines. As opposed to this, the agency has only offered commentary on a small number of rarely utilized cases, advising taxpayers to "examine all the facts and circumstances" of a deal. Is it acceptable to switch the exchange-traded fund that tracks the Standard and Poor's 500 from Vanguard to Blackrock? Some tax experts disagree, while others do. In addition to the ambiguous Internal Revenue Service instructions, there aren't many recent court cases that are applicable. (The Federal Revenue Agency chose not to provide a statement.)

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The Federal Tax Service data that ProPublica examined revealed dozens of instances of taxpayers transferring between funds with the exact same assets. Switches like Acton's between funds with substantial but incomplete overlap were more typical.

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The fact that ProPublica was unable to locate any instances of the Federal Tax Service contesting one of these trades is the strongest indication that the IRS does not view these transactions as in violation of the wash sale regulation.

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Indeed, audits hardly ever focus on wash sales at all, according to lawyers who have defended affluent taxpayers in IRS disputes, as reported by ProPublica. Partner at Kostelanetz & Fink Bryan Skarlatos stated, "I have only had one audit on this, and it was for a trader who really fouled up.

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Even though exchange-traded funds are widely used to harvest losses, the separately managed account—another invention from the 1990s—is the best method of distributing tax losses to rich clients.

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Although the investor directly owns the equities in these accounts, managers still choose what to acquire on behalf of the fund. Direct indexing is when the account closely resembles an index, such as the Standard and Poor's 500. Recently, sales of these goods have skyrocketed. According to a research published in 2021 by the consulting firm Cerulli Associates, $362 billion was invested in direct-indexing accounts, the majority of which belonged to "high-net-worth and ultra-high-net-worth clientele." According to the research, these accounts are mostly used for "tax optimisation."

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The benefit is that "with an exchange-traded fund, an investor may only harvest a loss when the entire index is down," according to Goldman Sachs in a recent promotional brochure. Yet, if you hold the constituents of an index, you suddenly have hundreds of stocks that may decline.

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For instance, 2017 was a terrific year for investors, with global markets rising even further and the American market increasing by about 20%. There were no clear, broad declines to take advantage of, yet Goldman Sachs still gave its clients significant tax losses.

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Ballmer's direct indexing accounts that year, which followed both US and global indices, reported tax losses totaling more over $100 million through 15 loss-harvesting transactions. In contrast, the way those indices performed in 2017 meant that Ballmer's accounts were overall far higher.

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You don't have to own every stock that makes up the index in a direct indexing account, and it doesn't really matter which individual equities they are either. What key is that the group of equities closely mimics the fluctuations of the index. In a recent issue of an investing magazine, a group of Morgan Stanley wealth managers described how they accomplish this by "thoughtfully sampling the underlying positions." When it's time to take advantage of tax losses, the manager sells the losing stocks and then selects new ones with the intention of maintaining index performance.

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Tax records demonstrate that Goldman Sachs regularly executed transactions for direct-indexing clients like Ballmer, including the sale and purchase of stock in the same organization. These businesses offered two classes of common stock, and Goldman was not obligated to mark trades from one class to the other as wash sales.

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Frequently, the only difference between these two classes of common stock was the ability to vote on matters like director elections and shareholder resolutions. For instance, the sportswear manufacturer Under Armour provides both Class A voting stock and Class C nonvoting stock. The price of the two classes is marginally different, with Class A shares often selling at a 10% premium. But, because of how in step prices change, they are almost perfect alternatives for loss-harvesting.

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Goldman clients also swapped other voting-nonvoting combinations from organizations like Discovery, Twenty-First Century Fox, and Liberty Global as part of bigger rebalancing moves.

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Ballmer's loss-harvesting deal in 2015 included Shell and BHP, both of which provided shares with two separate national bases. These two versions were interchangeable in the eyes of each organization. In actuality, both businesses decided to 1:1 merge their two stock classes in 2022.

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Several hundred examples of these kinds of deals by Goldman clients from as long ago as 10 years were found in ProPublica's Internal Revenue Service data. The records indicate that these deals have occasionally been executed through other brokerages, but by far the majority were carried out through Goldman.

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The company will "pay whatever expenditures they incur" as a result of prohibited losses, according to Goldman, who also claimed that the effect of the now-stopped trades on its clients would be "small." The statement added, "We have also begun discussions with the Internal Revenue Agency and will respond to any inquiries they may have on this topic." Only returns submitted within the last three years would typically be subject to an audit.

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Loss harvesting accounts are frequently created at wealth management companies to function in conjunction with other services as a kind of knob that can be turned up or down, depending on the situation.

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This is a component of an approach used at Iconiq Capital that extends far beyond investing to include things like managing individual employees. Divesh Makan, the co-founder of the company and a former banker at Goldman Sachs and Morgan Stanley, said in 2007 that he had even organized customers' parties and assisted them in finding potential spouses. Customers "expect us to look after them these days," he claimed.

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According to a regulatory filing, the San Francisco-based company manages around $13.2 billion for its 337 high-net-worth clients. One of them is Moskovitz, a co-founder of Facebook and Zuckerberg's former Harvard roommate. His financial situation has become significantly more complicated since the mid-2000s, when Moscovitz's six-figure Facebook pay made up nearly all of his income (he is currently worth over $7 billion). Moskovitz co-founded the software startup Asana in 2009 after leaving Facebook, but his holding in Facebook continued to be the source of the great bulk of his fortune. He began making changes to that. He sold $3.6 billion worth of his stock between 2012 and 2018, raising money that he was able to use for other ventures with the aid of Iconiq.

