Is Elon Musk really exploiting a loophole to avoid taxes?

Question

I've been loosely keeping up with some of the news about Elon Musk selling TSLA shares to pay for an upcoming tax bill (for exercising options from 2012). There is a lot of discussion surrounding this news, much of which is political (regarding whether Elon Musk and other billionaires are taxed highly/fairly enough).

Ignoring the topic of whether or not there should be taxes on unrealized gains (e.g. unsold shares of TSLA), some argue that even if Elon Musk is paying a large amount of taxes this year on his capital gains, there is a loophole that the he and other ultra-rich people exploit to pay as little as possible.

This "loophole" seems to be generally described as:

1. Rather than Elon Musk selling shares (and thus paying taxes) to pay for his "life" (like buying houses, vehicles, food, luxuries, etc.), he takes out loans using his shares of TSLA as collateral.
2. Because taxes aren't paid on loans taken out, he is paying no taxes on his income (which is coming in the form of loans).

At first, I thought it made sense. But when I thought about it a little more, I saw a few errors:

1. Even if Elon Musk takes out loans, he is paying interest on them.
2. The loans will have to be repaid sooner or later, and to do so, he will have to sell shares (and thus pay the taxes).
3. So overall, Elon Musk gets to avoid paying taxes sooner, at the expense of having to pay more money later (due to the taxes on his capital gains + the interest from his loans). So overall, Elon Musk isn't really avoiding paying taxes.

I don't have a strong understanding of economics, finances, or the tax code, so there might be mistakes in my thinking. However, if my understanding is correct, is it fair to say that billionaires like Elon Musk can't really avoid taxes as is claimed by many? Or is there some other "loophole" that wealthy people use to pay less taxes?

Answer 1

This "loophole" seems to be generally described as:

Rather than Elon Musk selling shares (and thus paying taxes) to pay for his "life" (like buying houses, vehicles, food, luxuries, etc.), he takes out loans using his shares of TSLA as collateral. Because taxes aren't paid on loans taken out, he is paying no taxes on his income (which is coming in the form of loans).

This is called "Pledged Asset Loan" or line of credit. Anyone (with enough assets) can have that. If you have a large enough value in your brokerage account your broker would be happy to extend credit to you using the shares in your account as collateral.

Even if Elon Musk takes out loans, he is paying interest on them.

You pay interest, of course, but it's much less than opportunity costs of rapidly appreciating stocks + taxes on liquidation.

The loans will have to be repaid sooner or later, and to do so, he will have to sell shares (and thus pay the taxes).

Later may be when they die, the estate pays off the debt with shares that got stepped up basis, and essentially capital gains are never paid (only estate tax after the exemption amount).

So overall, Elon Musk gets to avoid paying taxes sooner, at the expense of having to pay more money later (due to the taxes on his capital gains + the interest from his loans). So overall, Elon Musk isn't really avoiding paying taxes.

He is avoiding paying any taxes, and his estate avoids paying the capital gain taxes (if he even cares what happens after he dies).

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From the comments it appears that people take offense that I'm suggesting that Elon Musk is doing something bad, so I'll clarify:

• We're using Elon's name here just as a placeholder. I don't actually know if he is, personally, utilizing this scheme. The OP mentioned his name, and so did I, I didn't fact-check the OP.
• TAX AVOIDANCE IS NOT ILLEGAL. The fact that someone is legally avoiding paying taxes by choosing scenario X over Y doesn't mean they're doing anything wrong. The negative connotation to the term "tax avoidance" is unwarranted in my view, but is subjective in any case. From legal perspective there's nothing wrong with legally planning your financial transactions taking the tax treatment into account, and many of us are doing it - not just the billionaires. In fact we're all doing some kind of tax avoidance one way or another with our financials when we choose to use leveraging over liquidating assets, like a home mortgage or HELOC, margin accounts, etc. This is not conceptually different from the scheme described above, it's just a different scale.
• The discussion about "fair share" is subjective. We all have our opinions of what is fair and why, but it is irrelevant to this answer, I'm just explaining how the scheme works.

Answer 2

littleadv has a good answer on the federal side of things, but another aspect that people are missing is the state income tax side of things.

California treats capital gains as income and has a hefty state income tax(13%), which he obviously didn't pay with the loans. Musk is now (as of this year) no longer a resident of California, but of (low-tax) Texas. Musk's feud with California on regulations and Covid restrictions is vast, bitter and well documented, so it's reason enough to bid adieu by itself, but just coincidentally, moving out when he did will save him billions in taxes. California has recently passed a law that ex-residents still have to pay taxes on capital gains for a number of years, for just such a scenario, but the constitutionality of the law under US federalism is dubious and will be a multi-year court-case at best.

Answer 3

As long as the assets continue to grow, people are able to refinance those loans and continue to have money to live as they please. There's a really good series of articles published by ProPublica using leaked/stolen IRS records from billionaires that goes over all of this and more.

https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax

Answer 4

tl;dr;

You're right, mostly. You forgot to account for the time value of money in your counter arguments*, but also aligning with your counter points, risk should be considered. Most importantly, whether something is a tax loophole for .01% of people does not logically imply it is not the best system possible for the other 99.99%**.

Full answer:

Whether he is "exploiting a loophole" is very much a matter of perspective. Not something can be definitively answered in a factual manner.

However, while I would generally agree with your three counter arguments, the time value of money is certainly a huge factor in considering the "fairness" of this "loophole". And I think that's what you've left out. However so is risk, and I feel that hasn't been touched on in other answers.

While you are able to access capital without paying capital gains tax via these loans, and there is a list of advantages... there is an inherent risk to taking out a loan as described. Assets have a value that fluctuates. If you take out a loan of $50 million against $200 million in assets, and those assets lose 50% of their value, by the time you pay back the $50 million loan + pay your capital gains taxes when you sell to cover the debt, you're effectively left with $1-10 million***(based on interest rate and time paying) of the original $200 million. A ton of money, sure, but not exactly what anyone would consider an advantageous financial position.

Now Tesla losing 50% of it's value may seem far fetched, but here's an article from earlier this month:

Even worse, 23 of those companies have lost half or more of their value since reaching their highs, including Robinhood, which has plummeted 74% from its top in early August, and LegalZoom, which has plunged 58% since peaking in July.

Sure, Tesla is more established, and even if it lost 50%, its such a high value Musk would probably be fine, but it's important to remember that tax codes have to be created to apply to everyone, hundreds of millions of people. It's inherently unfair to apply different taxation to different people. The entire idea of debating tax policy around the most extreme possible edge case (richest man in the world) is like setting expectations for a 1st year, gen-ed writing course student to match or exceed the skills of Austin, Tolkein, and Dickens. Many policies that "correct the wrong" of the ultra wealthy "getting to avoid taxes 'til death" can harm the common man's finances far more than the "correction" is worth to society.

Notes:

*This is the single greatest advantage to financing this way

**Not to say it's the best system currently, would never go near the word "best", but writing laws for edge cases is never a good idea. In that regard, what some people may consider a "loophole" for a certain subset of individuals may actually be the most fair option a government can practically implement for everyone.

***I don't mean to exclude the original $50 million in value from the loan, and whatever was purchased or investments made with it will assumedly have kept their value (on avg), so it may be preferred to look at the "what's left" number as $51-$60 million instead. The point is to demonstrate the financial risk involved with financing a lifestyle in this manner. You still owe everything you borrowed, with interest, plus capital gains - no matter how much your asset devalues.