Tax Season 2021

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Senate Democrats Float “Billionaires Tax” on Unrealized Appreciation

A picture of a set of 100 dollar bill

Senate Democrats, currently hampered by Sen. Kyrsten Sinema’s (D-AZ) opposition

Senate Democrats, currently hampered by Sen. Kyrsten Sinema’s (D-AZ) opposition to an increase in individual, corporate, or capital gains rates, have floated a tax on unrealized appreciation to make up for the hundreds of billions of dollars in new revenue that would be raised by increasing tax rates. The latest news reports coming out of Washington are that Sen. Joe Manchin (D-WV) is against the proposal and that Congressional and Administration leaders are referring to it as “nearly dead”, but the situation remains fluid and no final decisions have been made. So here are some details on the plan.

The Billionaires Tax

Despite being referred to as the “billionaire’s tax,” the tax will apply to taxpayers that have assets of at least $1 billion for each of the prior three years OR at least $100 million in adjusted gross income for each of those years (applicable taxpayers). [New I.R.C. §495]

In addition, if a taxpayer becomes an applicable taxpayer they only cease to be subject to the tax if they have at least one year (in that three-year period) in which both: (1) their income drops below $50 million AND (2) their net assets drop below $500 million. [New I.R.C. §495]

Definitions required to navigate the new tax proposal

Some definitions are required to navigate the new proposal:

Covered Asset

All assets that are not cash (or an equivalent), an interest in a qualified retirement plan or other qualified savings plans (such as §529 accounts, IRAs, health savings accounts.), or a private placement life insurance or annuity contract. [New I.R.C. §497]

Tradable Covered Asset

Assets that are readily tradable on an established securities market or in a secondary market or online matching market (or any derivative regarding such an asset). Plus assets where the IRS decides there is a reasonable basis for determining an annual valuation. [New I.R.C. §497]

Nontradable covered asset

Any covered asset that is not a tradable covered asset. [New I.R.C. §497]

applicable transfer

Any sale, exchange, disposition, or other transfer that would ordinarily result in gain or loss recognition; or any disregarded nonrecognition event. [New I.R.C. §498]

Disregarded Nonrecognition Event

Exchanges under §351(contributions to corporations) or §1031 (like-kind exchange), transfers that involve a C corporation in connection with an asset that the corporation has not recognized gain or loss on, any nonrecognition transaction in which tradable assets get converted to nontradable assets or vice versa, and any other transfer that the IRS determines should be included to prevent avoidance. [New I.R.C. §498]

General rules of operation for new taxes

The new tax operates under the following general rules:

  • The IRS will tax applicable taxpayers on unrealized appreciation in tradable covered assets at the end of each tax year or upon the occurrence of a disregarded nonrecognition event. [New I.R.C. §491]
  • The tax contemplates the rules will cause losses in certain years but does not provide for any special ability to deduct those losses beyond current rules (e.g., capital losses being limited to capital gains plus $3,000).
  • Applicable taxpayers will be subject to an increased tax when there is a taxable event involving a nontradable covered asset – besides the tax on the gain from the transfer, the taxpayer will be required to prorate the gain to each day of the holding period, calculate a deemed tax that would have been due in prior tax years and pay an interest charge on those deemed amounts. [New I.R.C. §492]
  • The interest charge will be calculated at the §6621(b) rate plus 1 percentage point but cannot exceed a certain percentage of the total gain recognized equal to 49% minus the top capital gains or individual tax rate (depending on whether the gain is ordinary income or capital gain). [New I.R.C. §492]

Pass-throughs that own covered assets subject to special reporting rules

Pass-throughs that own covered assets are subject to special reporting rules, but will be required to pass through any gains captured by the new tax to significant owners (5% owners or those owning interests with aggregate value greater than $50 million). [New I.R.C. §493]

Gifts, Requests at death, and transfers to trusts

Gifts, requests at death, and transfers to trusts (including grantor trusts) will be treated as deemed sales requiring gain recognition. However, losses on a deemed sale stemming from a gift or transfer to a trust are disallowed. Transferees in such transactions will be permitted a FMV basis in the property. [New I.R.C. §494]

Election to pay tax attributable to first year

Applicable taxpayers will be eligible to elect to pay the tax attributable to their first year as such a taxpayer over a five-year period, and will be able to elect to treat nontradable covered assets as tradable covered assets in that first year. [New I.R.C. §496]

The proposal also includes certain conforming provisions of rules relating to trusts, to §1031, §351, and other Code sections implicated in the new tax.

Even if the provisions aren’t actually dead, they are, if passed, likely to face a constitutional challenge. The Constitution requires that any direct tax (such as income or wealth taxes) be apportioned among the states according to population. Although the 16th Amendment excepts an income tax from the apportionment requirement, long-standing precedent has held that unrealized appreciation in property is not “income” for purposes of the income tax laws. The estate tax, when challenged, was upheld as being an excise tax on the privilege of transferring wealth, not on wealth itself (which the courts suggested would be problematic). Thus, a challenge to the law would appear to have favorable odds of success based on existing precedent.

Get Prepared for More Tax Changes

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