Unrealized Capital Gains Tax: The Proposed Plan and What It Means

By December 6, 2021February 8th, 2022News

IRS Building in Washington

There may be a slew of complications associated with a new plan that would subject affluent investors to taxation on the appreciation of their assets, regardless of whether or not they sell their investments.

Senator Ron Wyden, the chairman of the Senate Finance Committee, has proposed a Billionaires’ Income Tax, which would broaden the definition of income for wealthy individuals to include asset appreciation, commonly known as unrealized capital gains, as well as other forms of wealth accumulation.

“Everyone needs to pay their fair share, and the best approach to achieving that goal is a mark-to-market system that would require the wealthy to pay taxes on their gains every year at the same rates all other income is taxed,” Wyden remarked in a statement.

Whether you think the bill is a good thing or a bad thing, if you’re affected by this bill now – or in the future, you should understand what it could mean if passed in the current language.

A Glimpse into the Proposed Tax Plan

According to the Democratic supporters of the proposal, approximately 700 of America’s super-rich taxpayers would be affected by the new tax proposal. The proposed billionaire’s tax would apply to those who have assets worth more than $1 billion or annual incomes of more than $100 million.

A summary from Wyden’s office states that it would establish a “mark-to-market” system for taxing the increase or loss in the value of stocks, dividends and other marketable assets on an annual basis. This type of asset would be liable to taxation at the end of the tax year based on the difference between its market value and its market value the prior year. Under current rules, any gain would be subject to long-term capital gains tax, which could be as high as 23.8 percent in some situations.

The Push To Tax the Rich

Ultra-wealthy Americans are now under no duty to reveal their net worth to anyone, even the Internal Revenue Service. That makes estimating the amount of revenue that a billionaire’s tax would earn complicated.

Additionally, research shows that the wealthiest Americans grew even wealthier during the pandemic, with the 400 richest Americans seeing a 40 percent increase in their wealth as the pandemic shut down large parts of the US economy during the epidemic.

The wealthiest people in the United States include well-known figures such as Elon Musk, the founder and CEO of Tesla, who is the world’s richest person with a net worth of nearly a quarter of a trillion dollars.

The plan is centered on a shift in how the federal government defines income for the wealthiest individuals. Rather than taxing a billionaire only on the salary he or she receives from a company, the tax would target billionaires’ unrealized gains, which include the billions of dollars worth of stock in their companies.

The Push Back

The proposal, on the other hand, was met with immediate skepticism and condemnation from Republicans and several Democrats, notably Joe Manchin, a moderate who has played a key role in attempts to reduce the size of the reconciliation package.

When it comes to the billionaire tax, Manchin said: “I don’t like it. I don’t like the connotation that we’re targeting different people.”

House Ways and Means Chairman Richard Neal said the billionaire tax “will be very difficult because of its complexity.”

When combined with a new 15 percent corporate minimum tax, the proposal would provide Biden with alternative revenue sources necessary to win over one key Democrat, Arizona Senator Kyrsten Sinema, who had previously rejected the party’s earlier proposal to reverse Trump-era tax breaks for corporations and the wealthy to raise revenue.

With the US Senate divided 50-50 between Republicans and Democrats, Biden will need the support of every Democratic senator to approve the budget plan with the required simple majority.

Gains on equities are not considered income by the federal government until the stock is sold. To get funds, billionaires take out massive personal loans, using their shares as security. Elon Musk pledged 92 million shares of Tesla stock, which is currently worth more than $1,000 a share, as security for personal debts.

The Issues With Taxing Unrealized Capital Gains

The first issue is that, under the existing rules, capital gains are only included in income for tax purposes when an item is sold and the gains are “realized,” which implies that the seller receives a profit because of the sale of the asset. Since unrealized capital gains are exempt from taxation, a person who has an asset that appreciates with each passing year can avoid paying income taxes on that appreciation until the item is sold.

Furthermore, even when capital gains are realized, they may be taxed at lower rates than other types of income. The result is that even when wealthy investors are paying taxes on their income, they may pay at lower rates than people who earn their income from work.

Under current law, the top income tax rate for capital gains is 20 percent while the top income tax rate for other types of income is 37 percent. (High-income people also pay an additional 3.8 percent tax to fund health care on both earned income and investment income like capital gains, so, including that, the top rates are 23.8 percent for capital gains and 40.8 percent for other types of income.)

There is general agreement among most Democrats in Congress and White House officials that the current top income tax rate for capital gains is too low but less agreement on exactly what the rate should be. The President’s plan would effectively remove the lower rate for capital gains entirely for millionaires. (Taxable income beyond $1 million would be taxed at 39.6 percent regardless of the type of income).

The bill recently approved by the House Ways and Means Committee would effectively set the top rate for capital gains at 28 percent (including a top income tax rate of 25 percent for capital gains plus a 3 percent surcharge on all income beyond $5 million). This means that the gap in tax rates would be narrowed, but not closed, under the Ways and Means bill.

Whom Does This Affect?

This new tax plan would not affect average Americans—including those who own stocks or homes but do not sell them. To be affected by this new tax proposal, you must earn at least $100 million in three consecutive years or have a net worth of $1 billion or more. The new tax proposal is expected to affect fewer than 1,000 people, all of whom are extremely affluent.

However, once passed, these requirements often change.  Consider that the Federal Income tax started in 1913 with only a 1% tax on high income earners and a 7% on the ultra rich.  Just 5 years later in 1918, the tax rate shot up to over 77% for top earners to support WWI.

So while the current bill may not impact you at its current income requirement, it could in the future.

Build a Wealth Plan Today

When it comes to navigating your financial investments, it is critical to deal with specialists that conduct a daily study and planning for affluent people. You can rest assured that Churchill Management Group has the expertise and experience necessary to assist you in making future financial decisions.

Please don’t hesitate to contact us at (877) 937-7110 or info@churchillmanagement.com if you need help with your investment options. We’d love to hear from you.

Financial Planning Services Disclosure; Churchill provides financial planning services to Clients that specifically engage Churchill for that service. The planning can include defining goals, designing a plan, assisting with implementing the plan, and evaluating and adjusting the plan over time, at the request of the client. The financial planning includes advice regarding securities investing and may include discussions of a client’s tax, insurance, employee benefits, estate planning, and other issues. Churchill, however, does not provide legal, insurance, employee benefit, estate planning, tax, or accounting advice, and the client must rely on legal, insurance, and accounting professionals for that advice and documentation.

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