Decades-Old Loophole: How Billionaires Sidestep Medicare Taxes

A recent investigation by ProPublica reveals that while most working Americans pay Medicare taxes, some of the wealthiest individuals on Wall Street have managed to avoid this obligation through a longstanding loophole. Nearly fifty years ago, Congress attempted to rectify a financial abuse by creating a regulation that inadvertently allowed these billionaires to circumvent Medicare tax payments.

ProPublica’s “Secret IRS Files” series highlights instances of prominent financiers, including Steve Cohen of the New York Mets, who reported paying no Medicare taxes despite massive earnings. In 2016, both Cohen and Blackstone’s Stephen Schwarzman reportedly paid zero. Bill Ackman, another hedge fund mogul, similarly shielded a significant portion of his income from this tax.

Self-employed individuals are typically required to report their earnings and pay associated taxes, including Medicare. However, high-end tax consultants have exploited a specific clause within the tax code, allowing them to sidestep Medicare tax liabilities. By structuring profits through companies, these individuals can declare their income exempt from Medicare tax even when they pocket substantial sums.

While the billionaires assert they adhere to existing tax laws and claim they pay other taxes at higher rates, these tactics contribute to growing concerns about the sustainability of Medicare. The program’s trust fund is projected to be depleted by the 2030s, and closing this loophole, along with addressing other tax avoidance methods, could generate over $250 billion for Medicare within the next decade.

The loophole, which first came to attention in the 1990s, has remained a point of contention. The IRS has recently intensified its scrutiny of wealthy individuals exploiting this gap, but its effectiveness remains uncertain. In that context, ProPublica’s examination uncovers the convoluted mechanisms through which wealthy financiers avert Medicare taxes.

Initially included as a part of a 1977 Social Security reform, the loophole was meant to prevent a specific type of income from counting toward Medicare and Social Security contributions. This provision was intended for passive investors in limited partnerships, who were not actively involved in managing the businesses.

As business structures evolved, particularly with the rise of limited liability companies (LLCs) and limited partnerships, the distinction became less clear. This shift allowed business owners to craft tax avoidance strategies that had not been envisioned when the law was passed.

The IRS attempted to address this issue in the late 1990s but faced political backlash that effectively prevented any regulatory changes. Over the years, numerous partnerships emerged that further complicated the landscape, often resulting in minimal reported self-employment income for these high earners.

ProPublica’s investigation tracks the IRS’s inconsistent responses to this burgeoning tax avoidance issue. Beginning in 2018, the agency initiated audits targeting business owners perceived to be abusing the loophole. However, the results have been mixed, with many taxpayers opting to quietly settle before cases escalate to higher courts.

Recent legal proceedings have called into question the validity of these tax avoidance strategies. A court case involving Soroban Capital found that being a “limited partner” does not apply to individuals who are merely limited on paper. This ruling signals a potential shift in how these loopholes are enforced.

As tax regulations continue to be scrutinized, the need for legislative action becomes increasingly apparent. Democrats have sought to eliminate this loophole as part of broader attempts to finance new initiatives. Yet the political complexities surrounding tax reforms have stymied these efforts, resulting in repeated failed attempts to secure a solution.

The ongoing challenges in reforming tax policy reveal the persistent divide between wealthy individuals and the tax burdens faced by average Americans. As lawmakers grapple with necessary changes, the future of Medicare and equitable tax contributions hangs in the balance.