The company’s two biggest-selling shareholders – Estee Lauder and her son Ronald-will likely never pay capital-gains taxes on the combined $340 million they recently pocketed selling stock in Estee Lauder Cos. The third largest seller, Ron’s brother, Leonard, did his own maneuvering to defer taking a gain on his $25 million sale until next year-that’s when the federal cap-ital-gains rate is expected to be much lower than it is now. By my math, clan matriarch Estee saves $49 million in federal, state and local income taxes, son Ron saves $74 million and son Leonard saves a couple of mill. That will pay for a lot of turkey. Or a lot of tax lawyers. Sure, public investors did well on the Nov. 17 offering, with the stock currently up around 30 percent from the $26 offering price. But the Lauders made out better than anyone. They not only got a sweet tax deal, they still own 100 million of the company’s 115 million shares.
The tax-saving numbers, by the way, are my own estimates. No one from Lauder-land would talk about the family’s tax games, and my normal tax mavens don’t want to offend the Lauders or their multitudes of lawyers and investment bankers. So this article is based on my reading of the company’s filings at the Securities and Exchange Commission, some Tax Court cases involving the Lauders and a Nov. 8 Wall Street Journal story about them. I’m assuming the Lauders’ cost of stock for tax purposes is zero, and that they’re in the top federal, New York state and New York City income-tax brackets.
Now that we’ve established the foundation, on to the tax clinic. Ron and Estee atomized their tax bills with a move that I’ve never seen in an initial public offering before. Instead of selling their own stock, Estee and Ron Lauder borrowed stock from other family members and sold the borrowed shares. As security, they pledged to the lenders the same number of shares they borrowed. Why go through this? Taxes. Selling shares that you own produces a capital gain. Selling shares that you borrow doesn’t produce a gain or loss until you close out the transaction by replacing the borrowed shares. Ron and Estee probably won’t replace the shares for years, and probably plan to take advantage of the ultimate federal gains loophole-death-to duck capital-gains taxes forever.
Let’s look at Estee’s deal, which is part of the tax-avoidance games the Lauders have been playing almost since Estee and her late husband, Joseph, founded the company in 1946. Something called the EL 1994 Trust borrowed 5.5 million shares from Leonard Lauder and sold them to the public, netting $24.57 a share after expenses. If Estee had sold 5.5 million of her own shares, it would have generated $135 million in taxable in-come. Selling borrowed stock generated no taxable income. If Estee– said to be at least 87-dies with the stock at, say, $35, she gets to use the death loophole. Her cost of the shares for tax purposes now is zero, as we said. If she dies with the stock selling at $35, the shares’ cost for tax purposes becomes $35. So her estate could turn over 5.5 million shares to Leonard, and generate a tax loss of $57 million–the difference between $35 and the $24.57 Estee pocketed on the Nov. 17 sale. Pretty slick.
Ron’s deal is pretty sweet, too. He borrowed 8.33 million shares from family members and sold the borrowed stock, netting some $205 million. As long as the lenders don’t get antsy, Ron never has to repay the borrowed shares, as best as I can tell. So he never has to pay tax on the $205 million. Assuming the tax laws don’t change, Ben, 51, can play the death-loop-hole game, too, and wait until he dies to close out the sale. His estate would get a deduction equal to the stock’s price the day he dies, less the $24.57 he pocketed.
Not to be outdone, Leonard also saved a few bucks. He didn’t play the borrow-and-sell game, for reasons that aren’t clear, Leonard, no powder puff, settled for deferring his profit until next year, when federal cap-ital-gains rates are expected to be lower than the current 28 percent. He did this by swapping 1.04 million shares for a promissory note that comes due next March. You can’t defer gains by selling stock in a public company through a so-called installment sale like this one. So Leonard sold just before the offering, when the company was still private. As you see, the real road to riches isn’t owning Estee Lauder stock–it’s hiring the family’s tax advisers.
All these transactions have been lawyered to the nth degree, and are doubtless legal. But when you look at the big picture, such as your obligation to pay some taxes because of your duty as a citizen, you have to wonder whether the Lauders are engaging in overkill. Think of tax avoidance as spraying an Estee Lauder fragrance on yourself. A few dabs can be really attractive, but putting on a bucketful makes you smell to high heaven.
