Plugging holes Featured

9:50am EDT July 22, 2002

It may be true that there’s no escaping death or taxes, but an entire cottage industry of tax attorneys and estate planners nevertheless is organized around the time-tested belief that in many instances, one can, with the right kind of advice, legally extricate oneself from plenty of the latter.

A favorite new tool for legal tax avoidance is to exploit an anomaly between federal and Ohio tax law. For the last few years, while the beneficiaries of so-called “electing small business trusts” have been taxed at the federal level, they haven’t been similarly subject to taxation in Ohio.

But one Cleveland-area state legislator is trying to close what he considers an unwarranted loophole that arose simply as a result of lack of coordination between federal and state tax regimes. Ed Jerse, who represents the Hillcrest area of the suburban East Side, is pushing House Bill 139, which would change the Ohio Revised Code and subject these trusts to Ohio corporate tax.

The situation arose as a result of the Small Business Job Protection Act of 1996, which for the first time permitted these ESBTs to hold shares in S Corporations, which have become an increasingly popular vehicles of business incorporation because they aren’t subject to double taxation (only their beneficiaries, not the corporations themselves, pay income tax).

So while beneficiaries of these trusts are taxed at the federal level, they have thus far escaped taxation in Ohio, which does not tax trusts.

In testimony earlier this year before the Ohio legislature’s Income Tax Subcommittee, Case Western Reserve University law professor Erik Jensen, who holds a chair named for Akron industrialist David Brennan, said the federal tax law changes, absent corresponding changes in Ohio tax law, “can create a legal, but unwarranted, shelter for Ohio income tax purposes because the trust’s share of corporate income falls through the cracks: It is not taxed to anyone.”

A member of the faculty since 1983, and before that a practicing tax attorney in New York City, Jensen said that “this problem was not created by villains; it was an accidental byproduct of a well-motivated federal tax change that unfortunately does not mesh with Ohio law.”

Accidental or not, it’s a provision to which estate planners and tax attorneys seem to have enthusiastically steered clients to reduce their tax bills. Jerse says he’s heard estimates of lost revenue that run as high as $100 million annually.

“If you sell a $60 million S Corp., you would have a 7 percent tax,” Jerse says. “So that’s $4 million on one deal that you’re missing. I would imagine you could go through the law firms of Cleveland alone, and find 10 or 20 of these deals in process.”

Still, Jerse has been stymied in trying to put a more precise number on the problem. For reasons he can’t understand, he’s thus far had no luck getting the state’s tax department to come up with appropriate numbers.

“The tax department has basically given me absolutely nothing in helping me estimate this [the magnitude of lost tax revenue]. They keep telling me they can’t figure this out, because it’s like trying to calculate the shadows on the wall.”

The professionals whose clients are benefiting from the tax provision, meanwhile, are stuck in their own balancing act: They can’t actively lobby in favor of continuing the loophole, which would only call further attention to it, but neither do they seem to want it closed.

“They’ve called several times, but they’ve never shown up at hearings,” says Jerse of these estate tax professionals. An industry official was reticent about the issue when contacted for this story.

“Arthur Andersen has no comment,” said one member of Andersen’s Family Wealth Planning Group, Patrick Saccogna.

Nevertheless, Jerse, whose legislative career won’t be affected by term limits until the year 2004, plans to push hard to get this loophole closed this year, despite the fact that the legislature won’t regroup until October, and then for only a few more days in 1999. He’s spoken to the speaker of the house, and to the chairmen of the tax subcommittee and the Ways & Means committee, “and nobody’s expressed any opposition.”

While some legislative observers think it will difficult to impossible to get action on the bill in the six or seven days of the legislative session that remain, Jerse remains optimistic. With revenues of this magnitude leaking out of state coffers, he says, “I don’t think they’re [legislative leaders] going to want to leave that out there. If the legislature has the will to do it ... I’m going to be pushing to get it done this year.”

It may be difficult to predict the outcome of the bill, but one thing seems certain: When campaign contributions from estate planners and tax attorneys are totaled at year’s end, don’t look for Ed Jerse’s name to be high on the list of beneficiaries of their largesse.

John Ettorre ( is a contributing editor at SBN.