‘Suspect’ inventory trades serving to CEOs skirt taxes: examine

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Are top company executives backdating stock gifts, and even manipulating stock prices, to cheat on their taxes?

Could be, report three finance professors after a deep dive into nearly 1,000 transactions over a 10-year period.

The transactions in question involve stock gifts made by CEOs to children and other heirs, and the taxes avoided are gift and inheritance taxes.

“We find a disproportionate number of gifts reported at or near monthly stock price minima, indicating the presence of backdating,” write Jennifer Brown of Arizona State University, HG. Ryan Huston of Texas Tech, and Brian Wenzel of Canada’s McGill in a new paper. They add: “We refer to these observations as ‘backdating suspects’… some gifts appear backdated to increase after-tax family wealth.”

As for the possibility of stock price manipulation: The researchers found lots of cases of abnormally bad stock price performance just before big gifts, driving down the value for inheritance tax purposes… followed very soon afterward by a big price recovery. Such stock gifts “generally follow temporary price suppressions,” they write, “and precede significant price appreciation.”

These “price suppressions,” accidental or otherwise, often involve companies missing earnings forecasts, they write.

“We find evidence of negative returns leading up to gifts and that (these) gifts follow quarters that miss analyst earnings forecasts and have losses,” they write. After the gifts, “We also find evidence of a quick turnaround in performance.” These turnarounds are so dramatic that you could actually make big money just by following the gifts, they add — although one problem is that these gifts, unless CEO stock purchases and sales, don’t have to be reported immediately.

The stocks in question rose on average by a stunning 18% in the year after the gift, the researchers found. They rose on average by 31% over two years.

And the average tax gain banked by the CEO and their family in just two years has worked out at $345,000. That’s not the gross value of the taxable gain, which is $2.75 million. It’s the actual cash value of tax savings just in the first 24 months after the transaction.

The mechanism is simple but clever. Give (say) 100,000 shares of your company stock to your child, and the value of that gift for federal estate tax purposes will be the value on the day of the gift. If the stock trades at $100, you’ve just made a $10 million gift. But if you make the gift on the day the stock drops to $70, even if only temporarily, the taxable value is $7 million.

If this is your only request, your heirs will not pay taxes on it anyway, as the latest exemption is $12 million (and $24 million for a married couple). But if the rest of your estate uses that up, your bequest will be subject to estate taxes of up to 40%.
The study was conducted looking at stock gifts over a 10-year period from 2004 to 2014. Any suggestion of stock manipulation or backdating could be explosive. It was in 2007 that The Wall Street Journal—owned, like MarketWatch, by News Corp.—won a Pulitzer Prize for Public Service for exposing how CEOs were using backdated stock and options to cheat their stockholders and pocket more money.

Meanwhile, the least of the revelations is startling enough: That CEOs are taking advantage of stock price volatility, quite legally, to get around the estate tax rules. The beneficiaries aren’t the wealth-creating CEOs themselves, either, but their offspring.

Never mind. If Uncle Sam needs extra money to fill the $1 trillion annual deficits or the $20 trillion hole in Social Security, he can always tax the working stiffs.

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