On March 28, 2022, the Biden Administration proposed a minimum tax on extremely wealthy taxpayers in its FY 2023 budget. For tax years beginning after December 31, 2022, the so-called “billionaires minimum tax” would apply a 20% tax on the total income—generally including unrealized capital gains—of taxpayers whose wealth, measured as the net of asset values less liabilities, exceeds $100 million. (Note that $1 billion is $1,000 million so the nickname is a something of a misnomer.) The Office of Management and Budget (OMB) estimates that the tax will raise over $360 billion in revenue over 10 years.
- President Biden seeks a 20% minimum tax that includes a wealth tax component on individuals whose wealth exceeds $100 million.
- Taxpayers subject to the new minimum tax could elect to pay it over a period of years.
- Wealth taxes arouse opposition but enjoy strong support from U.S. Senators Elizabeth Warren and Ron Wyden, the chair of the Senate Finance Committee whose jurisdiction includes taxation.
- The Biden Administration also would tax unrealized gains on gifts, bequests, and other asset transfers, and prevent permanent tax avoidance by eliminating stepped-up basis on death.
Minimum Tax Design: Regular Income Plus Unrealized Gains
The new minimum tax would apply annually to total income, both regular income and unrealized gains on investment assets, of ultra-wealthy individuals whose net assets exceed $100 million in value. This design incorporates a form of wealth tax. The new tax would apply to the difference between the taxpayer’s regular income tax and the amount due under the new 20% minimum tax.
The new minimum tax would not affect a taxpayer whose regular income tax liability exceeds the amount due under the 20% minimum tax. The proposal phases in the minimum tax so that the full tax applies to individuals whose wealth is greater than $200 million. Taxpayers’ payments would be credited as prepayments against the tax liability that otherwise would be due upon the disposition of their assets.
Taxpayers would not be required to treat their minimum tax liability as an amount for which they would be required to pay estimated tax. In addition, the prior year minimum tax liability would be excluded in determining the safe harbor from penalties for underpayment of estimated tax in the following year.
Transition and Offsets
Taxpayers subject to the new minimum tax could elect to pay their first-year minimum tax liability in nine equal, annual installments. In subsequent years, taxpayers could elect to pay the annual minimum tax for the year in five equal annual installments.
The proposal recognizes that asset values can fluctuate and reconciles any excess payments on unrealized appreciation when assets are transferred in a taxable disposition. If the ultimate tax due on asset dispositions is less than the owners’ prepayments and credits with respect to the minimum tax, taxpayers will receive refunds of their excess payments and unused credits.
The amount of the credited prepayment would be calculated as the minimum tax payment at the 20% tax rate, reduced by unrefunded, uncredited prepayments, and regular income tax. Uncredited prepayments equal the taxpayers’ cumulative minimum tax liability for prior years reduced by amounts credited against realized capital gains in the prior years.
A major issue associated with structuring a wealth tax is the valuation of assets subject to the tax. In the past, Treasury Secretary Janet Yellen has expressed concerns about the technical and administrative challenges in valuing assets that lack a public market.
The Biden proposal addresses the valuation issue. It would value “tradable” assets, such as stock, using their values as of December 31 of the calendar tax year. The value for non-tradable assets would be the greater of their original or adjusted cost basis, or their value as of the last valuation event based on investment, borrowing, or financial statements; or valuations could use methods to be determined under regulations. Annual valuations would not be required; rather, values would be adjusted according to the annual return at the five-year Treasury rate plus two percentage points.
Related Biden Tax Proposals
In addition to the taxation of the unrealized appreciation of some wealthy taxpayers, the Biden Administration is seeking separate changes that make some previously untaxed property transfers taxable and that increase taxes on high-income taxpayers’ investment income. Some of these changes would affect taxpayers at much lower income levels than the wealth tax discussed above.
Expansion of Taxable Transfers: Gifts and Inheritances
The Biden Administration’s revenue proposals include a major change in the treatment of certain transfers of property. Under the present tax rules, transfers of property by gift or upon death are not treated as taxable realization events. Gift recipients receive a carryover basis in the gifted property while a decedent’s beneficiaries enjoy a tax basis stepped up to fair market value.
If the proposed change is enacted, individuals’ transfers of appreciated property by gift or upon death would be taxable events. Tax would be due on the difference between the property’s tax basis and its fair market value. The new rule also would apply to transfers by noncorporate entities of property which has not been subject to tax on its appreciation since December 31, 1939. Transfers to and from trusts (other than grantor trusts) also would be taxable and transfers of partial interests in appreciated property generally would result in a tax proportional to the interest.
Transfers of property to a spouse or charity are exempt from these rules but receive a carryover basis. A per donor lifetime exclusion of $5 million (over and above the basic gift exclusion) is allowed for other gifts of appreciated property; any unused portion of this exclusion in the donor’s lifetime is allowed for the donor’s estate. Also, tax on unrealized appreciation of family-owned and operated businesses would be deferred until the business is sold or ceases to be family-owned and operated. When ultimately such businesses are subject to taxation, they would be granted a 15-year payment plan.