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A tax-loss generating account was one of those novel endeavors. According to Trade Algo's study, Moskovitz collected his first tax losses in late 2012. Just $309,000 was collected, a pitiful sum by a billionaire's standards, but it was a start. He had deposited over $100 million into the account by 2013, and his tax losses were growing. He liquidated 153 stocks in December of that year, resulting in his first million-dollar loss.

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Asset managers advise making gradual additions to a direct indexing account since it guarantees there are always new losses to harvest. This was the approach Moskovitz took, putting out $13 million here and $25 million there every few months. Tax losses increased along with the account's growth.

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ProPublica was unable to identify the index that Moskovitz's account followed, but the transactions had the unmistakable signs of direct indexing. For instance, in March 2016, Moskovitz sold a portfolio of 85 equities totaling $27 million and purchased a collection. According to Trade Algo's study, the two baskets were filled with equities that had had fairly comparable performance the year before. The trade resulted in losses of $6.2 million.

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In the meantime, Iconiq set up further assets for Moskovitz, the sole purpose of which was to generate profit. Moskovitz purchased sizable stakes in partnerships managed by the company with names like Iconiq Strategic Partners and Iconiq Access. The majority of the capital Iconiq manages is in the form of venture capital, private equity, and hedge funds. Iconiq companies sent Moskovitz more than $200 million between 2014 and 2018.

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The direct indexing account helped to lessen the impact of taxes on that income, making the two types of investing complimentary. Moskovitz's numerous loss-harvesting trades during that time period led to $84 million in tax losses. ProPublica calculates he avoided paying at least $20 million in taxes as a result.

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Iconiq offered the identical twin services of creating and wiping income to Zuckerberg as well. During the five-year period, his Iconiq investments generated returns of $88 million, while his tax-loss harvesting trades resulted in losses of $34 million.

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Iconiq and Moskovitz's representatives did not respond to written inquiries. Moskovitz has tweeted that he is "in support of hiking taxes on the wealthy." Mark Zuckerberg has always paid the taxes he is required to pay, according to a spokesman for him.

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Lawmakers would need to modify the law, according to experts, to stop the affluent from easily circumventing the wash sale regulation. Automating the taxation of investment value swings (sometimes known as "marking to market") would be a profound but unlikely reform. That would make tax-loss harvesting unnecessary and stop the wealthy from deferring taxes on earnings indefinitely.

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Yet even more restricted adjustments might have an effect. Using the example of direct-indexing accounts, Steve Rosenthal of the Tax Policy Center proposed a law that would target how these products are marketed. If an asset manager boasted about being able to swap out securities for positions that were economically equivalent, then those losses could be regarded as wash sales. This wouldn't be a significant shift, he explained, "but it might slow people down."

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The phrase "substantially identical" should be replaced with "substantially similar," which is a term that is used in several other areas of tax law, according to Schizer of Columbia Law School. According to him, that might rule out some of the most typical harvesting techniques. The law "should be revised to reflect how people invest today rather than how they invested 100 years ago," he asserted.

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Methodology

Overall Tax Losses Recovered

We restricted our examination of 1099-B forms to days in which all of the following conditions were met in order to determine the overall tax losses harvested for each taxpayer:

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• That day, at least ten positions were sold.
• At least 90% of such positions ended in losses.
• That day, the total sales losses outnumbered the total sales gains by a factor of ten or more.

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These restrictions were put in place to cut out days that didn't seem to be driven by harvesting losses. Although the approach successfully recognized loss-harvesting transactions involving only a small number of positions, such as selling a few sizable exchange-traded fund holdings, it did not capture sales from direct-indexing accounts, which sometimes involve dozens or even hundreds of positions. These are therefore conservative projections that most likely underestimate overall losses. The sums in the narrative correspond to the net losses that have been accumulated throughout loss-harvesting days from 2014 to 2018.

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In his estimation, Steve Ballmer employs a different method to determine his overall losses. For whatever reason, Ballmer's 2018 trades were missing from ProPublica's Internal Revenue Service database, so we calculated his totals for 2014 to 2018 using the Schedule D forms from his tax returns. His direct-indexing accounts at Goldman Sachs dominated his short-term trading outcomes, as indicated on his tax returns, according to our study of his 1099-Bs from prior years. In the field designated for trades that had been reported on a 1099-B form that included the basis, he marked these on his Form D. Ballmer's total for short-term trades that included a 1099-B form with the basis provided is therefore the sum throughout the years 2014 through 2018. No individual named in this article contested our findings or our methodology after ProPublica described our loss calculations in detail.

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Taxes Saved

Due to the fact that neither Ballmer nor Moskovitz generated significant net capital gains from short-term trading during the time periods we examined, we chose a straightforward approach to determine their tax savings: 23.8% of losses, which represents the long-term capital gains rate plus the net investment income tax. In the event that stock is sold in the future, the tax benefit of a harvested loss may be reduced (given the lower basis). Nonetheless, Ballmer, Moskovitz, and the other billionaires we studied kept their profits, and there is excellent reason to believe that they will keep them permanently.