How the rich make money by losing money

0:01NPR.

0:06Sierra Juarez:Decades ago, the richest Americans paid taxes as high as 40 % on their investments. That means if they sold a bunch of stock or their company got acquired, a good chunk of that payday would go to the government. But right now, some millionaires and billionaires are plowing their money through a tax loophole so big it could allow them to slash their taxes to zero. This is The Indicator from Planet Money. I'm Waylon Wong. And I'm Adrian Ma. Today on the show, we'll be joined by Bloomberg reporter Lukia Giftapulu. She covers investing and the wealth management industry. And recently, she and her colleagues did a series of stories on what they call this generation's Great American Tax Dodge.

0:47After the break, she explains how it works and tells us about the man behind it. a hot-tempered, computer-screen-punching financial whiz who runs the world's biggest hedge fund right here in the U.S.

1:03Sierra Juarez:This message comes from Superhuman. Superhuman brings together connected tools like Grammarly, Docs, and Mail into one productivity suite. Built on the idea that low-value tasks crowd out meaningful focus, Superhuman meets teams where they already work. It operates proactively alongside writing and email workflows to help clear what is in the way. Superhuman from the makers of Grammarly. Start streamlining your workflows with Superhuman today at superhuman.com. This message comes from Dell Technologies. Interruptions happen at work. But with the Dell Pro laptop powered by Intel Core Ultra with vPro built with optimized battery and built-in intelligence, your tech won't slow you down.

1:48Sierra Juarez:Dell.com slash Dell-Pro. Built for you. We the people make a free press possible. Together we hold power to account with reporting for the public, funded by the public. It takes all of us to protect the future of public media. Make your gift now at donate.npr.org. The story of this era's great American tax dodge starts with a man named Cliff Asnes. 59 years old, with a bald head and gray beard, and a Captain America tattoo on his arm. Cliff worked at Goldman Sachs in the 90s, and around that time, also got a PhD in finance. Cliff Asnes is a very big, bigger-than-life personality. That's Bloomberg reporter Lucia Giftapulu.

2:36He's, let's say, a mad genius in a way who's found this way to help rich people slash their tax bills potentially to the extreme. Another mad genius. There's very few geniuses that are described as stable. Yes. People who have spent a lot of time with him credit him as one of the smartest people they've ever met. At the same time, he's got a massively short fuse. He shouts at people. He's admitted that he's, during the financial crisis, he was punching through computer screens maybe afterwards as well. I don't know.

3:14Sierra Juarez:Cliff Asnes also loves to throw verbal punches. He's known for publicly insulting fellow finance bros like billionaire Bill Ackman. And he's written a lot of Wall Street Journal op-eds, including one where he defended what he called the working rich. I think Ebenezer Scrooge was a member of the working rich class. I think that would count. After his stint at Goldman, Cliff struck out on his own. He set up a hedge fund called AQR Capital Management. And for years, AQR was a pretty typical hedge fund, taking money from wealthy individuals or pension funds, investing it and trying to turn it into even more money.

3:51But then a few years ago, Lukia says, they made a pivot. They shifted towards something called tax-aware investing, which means what exactly? We help reach people slash their tax bills. That's what tax-aware investing means.

4:07Sierra Juarez:While traditional investing is focused purely on growing a pool of money, tax-aware investing is focused on reducing how much an investor owes to Uncle Sam. One classic strategy for doing that is something called tax-loss harvesting. That's when you sell off losing stocks and write off those losses to reduce your tax bill. Cliff and his team at AQR Capital took this basic strategy and complexified the hell out of it. They developed what's called a tax-aware long-short strategy, which sounds like total word salad. Basically, it means that they create complicated investment portfolios purposely engineered to generate losses.

4:45They have thousands and thousands of positions, many long, many short. They borrow money and they create losses. Long term, these strategies are supposed to also make you money, but they've engineered a product that can create losses that can then offset any tax you have to pay.

