There have been a number of recent proposals to impose special taxes on the super wealthy from the likes of Sens. Elizabeth Warren (D-Mass.), Ron Wyden (D-Ore.), and Bernie Sanders (I-Vt.). But now they have an ally in the White House, as evidenced by the proposal of the Biden administration in its 2023 Fiscal Year Revenue Proposals, to impose a minimum tax on the wealthiest individual taxpayers.
While imposition of a minimum tax on super high net worth individuals may seem simple and equitable—and potentially popular to the broader population—it is complicated and fraught with many difficulties.
Current Law and the Administration’s Proposal
In general, under current law, individual capital gains are taxable on a “realization” event basis, such as on a sale or disposition of an appreciated asset. Consequently, the increase in value of an asset that accrues during the asset’s holding period—the unrealized appreciation—is deferred until that realization event. With respect to unrealized appreciation at death, a step-up in basis for a decedent’s assets may result in the total elimination of federal income tax on that gain.
Effective for taxable years beginning after Dec. 31, 2022, the administration’s proposal would impose a 20% minimum tax on total income, including unrealized capital gains, for all taxpayers with “wealth”—assets minus liabilities—greater than $100 million. This is estimated to impact approximately 0.1% of individual taxpayers and raise $361 billion over 10 years. Not a large revenue impact by federal budget standards, but nonetheless a small step toward addressing perceived inequalities in the federal tax system. Under the proposal, the first-year minimum tax liability could be paid in nine equal, annual installments. For subsequent years, taxpayers could choose to pay the minimum tax, not including installment payments due in that year, in five annual equal installments.
The tax would effectively result in the “prepayment” of the unrealized gain. A taxpayer’s minimum tax liability would equal the 20% tax times the sum of taxable income and unrealized gains, including on ordinary assets, less the sum of the taxpayer’s uncredited prepayments and regular tax. Payments of the minimum tax would be treated as a prepayment available to be credited against subsequent taxes on realized capital gains, subject to certain limitations, to avoid taxing the same amount of gain multiple times. The amount of a taxpayer’s “uncredited prepayments” would equal the cumulative minimum tax liability assessed, including installments not yet due, for prior years less any amounts credited against realized capital gains in prior years. Special rules would apply to single and married decedents.
Tradable assets such as publicly traded stock would be valued using end-of-year market prices. On the other hand, taxpayers would not be required to obtain annual market valuations of non-tradable assets. Such assets, like private partnerships and art, would be valued using the greater of the original cost or adjusted cost basis, the last valuation event from investment, borrowing or financial statements, or other Treasury-approved methods. Valuations of non-tradable assets would be deemed to increase by a “conservative” floating annual rate—the five-year Treasury rate plus two percentage points—between actual valuations. The IRS may provide a means for taxpayers to appeal valuations, such as through appraisals.
There is a second part to this proposal: new annual reporting obligations for the super-wealthy. Those covered by the minimum tax would be required to report to the IRS on an annual basis, separately by asset class, the total basis and total estimated value, as of Dec. 31 of the taxable year, of their assets in each asset class, and the total amount of their liabilities. Taxpayers deemed to be “illiquid” could elect to include only unrealized gains in tradable assets in the calculation of the minimum tax liability, subject to a deferral charge upon and to the extent of realization of gains on any non-tradable assets. A taxpayer would be treated as illiquid if tradable assets, such as publicly traded stock, make up less than 20% of the taxpayer’s wealth. The deferral charge would not exceed 10% of unrealized gains.
In any discussion of this tax, the elephant in the room is its constitutionality. If this proposal, or any similar proposal, is enacted into law, its constitutionality will be tested in the courts—ultimately by the U.S. Supreme Court. There is little doubt about that. Would this be viewed by the courts as a “wealth” tax, and, if so, would it nonetheless be viewed as constitutional? Legal scholars have differing interpretations on the constitutionality of a wealth tax. Would it be viewed as a “legal” income tax, permitted by the 16th Amendment? While the matter is being adjudicated, might the courts enjoin the collection of the tax? How would refunds be administered by Treasury if the tax were determined to be illegal? Complicated.
Valuation of non-tradable assets could be a substantial headache for affected taxpayers and the IRS. Yes, it might be pointed out that in the case of individuals there are circumstances where income is accounted for on other than an “as realized” basis. Examples include original issue discount, Section 1256 contracts such as regulated futures contracts, and the tax treatment of electing Section 475(f) traders in securities. But that is generally for assets with a readily ascertainable tradable value.
As noted, the proposal attempts to mitigate some of the administrative burden by eliminating the annual valuation of such assets and assuming a “conservative” annual appreciation. While that might be a benefit in substantial up-markets, an assumed amount of appreciation, however conservative, may be inappropriate in weak or down-markets, in which case taxpayers may have a real need for actual valuations. And, if the taxpayer has many non-tradable assets in different asset classes, the valuation process could become rather burdensome. Could this lead to an explosion of dueling appraisals between the IRS and taxpayers?
Similarly, allowing illiquid taxpayers to include only unrealized gains in tradable assets in the minimum tax calculation does reduce the administrative burden somewhat, but many taxpayers covered by this tax will not be treated as illiquid. Might the 80% illiquid threshold incentivize taxpayers to manage their holdings to meet this test?
The politics of this minimum tax proposal seem challenging. It could be considered as part of a 2022 variation of the Build Back Better tax proposals, a totally new tax bill, or otherwise. Even if this proposal can be addressed under budget “reconciliation” procedures in the Senate—which allows the Senate to pass a bill with a simple majority, 50 votes plus the vice president as a tie-breaker if necessary—and without the risk of a filibuster, all Democratic senators would likely need to support the legislation. That level of support may not exist currently, but of course is subject to change. Possible alterations in the makeup of Congress following the 2022 mid-term elections may make the challenge more daunting.
That being said, the president’s adoption of the minimum tax concept is significant, suggesting the idea has become more mainstream than it was previously.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Richard J. Shapiro is a tax director at EisnerAmper. He has more than 40 years of law firm and accounting firm experience as a specialist in all aspects of federal income taxation, including the taxation of financial instruments and transactions, both domestic and international, corporate taxation, and M&As.
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