“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
Whenever there is a controversy over whether a politician paid enough in taxes, we are reminded of Hand’s famous quotation. There is nothing wrong with someone taking legal steps to reduce the taxes they may owe. However, in the case of politicians, there is also the matter of optics — and whether voters are bothered if a politician took advantage of ways to reduce his or her taxes that are generally not available to ordinary people.
In recent weeks, Rep. Jim Banks (R-Ind.) has touted a study by the Congressional Research Service (CRS) that he says shows “multimillionaire Joe Biden’s use of corporate loopholes to avoid paying taxes.” White House press secretary Jen Psaki said the story “has been debunked.” A reader asked us to sort this out, so let’s take a look.
During the 2020 campaign, President Biden released his tax returns, marking a distinction with President Donald Trump, who was the first president in decades not to routinely disclose his tax returns. (Biden, in fact, has released 23 years of tax returns.)
But no good deed goes unpunished. A sharp-eyed Wall Street Journal reporter noticed that Biden, in his 2017 and 2018 returns, had taken advantage of a tax loophole that President Barack Obama had sought unsuccessfully to close. The article suggested that Biden and his wife, Jill, saved as much as $500,000 in taxes as a result of the maneuver, though that estimate is probably too high, as we will see later in this article.
To be sure, the Bidens paid a lot in taxes — millions of dollars in the years in question. Their tax rate was 33 percent.
But the Bidens also had routed their income from books and speeches through S corporations. In doing so, they potentially avoided an additional 3.8 percent in Medicare taxes, some of which had been imposed on high-income individuals as part of the Affordable Care Act.
At issue is whether the tax returns included an appropriate estimate for “reasonable compensation” that would be subject to the self-employment and Medicare taxes. The Bidens’ 2017 tax return showed about $145,000 in earnings for Joe Biden and $100,000 for Jill Biden subject to such taxes, out of income of about $10 million in S corporation revenue. Their 2018 return showed $300,000 in earnings for Joe Biden and $200,000 for Jill Biden subject to the Medicare taxes, out of about $3.2 million in income.
In other words, about 2 percent of the S corporation income in 2017 and about 13 percent in 2018 was listed as wages. That caught the attention of tax specialists.
The Wall Street Journal quoted Steven Rosenthal, a senior fellow at the Tax Policy Center, as saying that to the extent that the Bidens’ income came directly from the couple’s consulting and public speaking, “to treat those as other than compensation is pretty aggressive.”
Rosenthal told The Fact Checker that he stood by that assessment. “I believe Biden routed his income through an S corporation to avoid some 3.8% Medicare tax/net investment income tax,” he said. He noted that Biden’s 2019 income tax return allocated a much larger percentage of his S corporation income to earnings that would be subject to the tax. (That year, almost 60 percent of S corporation income was listed as wages, significantly higher than in the two previous years.)
Now let’s take a look at the Congressional Research Service report touted by Banks, who chairs the Republican Study Committee, a coalition of House conservatives. Contrary to his statement, CRS did not look at Biden’s specific tax situation but more generally examined court cases in which the Internal Revenue Service accused taxpayers of seeking to avoid payroll and self-employment taxes through the use of S corporations. None directly mirrored Biden’s tax situation.
For instance, in one case examined by the CRS, an accountant transferred his 25 percent interest in an accounting firm to an S corporation. He continued to work for the firm but at a much-reduced rate that was subject to taxes. He was officially paid a $24,000 salary, far below his market value, but the S corporation received $200,000. Courts concluded that the $24,000 salary did not meet the test of “reasonable compensation.”
The study noted that the IRS automatically audits a president’s returns only for the years he is in office, so the tax returns under question would not necessarily face scrutiny. In May, Psaki noted that the S corporations were now dormant.
A White House official said the IRS declined to do any audits of the Biden tax returns in 2017, 2018 or 2019. The 2020 returns are under audit as is required for any sitting president under the law.
A big problem here is that the IRS, after years of budget cuts, does not have the resources to closely examine every tax return that might stretch such definitions — or the resources to wage a court battle with well-heeled people willing to defend their calculations of “reasonable compensation.” Biden’s Build Back Better plan, as passed in the House, would boost funding for the IRS to conduct more audits and increase tax collections — a revenue-raising tactic that many congressional Republicans oppose.
The House bill, now pending in the Senate, would also eliminate this tax loophole by extending a 3.8 percent net investment income tax to high-income taxpayers for their S corporation income. The Treasury Department, in its request for overhauling the law, had noted the current system is “a challenge” for the IRS to administer. Treasury described the loophole as “unfair, inefficient, distorts choice of organizational form, and provides tax planning opportunities for business owners, particularly those with high incomes, to avoid paying their fair share of taxes.”
In a letter to Biden earlier this year, Banks decried what he called Biden’s “hypocrisy” and demanded he “pay these funds back to the American people.” (We should note that we cannot find an instance where Banks made a similar demand of Trump — who used many tax-avoidance strategies and once declared that not paying income taxes “makes me smart.”)
What the Bidens may have saved in taxes is unclear — and subject to interpretation.
Robert Willens, a Columbia Business School professor who’s been educating The Fact Checker about intricate tax policy issues since the 1980s, said: “In light of the fact that ‘capital’ was not a material income-producing factor in connection with his business; and that his personal efforts produced the vast majority of the income the business reported, it would seem to me that his ‘reasonable compensation,’ in this case, could easily be at least 10 times the amount he reported as such.”
Under a rough calculation, that would have increased the level of the Bidens’ “reasonable compensation” estimate to about $7.5 million in 2017 and 2018, resulting in about $280,000 in additional taxes. That’s much less than $500,000 but still a hefty amount.
But, Willens said, “I don’t have any problem with what he did. In fact, he would have been almost derelict had he not channeled his earnings through an S corporation.” He added: “I’ll leave the morality of him adopting this strategy, particularly given his track record of attempting to ensure that everyone pays their fair share of taxes, to others to comment on.”
“The President has released over 22 years of tax returns and is proud to have restored the bipartisan tradition of being transparent with the American people about the personal finances of the chief executive,” White House spokesman Andrew Bates said in a statement. “After a 4-year hiatus, he also welcomes this born-again support for that critical tradition from congressional Republicans, and congratulates them on their 180. With the Build Back Better agenda, the President is fighting to ensure our economy delivers for middle class families — not just those at the top — which means the wealthy pay their fair share and the IRS is given the resources they need to crack down on wealthy tax cheats. He encourages his GOP colleagues to reverse themselves on that, as well.”
The Bottom Line
Whether Biden is being hypocritical or not is in the eye of the beholder. Indeed, whether his tax strategy was especially aggressive or par for the course is also a matter of interpretation. As president, he’s now taken steps to close the very loophole that may have saved him a significant sum of money. Biden still paid a hefty tax bill. But as Hand would note, he did not have a “patriotic duty” to voluntarily increase the size of his tax payment.
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