Rate Increase: Gains and Dividends of High-Income Taxpayers
In addition, for taxpayers whose taxable income exceeds $1 million, the tax rate applicable to long-term capital gains and qualifying dividends would increase from 20% to 39.6 % under the proposed revisions. If such a taxpayer also is subject to the 3.8% net investment income tax, the total rate would equal 43.4%.
Goal: Improve Tax Equity
The Administration’s minimum tax proposal is intended to address the inequality in individual tax burdens resulting from the present federal income tax system. In particular, the current treatment of unrealized gains disproportionately benefits extremely wealthy taxpayers. The Administration estimates that US billionaires paid a rate of approximately 8% on their income between 2010 and 2028, while many lower-income families paid taxes at far higher rates. The richest taxpayers achieve low rates of tax because most of their wealth derives from unrealized appreciation in capital assets—while middle- and lower-income households depend on wage and salary income, which is taxed annually at graduated rates.
If wealthy individuals dispose of their appreciated assets, the top capital gains rate currently is 20%, plus, for some, a 3.8% net investment income tax. Thus, the combined rate on their capital gains is lower than the 37% income tax rate on wages, salaries, and other ordinary income. Moreover, the rich need not dispose of these assets to fund their lifestyles; they can obtain significant cash by borrowing against the value of their assets. If they do not dispose of their assets prior to death, under present law their heirs receive the assets with a tax basis stepped up to fair market value and the appreciation permanently escapes tax.
In addition, the Administration explains that the present rules taxing increases in value only upon the disposition of assets results in economic inefficiency. It incentivizes taxpayers to hold assets indefinitely to avoid capital gains tax, instead of redirecting their capital to more productive investments.
Prospects for Enactment
The prospects for the enactment of a new tax structured as—or incorporating—a wealth tax are uncertain. The disparity between the low tax rate paid by many of the wealthiest taxpayers and the higher rates imposed on taxpayers with more modest incomes has evoked widespread criticism. However, wealth tax proposals have been controversial and have attracted powerful opponents.
In the current Congress, the Biden proposal would need the votes of all Senate Democrats even to pass in the budget reconciliation process which generally requires only majority support, 51 votes, to enact legislation. The legislative calendar and midterm elections create substantial hurdles to the proposal’s passage this year. And, with budget bills often taking many months to get through the legislative process, even in non-election years, the proposed minimum tax may not be addressed until after a new Congress is sworn into office in early 2023, if ever.
Other Wealth Tax Proposals: Senators Warren and Wyden
Although controversial, a wealth tax does have some ardent legislative supporters. Two current Senators offer variations of a wealth tax. The Biden proposal differs from both of these.
Senator Warren: Annual Tax on Net Asset Value
Senator Elizabeth Warren has long promoted a wealth tax and has introduced a bill that would impose an annual 2% tax on the net value of assets in excess of $50 million. The rate would increase to 3% in the case of taxpayers whose assets have net values in excess of $1 billion.
The Warren proposal would tax all assets includable in an individual’s estate except for tangible personal property valued at $50,000 or less, without regard to debt owed with respect to the property. Valuation methods are not specified but would be determined by Treasury regulations.
Senator Wyden: Tax on Annual Increase in Value
Senator Ron Wyden—who chairs the Senate Finance Committee, which has jurisdiction over tax legislation—also is a serious advocate for a wealth tax. While Senator Warren’s bill would tax the total value of a taxpayer’s assets annually, Senator Wyden’s approach would tax the annual increase in asset values of taxpayers whose net worth exceeds $1 billion or whose income exceeds $100 million for three consecutive years.
Senator Wyden would impose a tax at the top current capital gains tax rate of 20%—plus the 3.8% net investment income tax, when applicable—on the annual increase in value of a taxpayer’s “tradable“ assets, such as stocks, whose values are determined and reported to the owners annually. Non-tradable assets would be subject to a special “deferral recapture” tax upon their transfer whether by sale, gift, bequest, or transfer to a trust. This proposal effectively would impose tax on certain presently non-taxable property transfers. And by imposing the deferral recapture rule on bequests, the Wyden proposal would prevent permanent tax avoidance.
The additional tax on asset dispositions would be structured as a type of interest rate, charged for the years that the assets are held and determined by the short-term rate on certain U.S. Treasury securities, plus one percent. The Wyden draft bill includes detailed technical rules, including rules for handling pass-through entities, transitions, life insurance and annuities, and tax-favored transactions and investments.
The Bottom Line
President Biden’s proposal is his first endorsement of a wealth tax, a policy that probably faces an uphill battle. The proposed minimum tax and rate hikes affecting extremely wealthy and high-income taxpayers are likely to be resisted by those affected. The broader, related changes—particularly the treatment of currently tax-free property transfers as taxable events and the effective elimination of “stepped-up basis” at death—could impact a wider population and be unwelcome to many.