5:07Sierra Juarez:To make that concrete, here's an example from Lucia's reporting. In a presentation AQR Capital gave to potential investors, they explained how their souped-up version of tax loss harvesting works. They said, if you invest$100 million with us over the next 10 years, it'll grow to$300 million, which is a pretty good return. But here's the icing on the cake. They said over that same period, the fund could incur$600 million in losses, losses which you can use to erase your tax liability on your winning investments. Grow your money and slash your tax bill. That is what AQR is promising. Who doesn't want to do that?

5:46Right? I mean, sign me up. Oh, wait, I don't have anywhere near the amount I would need to buy it. Never mind. We'll get back to you. Yeah. A few years ago, AQR started offering this strategy to clients who had at least a million dollars to invest. And Lakia says they exploded in popularity. They went from having$3 billion in these accounts to having$70 billion, and maybe more now. They stopped publishing those numbers. And to put this in perspective, outside AQR, some of the most prominent hedge funds in the world, it took them decades to raise this amount of money. We're talking about$70 billion in three years.

6:27This is, you know, outrageously fast for anyone who knows this world. So this kind of puts a bit in perspective how much people want something that will help them not pay their dues to the government.

6:42Sierra Juarez:And with some creative accounting, Lukia says investors who use this strategy might even be able to pass on their assets to their heirs without ever incurring a tax bill. And that's why in just a couple of years, AQR Capital has grown into the world's largest hedge fund. And now this strategy is in such high demand among wealthy clients that other investment firms have started offering their own similar investment products. Lukia says it's a sign of an anti-tax mood among the rich that these funds have become so popular. But it's also interesting that this is happening during a time when there's a growing anti-billionaire tax the rich, eat the rich conversation happening in politics.

7:21Policymakers in states like California, Maryland and New York are debating new taxes on the rich. Others, like Hawaii, Washington, and Maine, recently passed a millionaire's tax. I think a lot of people would hear this and feel like it doesn't seem right that maybe this is not illegal,

7:41Sierra Juarez:but these millionaires and billionaires have found a very clever way to at least skirt the spirit of the tax law by finding a loophole and then plowing all their money through it. Do you think people would be justified in feeling that way? If you are a schoolteacher, you know, who doesn't have$1 million to invest in a tax law strategy, and you pay your full amount in tax, and somebody with a lot more money can avoid it exactly because they have more money. I think it's fair for people to wonder why. It's possible the IRS may be wondering why, too. Recently, Treasury Department officials expressed concern about what they called potentially abusive tax avoidance strategies, although they didn't specifically call out AQR's approach by name.

8:31And Congress could, in theory, close the loophole. Amid this uncertainty, some investment firms like Charles Schwab and Fidelity that work with AQR have pulled back on offering this type of account to new clients.

8:43Sierra Juarez:And yet, Lucia thinks this isn't going away. You know, hedge funds going to hedge fund. You know, they're just going to keep making money for the clients. And if they can offer it to them, they will. And asset managers would do the same. And then if someone comes and says, this is illegal, then they're going to have to stop it. And somebody might have to pay a lot of money for it in penalties. But until then, it's just going to keep growing. And in fact, some money managers have even begun selling this tax avoidance tool to the masses. What do you mean by masses? You mean people like you and me?

9:20I mean, like instead of just pay whatever the TurboTax online thing tells you to pay at tax time.

9:26Sierra Juarez:Well, they're not just offering it to the ultra wealthy, but maybe even the the merely very wealthy. Oh, my goodness. They finally are going to catch a break. And Lucia says that could be a problem because these funds aren't without risks. Many financial advisors are pitching this to every single client, even if the clients are not right for this strategy. People can be trapped in accounts they do not understand, which might cost them a lot more because these things are complicated and you can't really get out of them whenever you want. So you're saying I just can't, you know, Robin Hood my way.

10:06Sierra Juarez:to tax loss riches. That'll be a follow-up episode. If you have a creative tax avoidance strategy, listen, don't keep it to yourself. Let us know. Indicator at npr.org. This episode was produced by Cooper Katz McKim and engineered by Jimmy Keely. It was fact-checked by Sierra Juarez. Kate and Cannon is our editor and the Indicator is a production of NPR. This message comes from Easy Cater. making it easy for organizations to order food for meetings and events from favorite restaurants, set up meal programs for their employees, and manage food spend all in one place at easycater.com. This message comes from Squarespace.

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