A Democratic proposal, called by some the Billionaire's Tax, would tax unrealized capital gains of wealthy Americans. And it is causing angst in the investment world.
Under current law, any appreciation of an asset — such as stocks, cryptocurrencies or real estate — isn't taxed until the asset is sold. But a proposal in the Biden administration's "General Explanations of the Administration's Fiscal Year 2025 Revenue Proposals" would change that. It would tax unrealized capital gains, or the "paper gains" on assets that are sitting in an account but haven't been sold yet.
Details are scant as to how this would work. But imagine investors who bought $100,000 worth of stock on Jan. 1. And say the stock's value hit $125,000 on Dec. 31. They'd be subject to a tax on the $25,000 gain even if the stock was never sold.
The good news is the proposed tax change only applies to uberwealthy folks. Centimillionaires with assets totaling $100 million or more would be affected. There's only about 10,000 centi-millionaires in the U.S., according to the "2023 Centi-Millionaire Report" by Henley & Partners, a U.K.-based wealth firm. New York, which has 775 centimillionaires, has the most in the world.
Will The Billionaire's Tax Happen?
There's been speculation swirling about the Billionaire's Tax for a few years. Lawmakers seek revenue to trim a ballooning federal debt. In December, Senate Finance Committee Chair Ron Wyden, D-Ore., introduced legislation to tax the unrealized gains of those with assets over $1 billion and those with incomes of $100 million or more.
Now, the topic is front and center again. Democratic presidential nominee Kamala Harris says she backs President Biden's 2025 revenue-generating proposals.
Adding to the angst: unsubstantiated chatter on social media that the tax man is coming for unrealized capital gains of mom-and-pop investors, too. However, it's important to note that Harris hasn't proposed taxing unrealized capital gains for everyday Americans.
Are Your Gains Safe?
So, should Americans with 401(k)s and brokerage accounts be worried. Will Uncle Sam come after gains on assets they haven't sold yet, too? The short answer is no.
The fact is this new tax would only impact a small sliver of America's richest people. It's part of the Biden administration's push for the uber-rich to pay a minimum 25% tax on their income. So, there's no reason for folks making $100,000 — and who are not members of the $100 million club — to lose sleep over the federal government's newest revenue-gathering idea. That's the case at least for now. If you're not a mega-earner like Elon Musk, Warren Buffett or Jeff Bezos, this proposal doesn't apply to you.
If you have massive wealth tied up in a private company it's a potential issue. Otherwise, you likely don't need to stress about it.
"As the years go on, tax laws change and the more the government needs tax revenues, the more they're going to expand this revenue stream," said Kelly Gilbert, owner of EFG Financial. "So, you shouldn't lose sleep this year, but in five years you might."
Will This Tax Become Law?
What's more, given the current makeup of Congress, it's a long shot that this current tax proposal would ever be voted into law.
"Nothing in Washington, D.C., has zero probability, but I don't see a roadmap to get taxation of unrealized capital gains through Congress with the likely narrow majorities either party is likely to have in both the House and Senate," said Tom Block, policy strategist at Fundstrat, a Wall Street research firm.
A Democratic sweep of the November elections is the only path to this proposed Billionaire's Tax becoming law.
There are also legal issues that could make it hard for lawmakers to pass this type of tax. Harvard law professor Thomas J. Brennan, who addressed the issue back in 2021 in a Harvard Law Today Q&A, says there are many hurdles. The effort to tax unrealized gains would face legal and practical challenges.
The 'Slippery Slope'
Still, it is the slippery-slope argument that worries some Wall Street pros.
"The Billionaire's Wealth Tax is like a trial run that applies only to centimillionaires for the purposes of getting started, but it could eventually apply more widely," said James Lucier, managing director of Capital Alpha Partners, an independent public policy research firm. "Any tax on paper gains is obviously a bad thing that will apply to more and more people as time goes on."
The Biden administration argues the proposed tax generates needed revenue. But it also addresses the current inequity in the tax code. It argues that high-income taxpayers get preferential treatment that allows them to pay lower tax rates than working-class Americans. "Coinciding with this period of growing inequality, the long-term fiscal shortfall of the United States has significantly increased," the administration wrote in its 2025 budget proposal.
Opening The Door To More Tax
The fear is if this tax becomes law, it opens the door to tax the paper profits of more taxpayers. If the Billionaire's Tax gets passed, critics say it's only a matter of time before the current $100 million threshold would be lowered. And that would increase the number of Americans who would owe unrealized capital gains taxes. "Once in place, it won't be long before the threshold is lowered to hit more and more Americans," according to Americans for Tax Reform, a conservative political tax advocacy group.
"One way to think about this is that even though the proposal is still called the 'Billionaire's Tax,' it already is slated to impact those with only 10% of that net worth ($100 million)," said Daniel Razvi, senior partner, lead tax attorney and COO at Higher Ground Financial Group. "Who is to say that it would not reduce to $1 million by the time it became law?"
Issues Looming Next
Jamie Cox, managing partner at Harris Financial Group, notes that the proposal to tax unrealized capital gains is just one of many ideas to boost government revenue. "This proposal is a red herring," said Cox.
The administration, he notes, is also looking to eliminate the so-called "step-up" in cost basis at death on all appreciated assets. Under current law, the value of an asset is adjusted to its fair market value on the date of the asset holder's death. If the step-up provision was abolished, the deceased's estate or heirs would be subject to taxes on the appreciated assets.
That said, if lawmakers pass a tax on unrealized capital gains, "it would almost certainly be challenged in court," said Razvi.
Is The Tax Constitutional?
Razvi notes that most attorneys assume a tax on unrealized gains would be unconstitutional. The 16th amendment only gives Congress the power to tax "incomes." But a June Supreme Court decision in Moore v. United States muddied the waters. The top court held in a narrow decision that a Trump-era rule taxing certain foreign undistributed assets was constitutional. But the court made it clear that the ruling was not to be used to greenlight a wealth tax, Razvi adds.
That ruling, despite focusing on foreign investment, has raised fears. Does it open the door for the Biden administration to try to pass a tax on unrealized gains on domestic investments?
"It's a trial balloon to see if they can create additional tax revenues," Gilbert said. All assets could face this type of tax. That includes home values because unrealized gains include appreciation on stocks, artwork, collectibles and homes, Gilbert says.
Said Cox: "It's difficult to see where the tentacles reach." So, stay tuned.
"Taxing unrealized capital gains seems like the magical solution (for a) government that urgently needs new revenues," said Lucier. "We are definitely going to hear more about it."
