Everything You Need to Know About Proposals to Better Tax Billionaires
December 21, 2023
Steve Wamhoff
Federal Policy Director
December 21, 2023
Update: President Biden is expected to discuss his proposed Billionaire Minimum Income Tax, which is described below, in his State of the Union address on March 7.
Tax policy may not be on the minds of most Americans during the final weeks of 2023, but billionaires with an eye on their own tax bills have been riveted by developments in D.C. At the end of November, Senate Finance Committee Chairman Ron Wyden introduced his Billionaires’ Income Tax while members of the House introduced President Biden’s proposal, called the Billionaires’ Minimum Income Tax (a confusingly similar name). Then, in early December, the Supreme Court heard a case widely understood to be an attempt to block these proposals from ever being enacted.
All these developments revolve around the concept of income that is not “realized,” which is a hazily defined term used by tax experts and virtually unknown to everyone else. What is this all about?
Q: What do the “billionaires’ tax” proposals in Congress do?
A: The proposals limit a huge break for “unrealized” capital gains, a type of income that is not taxed under current rules. The proposals only limit this tax break for extremely high-income or high-net-worth people who are far more likely to have this type of income.
A capital gain is the increase in value of an asset. When an asset increases in value, the owner has two options. The first option is to keep the appreciated asset, in which case the increase in value is an “unrealized” capital gain and not subject to tax. The second option is to sell the appreciated asset, in which the increase in value is “realized” as the profit made from that sale, and this realized gain is subject to income tax (but often at a lower rate than applies to other types of income).
Q: Why should anyone care whether unrealized capital gains are taxed?
A: By not taxing unrealized capital gains, our tax code is more lenient on extremely wealthy people who are more likely to have this type of income than most of us who pay taxes on income from work as we earn it.
Unlike most regular working people, extremely wealthy individuals often arrange to receive income that is unrealized capital gains rather than income that would be taxed right away.
From 2014 through 2018, Jeff Bezos officially reported income of $4.22 billion, an enormous sum by any measure. But his true income was vastly more than that. Over the same time, his wealth increased by $99 billion, mostly because of the appreciation of Amazon stock.
An economist would say he must have had income of at least that much during that time because his ability to spend money on whatever he wants increased by $99 billion. But under the tax rules, most of this asset appreciation constitutes capital gains that are not realized and not included in his taxable income until he sells the assets and receives the profit.
Most of us simply earn money by working for an employer, and we pay income taxes on those earnings immediately because our employer withholds them and remits them to the federal government. We do not have the option of arranging to receive income in a form that is not taxed.
Q: How much does it really matter if wealthy people do not pay taxes on this income right away? Won’t they eventually pay taxes on this income?
A: They will not necessarily pay taxes on this income. If an individual dies and transfers an asset to heirs, the unrealized capital gain, which can be a significant amount of untaxed income, is exempt forever from the income tax.
Under current law, Bezos’ heirs will enjoy a “stepped-up basis.” This means that even if they sell the assets he leaves to them, neither they nor anyone else will ever be required to pay income tax on the asset appreciation that occurred during Bezos’ life.
When a person buys and sells an asset, the calculation of any realized capital gain is straightforward. They subtract the basis, which is their purchase price, from the sale price they received. The resulting profit from the asset sale is their realized capital gain. However, if an individual sells an asset they inherited, they do not pay taxes on the difference between the current price and the original purchase price because current rules step the basis up to the asset’s value when it is inherited. If Bezos’ heirs sell the assets they inherit, the unrealized gains that accrued during his lifetime, which by now are greater than $99 billion, would be exempt from income tax forever.
Both Wyden and Biden’s proposals would address this by taxing any remaining gains that are unrealized and untaxed upon the death of an affected taxpayer.
Q: But if a wealthy person does sell most of their assets before they die, they do “realize” capital gains and pay income taxes on them at that time, right?
A: Yes, but even then the ability to put off paying the tax on unrealized gains for many years before finally selling the assets has allowed these individuals to build up wealth far more rapidly than the rest of us can.
Under current law, a taxpayer can invest $1,000 in stock of a successful company and if the stock appreciates at an annual rate of 11 percent each year, its value will be about $8,000 20 years later, with no income tax paid on any of the $7,000 in “unrealized” capital gains. If the taxpayer sells that stock and realizes the gains, they can pay a federal tax rate of 23.8 percent on that income (a special personal income tax rate of 20 percent for long-term capital gains plus a 3.8 percent tax to help fund Medicare), which would reduce the $7,000 in pre-tax income to about $5,400 in after-tax income.
