Climbing stocks and a zero interest rate have given wealthy Americans a big benefit: cheap loans they can use to finance their lifestyle while reducing their tax liability.

Banks say their wealthy customers are borrowing more than ever, sometimes using loans backed by stock portfolios and bonds. Morgan Stanley customers have $ 68.1 billion in non-mortgage-based bonds and other loans, more than double what they had five years ago. The Bank of America has announced that it has $ 62.4 billion in bond-based loans, dwarfing its line of credit on real estate assets.

Loans have special benefits beyond flexible repayment terms and a low interest rate. They allow borrowers who need cash to avoid selling in a market that is hot. Founders of start-ups can turn their share in the company into money without losing control of their companies. The wealthiest often use these loans as part of a “buy, lend and die” strategy to avoid paying taxes on capital gains.

The rich also borrow against their investment portfolios. When Tom Anderson started working at the Merrill Lynch Bank branch in Cedar Rapids, Iowa, in 2002, many of his fellow advisers had only one or two report-based loans. Over the years, he has encouraged more customers to lend and noticed that other employees do the same. It is now common for consultants at large companies to have dozens of such loans, he said. Merrill Lynch is now part of Bank of America.

“You can buy a boat, you can go to Disney World, you can buy a company,” said Anderson, who now advises banks on how to manage the risks involved in these loans. “The tax benefits are amazing.”

For borrowers, the calculation is simple: if a property rises in value faster than the interest rate on the loan – they make a profit. Under existing law, investors and their heirs do not pay income tax unless the shares are sold. The assets may be subject to estate taxes, but the heirs pay tax on capital gains only when they sell and only on profits made since the death of the previous owner. The more they can borrow, the longer they will be able to hold assets that exceed their value. And the more they hold on to them, the greater the tax savings.

“Ordinary people don’t think about debt the way billionaires think about debt,” said Edward McPhree, a law professor at the University of Southern California who says he coined the term “buy, borrow and die.” “Once you’re rich, it’s easy. It’s just buying, borrowing and dying. These are elements of the law that have been around for 100 years.”

U.S. President Joe Biden and Democrats in Congress are trying to change some of these laws and say they together constitute a huge income tax haven for the wealthiest Americans.

Under the president’s tax plan, the capital gains tax will rise to 43.4% from 23.8% today and make profits made before the deaths of property owners taxable after the first million dollars. The changes will make a loan less attractive but will not remove all the benefits of deferring tax payment by taking out loans against wealth. It may not succeed in passing in the divided Congress, where Republicans have made up their minds to oppose any tax hike and Democrats have raised concerns about the potential impact on investment and family-owned companies.

The issue of lending received less attention in terms of policy compared to the issue of capital gains at the time of death. Restrictions on tax-exempt loans or over-consumption taxes should put in place governments from richer Americans faster than taxation at the time of death, but there are also drawbacks. First, making loan payments taxable will make a substantial change in income taxation. Second, even though many people take out loans, they all die in the end, so Biden’s proposal will affect a lot of Americans, not just the rich.

Bond-based loans tend to follow the market. Wild stock price fluctuations in the first days of the Corona plague have raised the issue of marginal calls – lenders’ demands for additional guarantees or repayment in order to avoid losses. But the markets climbed back up, and the rich borrowed even more.

Borrowers based on debentures face less bureaucracy than those who apply for a mortgage or car loan. There are few forms to fill out and debt often does not appear in credit reports. While some customers prefer to repay loans quickly, many choose to accrue interest indefinitely without making the monthly payments.

In addition to special loans offered by the Goldman Sachs Group to the clients of its exclusive private bank, the Wall Street Company publishes bonds based on bonds in the amounts of $ 75,000 to $ 25 million to clients of external financial advisers who have no personal financial statements, tax refunds or application forms. “. Merrill Lynch Bank recently gave customers an interest rate of 3.2% for customers who have at least $ 1 million in assets. Those with 100 million or more can get an interest rate as low as less than one percent – 0.87%.

Banks do not care about the low interest rate because they receive management fees on the assets that customers may otherwise sell. Banks will typically give the loan at least 50% of the value of a diversified investment portfolio, Anderson said. But when he was a financial adviser, Anderson warned clients not to use more than 25 percent of their portfolio value to reduce the risk of the bank requiring repayment if the market collapses.

While many board members now do not encourage or even ban executives and directors from lending against the shares in the companies they manage, secretaries in American public companies including Tesla CEO Alon Musk and cable billionaire John Malone have used more than $ 150 billion of their shares as collateral for loans. This can be learned from an analysis by research firm InsiderScore.These loans are declared in disclosures to authorities, but loans against other assets are usually not found in proper disclosure documents.

Fred Smith, founder, chairman and CEO of FedEx, used about $ 598 million of the company’s shares as collateral – about 23.4% of his holdings – for loans in July 2020. These loans gave him money for other business ventures and purchases of FedEx shares in the past, so learn Disclosures to the tax authorities.

Smith’s loans are in violation of FedEx’s policy, made between instincts because the company says it has shown its ability to repay them when needed without selling the shares used as collateral. After the company’s share price dropped, the company allowed him to use additional shares as a guarantee in March 2020, noting he would not have been given this option he might have had to sell shares. A FedEx spokeswoman declined to comment.

The loans are particularly appealing to founders of companies who want to avoid losing voting rights after making their memberships public.

Jared Isaacman solidified his position as a billionaire when his payment processing company went public in June 2020. Three months later, he put about half of his stake in Shift4 Payments as collateral for a loan from Citigroup. He repaid this loan in March – and Clarification took out another loan from Goldman Sachs.

The loans allowed Eisman, who is 38, to use his wealth without shrinking his share of the company – which is currently worth about $ 3 billion. It retained more than 70 percent of its voting power as of April, having invested most of its net capital in the company’s initial public offering.

Shift4 Payments did not disclose Isaacman’s loan terms. He used about 30 percent of his share of the Goldman loan, according to tax reports; Such loans are usually smaller than the value of the shares used as collateral. Shift4 Payments has risen about 20% since March.

“These tools enable participation in economic benefits and do not force him to take down his stake in the company,” said Nate Hirschberg, vice president of marketing at the company. “These arrangements are here to help fund some personal and charity-related issues and are not the result of tax planning.”

Theo Francis participated in the preparation of the article.

By Editor

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