Joe Biden Used Tax-Code Loophole Obama Tried to Plug

Democratic presidential candidate Joe Biden used a tax loophole that the Obama administration tried and failed to close, substantially lowering his tax bill.

Mr. Biden and his wife, Dr. Jill Biden, routed their book and speech income through S corporations, according to tax returns the couple released this week. They paid income taxes on those profits, but the strategy let the couple avoid the 3.8% self-employment tax they would have paid had they been compensated directly instead of through the S corporations.

The tax savings were as much as $500,000, compared to what the Bidens would have owed if paid directly or if the Obama proposal had become law.

“There’s no reason for these to be in an S corp—none, other than to save on self-employment tax,” said Tony Nitti, an accountant at RubinBrown LLP who reviewed the returns.

“As demonstrated by their effective federal tax rate in 2017 and 2018—which exceeded 33%—the Bidens are committed to ensuring that all Americans pay their fair share,” the Biden campaign said in a statement Wednesday.

The technique is known in tax circles as the Gingrich-Edwards loophole—for former presidential candidates Newt Gingrich, a Republican, and John Edwards, a Democrat—whose tax strategies were scrutinized and drew calls for policy changes years ago. Other prominent politicians, including former President Barack Obama and fellow Democrat Hillary Clinton, as well as current contenders for the 2020 Democratic nomination Sens. Elizabeth Warren and Bernie Sanders, received their book or speech income differently and paid self-employment taxes.

Some tax experts have pointed to pieces of President Trump’s financial disclosures and leaked tax returns to suggest that he has used a similar tax-avoidance strategy.

Unlike his Democratic rivals and predecessors in both parties, Mr. Trump has refused to release his tax returns, and his administration is fighting House Democrats’ attempt to use their statutory authority to obtain them. Democratic presidential candidates have released their tax returns and welcomed criticism to draw a contrast with Mr. Trump.

Mr. Biden, who was vice president from 2009 to 2017, has led the Democratic field in polls since entering the race. He is campaigning on making high-income Americans pay more in taxes and on closing tax loopholes that benefit the wealthy.

Mr. Biden has decried the proliferation of such loopholes since Ronald Reagan’s presidency and said the tax revenue could be used, in part, to help pay for initiatives to provide free community-college tuition or to fight climate change.

“We don’t have to punish anybody, including the rich. But everybody should start paying their fair share a little bit. When I’m president, we’re going to have a fairer tax code,” Mr. Biden said last month during a speech in Davenport, Iowa.

The U.S. imposes a 3.8% tax on high-income households—defined as individuals making above $200,000 and married couples making above $250,000. Wage earners have part of the tax taken out of their paychecks and pay part of it on their returns. Self-employed business owners have to pay it, too. People with investment earnings pay a 3.8% tax as well.

But people with profits from their active involvement in businesses can declare those earnings to be neither compensation nor investment income. The Obama administration proposed closing that gap by requiring all such income to be subject to a 3.8% tax, and it was the largest item on a list of “loophole closers” in a plan Mr. Obama released during his last year in office. The administration estimated that proposal, which didn’t advance in Congress, would have raised $272 billion from 2017 through 2026.

Under current law, S-corporation owners can legally avoid paying the 3.8% tax on their profits as long as they pay themselves “reasonable compensation” that is subject to regular payroll taxes. S corporations are a commonly used form for closely held businesses in which the profits flow through to the owners’ individual tax returns and are taxed there instead of at the business level.

The difficulty is in defining reasonable compensation, and the IRS has had mixed success in challenging business owners on the issue. The Bidens’ S corporations—CelticCapri Corp. and Giacoppa Corp.—reported more than $13 million in combined profits in 2017 and 2018 that weren’t subject to the self-employment tax, while those companies paid them less than $800,000 in salary.

If the entire amount were considered compensation, the Bidens could owe about $500,000. An IRS inquiry might reach a conclusion somewhat short of that.

“The salaries earned by the Bidens are reasonable and were determined in good faith, considering the nature of the entities and the services they performed,” the Biden campaign statement said.

For businesses that generate money from capital investments or from a large workforce, less of the profits stem from the owner’s work, and thus reasonable compensation can be lower. For businesses whose profits are largely attributable to the owner’s work, the case for reasonable compensation that is far below profits is harder to make.

To the extent that the Bidens’ profits came directly from the couple’s consulting and public speaking, “to treat those as other than compensation is pretty aggressive,” said Steve Rosenthal, a senior fellow at the Tax Policy Center, a research group run by a former Obama administration official.

Mr. Nitti said he uses a “call in sick” rule for his clients trying to navigate the reasonable-compensation question: If the owner called in sick, how much money could the company still make?