Now imagine that the taxpayer was required to pay income tax on the unrealized gains each year as they accrued rather than waiting until selling the asset. (This is how interest income from a normal savings account is taxed – annually.) The 11 percent growth rate of the investment would be reduced by 23.8 percent to a growth rate of about 8.4 percent. That may not seem important but over the 20-year period, the investment grows from $1,000 to just $5,000. Assuming the taxpayer sells the stock at that point, the after-tax income is therefore $4,000 compared to the $5,400 after-tax income described above when the tax is deferred until the taxpayer sells the asset.
Now imagine this is happening with much larger numbers and much higher rates of return and happening over many more decades. This is how the tax code is often more generous to wealthy people with investment income than to working people who pay taxes every year on their earnings.
Q: It may be true that wealthy people have a lot of unrealized capital gains, but don’t ordinary people also have unrealized capital gains sometimes? Why is that any different?
A: It’s different because the rules allowing most people to defer paying income tax on capital gains have some justifications that do not apply to the very wealthy.
For an ordinary person with a typical income and typical net worth, it makes sense that the rules allow deferral of any income tax on capital gains until an asset is sold.
For example, if you make $70,000 a year and you purchased a rental property a decade ago for $150,000 and now it is worth $200,000, no one expects you to pay income taxes on the $50,000 of unrealized capital gains until you sell the property, mainly because you may not have cash to pay that tax until you sell the property. No one is suggesting that we change that.
Q: Is the situation for wealthy people with different kinds of investments with unrealized gains all that different from the middle-class person who has a rental property with unrealized gains? In both cases, the taxpayer has property but has not sold it for cash, right?
A: The situation for the wealthy is completely different because they can control the form their income takes and can effectively spend income without technically realizing it.
Much of the wealth owned by high net-worth people is stock that they can easily sell whenever they need cash. Often, they can avoid selling and instead borrow against their assets to finance their lifestyles without realizing any gains that would be subject to income taxes. CEOs and founders of successful companies sometimes choose to receive most of their income in the form of unrealized gains and they decide how much income to realize each year (by selling stock). They naturally realize relatively little of it, so most of it goes untaxed.
Q: How do the House and Senate proposals that address this differ from each other?
A: The Senate bill would tax unrealized gains of the very wealthy like other income while the House bill is President Biden’s proposal to create a minimum income tax for the very wealthy that applies to unrealized gains as well as other income.
Both proposals address the same problem, which is that very wealthy people are often able to defer and even avoid taxes on their income in ways that the rest of us would find hard to imagine.
Under Sen. Wyden’s proposal, very wealthy people would pay income tax annually on unrealized gains on publicly traded assets like stocks, which have a value that is easy to track each year. This approach is often called mark-to-market taxation. For other assets, which have values that are not easily determined, wealthy individuals would defer paying income tax until selling the asset (as under current law), but the tax due at that time would be increased to offset the benefit of the deferral. This approach for non-tradable assets is not technically mark-to-market taxation, but if structured well it can have a very similar effect on wealthy taxpayers.
The President’s Billionaires’ Minimum Income Tax works differently. Instead of mark-to-market taxation, very wealthy people would be required to pay a minimum tax equal to at least 25 percent of what we could call their “true income,” including both traditional taxable income and unrealized capital gains.
Under the president’s proposal, payments of the minimum tax would be partial prepayments of the tax that would eventually be due when gains are realized. The tax assessed for each year could be paid out in installments over five years.
Both proposals would therefore end the tax break that effectively provides the extremely wealthy with an interest-free loan on taxes on their unrealized capital gains. This would be a big step toward ensuring that the very wealthy pay a reasonable amount of income tax just like middle-class people.
Both proposals would also tax any unrealized gains of assets that applicable taxpayers leave to heirs.
Wyden’s proposal could be the stronger of the two in some ways because Biden’s minimum tax would not apply to a taxpayer whose mix of unrealized gains and other types of income already results in an effective tax rate of at least 25 percent under the regular rules.
On the other hand, Biden’s plan may be stronger because he also proposes to eliminate the special, lower income tax rate for capital gains and dividends (for taxpayers with taxable income exceeding $1 million). The tax payments made on unrealized gains under his plan would therefore be prepayments of some of the tax eventually due when taxpayers sell their assets or leave assets to their heirs.
Q: But even if some billionaire’s assets appreciated dramatically over a few years, the value might fall before the taxpayer ever sells the assets. So, wouldn’t these proposals tax income that doesn’t really exist?
A: No, because both proposals allow taxpayers to deduct losses when assets lose value.
Current law already allows taxpayers to deduct losses generated by asset sales from the gains generated by assets sales when calculating capital income. Both proposals would expand the same concept to unrealized gains and unrealized losses.
Further, under the President’s proposal, the minimum tax due for a particular year could be paid in installments over the next five years. If an asset appreciated one year and lost value the next, the taxpayer will have paid only a portion of the tax, which could then be refunded.
Q: How will these proposals be limited to apply only to the richest taxpayers?
A: Most of us do not know anyone rich enough to be affected by these proposals.
