Critics Say Trump Appointees Can Dodge a Huge Tax Bill. That’s Not the Case.

Donald Trump's nominees for Treasury secretary, Steve Mnuchin (l), and for Commerce secretary, Wilbur Ross (r).
Kate Rooney | CNBC

"Not only is Donald Trump giving a gang of billionaires control of our government, he's offering them a special tax break just for signing up."

That was Senator Elizabeth Warren, Democrat of Massachusetts, last week criticizing what has been called a "loophole" in the tax code that allows government appointees to defer paying taxes on stock sales. These appointees — who currently include some of the wealthiest people in the country — are typically required to sell all of their stock in individual companies to comply with conflict-of-interest rules, and this tax-deferring aspect of a 1989 law is meant to help offset that requirement.

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(President-elect Donald J. Trump is not covered by the same rules. But that's another column.)

You're going to be hearing a lot about this "loophole" over the next couple of weeks, if you haven't already, as Mr. Trump's nominees — many of them billionaires with huge holdings that they will most likely have to sell — get grilled in hearings and their financial disclosure forms become public.

If you just read the headlines, you might be convinced that Mr. Trump's nominees were about to receive the windfall of the century, a gift that would allow them to eliminate capital gains taxes on much of their wealth.

"Have you heard about the latest tax shelter for the super-rich?" Brett Arends, a MarketWatch columnist, wrote, suggesting that a government appointee "can cash out all his big stock gains and pay zero — read that again: zero — tax. Cha-ching!" Others have described it as an extraordinary method to duck taxes.

But that's not how the tax rule works. The rule has been repeatedly misconstrued and misexplained, including by me.

The actual law, which was put in place by President George Bush, governs what is known as Section 1043 of the tax code. It allows government appointees to apply to the Office of Government Ethics to receive approval to defer paying capital gains on stock sales as part of any divestment plan that is required by their office.

As long as appointees sell all of their stock and then reinvest it in Treasuries or mutual fund indexes that don't pose a conflict with their roles in the administration, the capital gains are deferred until they sell the Treasuries or mutual funds.

But notice this: The taxes are not eliminated. Not at all. They will eventually have to be paid.

The idea behind the tax law was to make it less unattractive for people with wealth to pursue a role in public service, given that those people are forced, often within a short window of time, to sell all assets that could pose a conflict in their new role.

For example, Gary D. Cohn, the president of Goldman Sachs, who was recently appointed to lead Mr. Trump's National Economic Council, will have to sell all his stock in Goldman. Or take Rex Tillerson, Mr. Trump's pick to be secretary of state, who will be divesting his shares in Exxon Mobil. Ordinarily, doing so would cause them to have a tax bill worth tens of millions of dollars. Instead, they will most likely put their assets in index funds or in a diversified blind trust, and then pay the tax bill on those assets when they sell them.

Henry M. Paulson, the former chairman and chief executive of Goldman Sachs, is perhaps the most famous appointee to have used the tax deferral, when he became secretary of the Treasury under President George W. Bush in 2006. People noted at the time that Mr. Paulson was the beneficiary of a law that had been signed by his new boss's father.

The tax treatment has been called a boondoggle for the rich. Ms. Warren, along with three other senators — Sheldon Whitehouse of Rhode Island, Tammy Baldwin of Wisconsin and Dianne Feinstein of California, all Democrats — have introduced legislation to limit to $1 million the amount of capital gains that can be deferred, preventing, as they put it, "billionaires from reaping outsized tax write-offs."

A Wall Street Journal analysis suggested the executives could save tens of millions in dollars in taxes.

"It's inappropriate for the federal government to provide excessive tax breaks to Cabinet members in return for complying with ethics rules," Ms. Feinstein said in a statement last week. "Public service is an honor, and billionaires shouldn't require federal tax breaks for their service."

But the senators seem to not appreciate that the tax law is hardly an inducement to leave a high position for public service. To believe that the tax treatment is a huge boon would oddly assume that a chief executive was leaving for the government because he or she was preparing to dump all of the stock in their company in the next three months.

That is unlikely. Most executives like to control their finances, something that they effectively give up when selling.

If there is a benefit, it is the ability for an executive to diversify out of their own stock into other assets. Some lawyers have called it the equivalent of a "tax-free loan." But, again, if the political appointees want to cash out to buy a house or a boat or whatever you think a billionaire is supposed to buy, they will pay the full tax bill.

Indeed, the tax code ensures that the tax basis in the assets they are forced to sell transfers to the Treasuries or mutual funds they purchase, so the tax bill remains the same when they cash out.

Executives like Steven T. Mnuchin, the Treasury secretary nominee, and Wilbur Ross, the choice for commerce secretary, may actually lose money on some of the assets they have to sell. Many of their holdings are in illiquid assets, like private equity funds, that they may have to sell at a discount.

There has been a lot of conjecture among the Manhattan business cognoscenti that somehow the tax treatment could allow someone like Mr. Ross, who is 79, to avoid paying taxes entirely if he reinvested his assets in 30-year Treasury bonds that outlive him. But under the tax rules, his estate would eventually have to pay the taxes.

There has even been speculation that clever appointees could roll their stock into Treasuries and then take out a loan against the underlying assets. That's true, but they'd be taking a risk on the value of those Treasuries. And even without a political appointment, they could have taken out a loan against their stock before, so the tax treatment doesn't change the underlying equation.

There are a lot of important issues to examine and reasons to worry about the remarkable conflicts of interests that Mr. Trump and his cabinet selections may present.

But — in this instance — the tax treatment they receive is not one of them.