“The reasonable comp standard is a nebulous one,” Mr. Nitti said. “This is pretty cut and dried. If you’re speaking or writing a book, it’s all attributable to your efforts.”

The IRS puts more energy into cases where the business owners pay so little reasonable compensation that they owe the full Social Security and Medicare payroll taxes of 15.3%, Mr. Nitti said.

In a statement released Tuesday along with the candidate’s tax returns, the Biden campaign noted that the couple employs others through its S corporation and calls the companies a “common method for taxpayers who have outside sources of income to consolidate their earnings and expenses.”

Why I Was Wrong About Elizabeth Warren

And her growing popularity suggests others are coming around, too.

As the Democratic presidential campaign began, I was deeply skeptical of Elizabeth Warren.

My first objection was that she appeared to have parlayed possible Native American heritage to gain academic jobs (Harvard Law School listed her as Native American beginning in 1995). That offended me, and I knew it would repel huge numbers of voters.

Second, I thought she shot from the hip and, with her slight political experience, would wilt on the campaign trail.

Third, I thought she was a one-note Sally, eloquent on finance but thin on the rest of domestic and foreign policy.

So much for my judgment: I now believe I was wrong on each count, and her rise in the polls suggests that others are also seeing more in her. Warren has become the gold standard for a policy-driven candidate, and whether or not she wins the Democratic nomination, she’s performing a public service by helping frame the debate.

Let’s examine my misperceptions. First, The Boston Globe conducted a rigorous examination of Warren’s legal career, and it is now clear that she never benefited professionally from Native American associations.

“The Globe found clear evidence, in documents and interviews, that her claim to Native American ethnicity was never considered by the Harvard Law faculty, which voted resoundingly to hire her, or by those who hired her to four prior positions at other law schools,” the newspaper concluded.

Then there’s the concern about political naïveté and inexperience. Warren first ran for office only in 2012; even Pete Buttigieg has been in elective politics longer.

It’s reasonable to worry about her electability, partly because last year she won re-election in Massachusetts as senator with a smaller share of the popular vote than Hillary Clinton had received two years earlier in the state. In contrast, Senator Amy Klobuchar of Minnesota hugely outperformed Clinton.

I worried about a tendency to shoot from the hip when Warren misread an article and in 2016 wrote a Facebook rant denouncing a supposedly greedy Trump-supporting investor, Whitney Tilson. In fact: Tilson opposed Trump and agrees with Warren on most issues; indeed, Tilson had previously donated to Warren.

The unbalanced screed resembled a Trump tweet and made me wonder about Warren’s judgment. But Warren later apologized, and she has been more careful since. Tilson told me that he thinks the rant was not part of a pattern but perhaps reflected a sleep-deprived moment.

More broadly, Warren has improved tremendously as a politician. Early on, she sometimes came across as a stern Harvard professor eager to grill you about an obscure tort case. She’s now much better on the hustings. Forget the tort case and Harvard Law; she’s an Oklahoma gal who wants to have a beer with you.

Finally, I was manifestly wrong on Warren’s policies. She has been a geyser of smart proposals, including one I particularly like for universal child care. This would resemble the outstanding child care program operated by the U.S. military and would benefit both working moms and at-risk kids.

Warren also has a range of other proposals, pertaining to everything from election reform to housing, antitrust to corporate governance. Then she offers a wealth tax to help pay for social programs.

One of America’s biggest problems is the collapse of the working class and the lower middle class, with suicide at a 30-year high and drug and alcohol abuse causing life expectancy to fall. Warren confronts that crisis head-on both with her personal story and with sharp policies to boost opportunity. Her 2017 memoir, “This Fight Is Our Fight,” is that rarity of campaign books: a decent read.

Warren’s proposals might or might not succeed, but they are serious, based on work by top scholars. She is a believer in a market economy, regulated to keep it from being rigged, and in corporations that contribute to the well-being of all. And while she’s no expert on foreign policy, her instincts on avoiding war with Iran and showing concern for Palestinians seem good ones.

At her best, Warren is also brilliant at shaping the narrative. In 2011, she explained why taxing the rich isn’t “class warfare.”

“There’s nobody in this country who got rich on his own — nobody,” she said in a clip that went viral. “You built a factory out there? Good for you! But I want to be clear: You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police forces and fire forces the rest of us paid for.”

She ended: “You built a factory and it turned into something terrific, or a great idea? God bless! Keep a big hunk of it. But part of the underlying social contract is, you take a hunk of that and pay it forward for the next kid who comes along.”

That’s a conversation we need to have in America, and I’m glad Warren is getting attention so that she can make her case.