Sen. Wyden’s bill would affect those who either have income exceeding $100 million or have assets exceeding $1 billion and meet at least one of those tests each year for three consecutive years. This would affect an estimated 700 taxpayers.
Biden’s proposal would be phased in for those with net worth between $100 million and $200 million, but even someone with net worth above $200 million might have some unrealized gains and not be affected. It depends on the other income the individual receives and how much they paid in taxes, because the proposal is structured as a minimum tax on the taxpayer’s total true income, including unrealized gains as well as other income.
Q: Aren’t these proposals incredibly complicated?
A: Not compared to the convoluted schemes that wealthy people are engaging in right now to exploit the tax breaks that would be cut off under these proposals.
Taxes for extremely wealthy people are complicated. This happens either because they engage in complicated maneuvers to avoid taxes, or because policymakers create complicated rules to block those maneuvers. Either way, high net worth individuals will always have accountants and lawyers handling their taxes for them, unlike the rest of us. If complexity for the very wealthy is inevitable in any scenario, Congress might as well choose the approach that requires the wealthy to pay their fair share.
For example, Ronald S. Lauder, heir to the Estée Lauder fortune, once entered into a contract to “lend” $72 million worth of stock without paying taxes on the capital gains until several years later, when the stock was technically sold under the contract, which was a type of derivative. Lauder had, for all practical purposes, sold the stock upon entering the contract, and received a profit, but he used this technique to claim he had not received income until years later. Several other billionaires used similar schemes involving derivatives, some of which the IRS eventually blocked.
These are just examples of the many types of tax avoidance tactics available to billionaires that would be eliminated or dramatically reduced if they are required to pay taxes on their gains regardless of whether they have sold assets.
Q: Why did the Supreme Court just hear a case about whether Congress can tax income before it is realized?
A: Because some right-wing organizations are pushing the Supreme Court to adopt a radical legal theory that would block proposals to tax unrealized capital gains and also possibly invalidate many tax provisions in effect already.
In the 1890s, the Supreme Court ruled that Congress could not tax many types of income without using an extremely convoluted and impractical method (apportionment by population) spelled out for a very vaguely defined category of taxes in the Constitution.
The 16th Amendment reversed this result as far as Congress’ authority to tax incomes is concerned. Some believe (wrongly, in our view) that the 1890s decision would still apply to block a federal tax on wealth. But federal taxes on income should not be controversial given the explicit sanction of the 16th Amendment.
And yet the plaintiffs and their supporters in the case just heard by the Justices argue that the 16th Amendment does not apply to income that is not realized.
Q: How can the Supreme Court block tax proposals on unrealized capital gains that have not even been enacted?
A: The plaintiffs in the case are challenging an existing tax law, claiming (incorrectly in our view) that it taxes unrealized income. If the Court accepts their argument it could endanger both existing tax statutes and also any proposal to tax unrealized gains of the wealthy.
Paradoxically, the plaintiffs in the case, Moore v. United States, are suing to block a part of 2017’s Tax Cuts and Jobs Act, which is widely recognized as a massive tax break for the wealthy.
This law, signed by President Trump in 2017, included some provisions that raised revenue to offset a small portion of the huge tax cuts it provided. One revenue-raising provision was a transition tax imposed on offshore profits held by American-owned foreign corporations that had never been taxed. Those offshore profits were (in theory) supposed to be eventually taxed under the old rules, and the Trump tax law imposed a tax (at a low rate) on these profits to serve as a transition to the new rules, which would exempt most offshore profits from U.S. taxes.
In most cases, the foreign corporations affected by this provision are subsidiaries of big American corporations like Apple or Meta or ExxonMobil. But in a few cases, the American owners of the affected foreign corporations are individuals, such as the Moores, the plaintiffs in this case before the Supreme Court. The Moores owe about $15,000 of transition tax on the offshore profits from a small India corporation in which they own shares. Their reasons for challenging the tax are clearly ideological and go far beyond the $15,000 that they owe.
Q: What does a tax imposed on offshore corporate profits even have to do with unrealized capital gains?
A: The honest answer is nothing, but the Moores and the right-wing organizations supporting them claim that the offshore profits are income that has not been realized and that Congress does not have the authority to tax such income under the Constitution.
No one knows how the justices will rule, but the plaintiffs’ arguments are clearly wrong.
First, tax experts generally believe that corporate profits are in fact realized, meaning they are realized to the corporation that receives them. Under this widely-held view, Congress is merely attributing realized income of the corporation to the owners of the corporation for tax purposes.
Second, even if offshore profits in question are unrealized, there is no reason to believe that the 16th Amendment’s grant to Congress the “power to lay and collect taxes on incomes, from whatever source derived” is limited to income that meets some definition of “realized” income mentioned nowhere in the Constitution.