Tax loopholes that mainly benefit the rich

Second-home mortgage interest deduction

Not to keep picking on homeowners, but there's yet another residential deduction that needs to go: the deduction for interest on a vacation home loan.

Yes, some owners of second homes are far from wealthy. But those who own a ski chalet in Aspen, Colo., an ocean-view getaway along Miami's South Beach or a pied-a-terre in New York City in which to rest after a late Broadway opening night usually are rich. And they get to write off the interest on those expensive second homes as an itemized deduction, for mortgage debt as high as $1 million.

Even more amazing, owners of luxury yachts can deduct mortgage interest on loans they took out to buy their mini-Queen Marys. That's right: The Internal Revenue Code says a boat can be considered a home as long as it has sleeping quarters, a kitchen and a toilet.

The home designation rules also mean that recreational vehicles could qualify as residences, providing owners of those luxury buses an added tax deduction, too.

Sure, some people do live in straightforward houseboats. And because the deduction applies to all types of second-home options, supporters of the tax break argue that it's fair.

But the tax code would be even fairer if the vast majority of single homeowners didn't have to subsidize any second homes.

Carried interest special tax treatment

Remember the controversy over the low tax rates that Republican ex-presidential candidate and former Massachusetts Gov. Mitt Romney paid? Part of the reason was because of his capital gains on investments.

But Romney also got some pay for his work at Bain Capital. And a tax loophole allows that compensation to be taxed at a lower rate.

Managers of most private equity funds get a percentage of the net gains as a management fee. This payment is known as carried interest, and here's the beautiful part for the fund manager: Carried interest is not taxed like the regular interest most taxpayers get on regular savings accounts. It's taxed as a capital gain.

That means while regular interest received by most taxpayers on their savings accounts is taxed at rates that could go up to 35 percent, folks who get carried interest payments owe a current top rate of 15 percent on that special interest.

Listen to audio
Show Show Transcript

Tax loopholes aren't illegal, but they appear to provide disproportionate tax benefits to a select few.

Take the current 15 percent capital gains tax rate for most investors, and the zero percent rate for taxpayers in the lowest two tax brackets. The lower capital gains tax is supposed to encourage investment, which helps create new companies that hire more people.

But this tax loophole is estimated to cost the U.S. Treasury nearly $457 billion over four years. Ordinary taxpayers pay tax on their earnings at income tax rates up to 35 percent.

The really rich tend to make most of their money with investments instead of standard paychecks -- meaning most of their money is taxed at 15 percent.

And what about the wonderful zero tax rate for investors in the 10 and 15 percent tax brackets? Most folks at those levels don't have a lot, if any, cash left over to invest after paying their bills.

A Bloomberg Global Poll in January found that two-thirds of poll respondents worldwide said the carried interest tax break isn't justified. That's consistent with the poll's finding on the topic in the United States, where 67 percent said the lower tax rate isn't fair.

A bill was introduced in Congress to change the tax treatment of equity fund managers' earnings. Not surprisingly, it went nowhere.

Tax break for offshoring US jobs

Businesses also get their fair share of tax breaks and tax loopholes. The ability to save on corporate taxes by shipping operations overseas is one of the most vilified corporate tax breaks.

Yes, companies can expense the costs of relocating abroad. True, it's not a special tax break for moving, say, a factory and its 600 jobs from St. Louis to Singapore. And, says the Tax Foundation, jobs are at least three times more likely to be relocated from one state to another than overseas.

Still, when U.S. unemployment is high, a tax break that rewards the elimination of more U.S. jobs seems like a really bad idea.

Will these and other individual and corporate tax loopholes, deductions or, as the federal government calls them, tax expenditures, be eliminated or even tweaked a bit? It's not likely. All are quite popular among the groups that receive tax savings from them. And they are the same folks who tend to contribute generously to political campaigns.

But anything can happen on the way to the "fiscal cliff."


Show Bankrate's community sharing policy
          Connect with us

Connect with us