The wealthy business executives being tapped for President-elect Donald Trump’s Cabinet may be able to avoid a big tax bill if they opt to take advantage of a little-known provision of the federal tax code.
Section 1043, introduced during the George H. W. Bush administration, essentially says that an officer or employee of the executive branch or a judicial officer who is required to divest any property to comply with federal conflict of interest rules can defer paying taxes on capital gains.
In order to qualify, there are three key parts to Section 1043.
First, the individual has to be an “eligible person.” That includes appointees, as well as spouses or children of the appointee whose ownership or property is attributable to the appointee.
Second, the eligible person must obtain a “certificate of divestiture”, which is issued either by the Office of Government Ethics or the president. This certificate identifies the property to be divested and it states that the divestiture of the property is necessary to comply with federal conflict of interest rules.
Third, there is a reinvestment requirement where the person is required to invest the proceeds from the sale of the property in what’s called “permitted property.” Permitted property means two things — any obligation of the US (i.e. Treasury bonds) or any diversified investment fund approved by regulations issued by the Office of Government Ethics.
“The reason they put [Section 1043] in place is to ensure people wouldn’t be unduly penalized if they were asked to serve in a high government position and were forced to sell their life’s assets, the assets they accumulated, to avoid conflict,” tax expert Robert Willens, president of Robert Willens LLC and adjunct professor at Columbia Business School, told Yahoo Finance.
“If there were no way to at least defer the tax from forced sales, qualified people would say, ‘The heck with it’ because of the fortune in taxes to become a member,” he added.
This tax loophole could prove beneficial for some of Trump’s newest picks.
On Monday, Goldman Sachs’ president/COO Gary Cohn was named head of Trump’s National Economic Council. Cohn owns approximately 872,712 shares of Goldman Sachs (GS), a position valued at more than $211 million, according to data compiled by Bloomberg.
A New York resident, Cohn would be taxed at a 31.5% rate for capital gains.
Meanwhile, Exxon Mobil (XOM) CEO Rex Tillerson is being considered for secretary of state. Tillerson owns 2,618,856 shares of Exxon Mobile, a position valued at more than $233 million. In Texas, capital gains are taxed at 25%.
If the person is deemed eligible and they obtain a certificate of divestiture, they have 60 days in which to make the investment in the permitted property. If they invest all the proceeds from the sale in permitted property then they won’t have to recognize the gain from the sale of the offending property, Willens explained.
Keep in mind, the only thing they’re allowed to defer is the capital gain. They can’t defer ordinary income. Stock options would be considered ordinary income because they are compensatory, he added.
Earlier this month, Senators Sheldon Whitehouse (D-RI), Elizabeth Warren (D-MA), and Tammy Baldwin (D-WI) introduced new legislation called “Whitehouse and Warren’s No Windfalls for Government Service Act” that would limit the amount of capital gains that can be deferred to $1 million. Their argument is the wealthy don’t need a financial incentive to enter public service.
“It is technically just a deferral,” Willens said. “If they allowed you to avoid the [tax on the] gain without taking specific action, maybe [Elizabeth Warren] would have more of a leg to stand on.”
The benefit to Section 1043, of course, is that the person can defer as long as they want, especially if there’s no great need to divest from the approved investment funds. The only way a deferral can be made into a permanent avoidance is if the person dies with the property.
Julia La Roche is a finance reporter at Yahoo Finance.