NEW YORK: Wall Street money managers love to purchase fancy aeroplanes.
Thrive Capital Management, the venture capital firm run by Jared Kushner’s brother Joshua, bought a used Bombardier Challenger 300 earlier this year.
Hedge fund manager Harsh Padia bought a used Bombardier Global Express last spring.
Matthew Bronfman of Lincoln Avenue Capital, a real estate fund founded as an affiliate of his family office, bought and registered a used Bombardier 600 just days before Christmas.
While wealthy people buying aeroplanes is nothing new, the Republican-led tax overhaul provided a new incentive.
It’s not clear whether any of these money managers had this in mind when they bought their jets, but a provision in the new tax law caps deductions of so-called “excess business losses,” meaning that some investors can face sizable tax bills on personal income that they previously would have offset.
So some tax experts have found a way around the excess business loss cap, which was projected to raise US$150 billion over 10 years – by advising their clients to buy private planes.
It’s an expensive purchase that can cost as much a US$67 million but can arguably be used principally for work – unlike, say, a yacht or a mansion in the Hamptons.
The prospect of using this workaround to buy private planes risks undermining Republican efforts to use the tax overhaul as a selling point in the 2020 elections, when the White House and both chambers of Congress will be in play.
Polling shows Americans are about evenly split on whether they believe the Democrats – who say the new tax law chiefly benefits the wealthy – or the GOP, which argues that it’s a boon to the middle class.
The recent aeroplane buyers won’t say why they decided to make such a big purchase this year.
Still, “it’s logical not to waste a loss,” said Michael Kosnitzky, a tax lawyer.
Jesse Derris, a spokesman for Thrive Capital, and Padia declined to comment.
Zachary Ulman, chief operating officer for Lincoln Avenue Capital, said Bronfman acquired the plane through a limited liability company registered at Lincoln Avenue Capital’s address.
The biggest tax-code rewrite in a generation slashed rates for businesses and individuals, and sought to fulfil a campaign promise from President Donald Trump to get “the hedge fund guys to pay more taxes.”
The new law made it harder for managers at hedge, private equity and venture capital funds to get the preferential rate of 20% (plus 3.8% for the Affordable Care Act levy), rather than the top rate of 37%, on a key source of compensation, known as carried interest – typically 20% of a fund’s profits.
The law triples the time to three years that investors must hold their underlying investments.
With the new loss cap, Kosnitzky said, “You should expect highly sophisticated investment fund and family office managers to also find strategies that arbitrage the tax code to benefit themselves.”
Kosnitzky, who chairs the private client group at Pillsbury Winthrop Shaw Pittman, said he has clients, whom he won’t name, who have bought planes to take advantage of the tax manoeuvre.
At first glance, buying a multimillion-dollar private jet would seem only to compound the potential problem of the business-loss restriction.
That’s because “bonus depreciation” creates sizable business losses that are now capped – potentially making it harder for managers to offset their profits from carried interest.
Yet when they buy a jet, investment-fund and family-office managers are recasting on paper the way they get paid, according to three investment fund professionals.
By morphing their carried-interest payouts into management fees that are business income to the fund, managers can soak up the sizable business loss that buying an aeroplane usually creates.
Managers can thus avoid both what originally would have been a capital gains tax bill on their carried interest, and what would have been ordinary taxes on their management fees.
Jason Traue, a tax partner at Morgan Lewis & Bockius, said funds “are exploring restructuring or structuring new funds to take into account the effect of these rules.”
He added that “increasing business income allows you to have fewer business expenses disallowed.”
Business income to a fund, deductible by managers and most outside investors, consists largely of management fees paid by investors, historically 2% of assets under management but now 1.45%, according to Credit Suisse.
While the workaround doesn’t affect investors like pension funds or foreign individuals and businesses, it can hurt US individual investors.
That’s because the new law ended their ability to deduct their share of the fees – now increased as a result of the aeroplane buys.
Before the Republican tax overhaul, businesses of all stripes could generally deduct all of their business expenses.
The old rule was meant to encourage companies, especially startups that run losses in early years, to grow over the long term.
Owners of pass-throughs, like hedge fund and other money managers, can now deduct only a small chunk of business losses that exceed their business income – US$250,000 for a single filer, or US$500,000 if married filing jointly.
Any leftover, or “excess,” losses have to be carried forward to future years and can reduce only 80% of taxable income.
A business loss at a publicly traded company used to flow to the company itself.
For non-corporate pass-throughs, which pass on their deductions and income to their owners, the deduction flowed through to the entity owner’s personal tax return.
That usually allowed the owner to offset, or reduce taxes upon, all of his or her non-business income from salaries, dividends and capital gains.
Business losses that exceeded that other income could be carried back two years or forward 20 years.
But the new excess business loss cap “will come as a surprise to a lot of people that have not been really doing hard numbers throughout the year,” said David Kirk, a partner in private client services at Ernst & Young’s National Tax Department and a former IRS lawyer.
The cap, in force until 2026, is supposed to raise nearly US$150 billion over a decade, according to Congress’s Joint Committee on Taxation.
“This is an industry that likes private planes, gets paid a lot of money and wants to minimise taxes,” Kosnitzky said.
So with the workaround to the GOP tax law, “no one should be surprised.”