The so-called billionaire minimum tax contained in President Joe Biden's fiscal year 2023 budget proposal rests on novel and largely untested premises and tax principles, some tax experts said Tuesday.
The minimum tax was described in the president's budget as necessary to counterbalance wealthy taxpayers' ability to reduce their tax rates below those of middle-class taxpayers by exploiting "giant loopholes" in the Code and employing "sophisticated tax planning." Treasury's general explanations of the budget's revenue proposals, known as the Greenbook, include some details about how the minimum tax would work.
"The proposal is problematic on many fronts," said Roby B. Sawyers, CPA, Ph.D., a professor of accounting at North Carolina State University in Raleigh. "It would be administratively difficult to enforce and a compliance nightmare for high-wealth individuals with illiquid 'nontradeable' assets."
Moreover, the proposal "would almost surely raise constitutional issues as well," Sawyers said.
How the tax would work
Unlike most current tax provisions, the minimum tax would be levied on unrealized, as well as realized, gains, both capital and ordinary. Normally, income is taxed only as it is earned or received, sometimes constructively. Currently, the value of investments and other assets may appreciate in value untaxed until a realization event occurs, most often, the asset's sale or other disposition. Long-term net capital gains are currently taxed at a maximum rate of 20%, plus, for investment gains generally realized by taxpayers above a certain level of modified adjusted gross income, the 3.8% net investment income tax.
Under the president's proposal, a minimum tax of 20% would be imposed on all realized and unrealized income, phased in at net wealth between $100 million and $200 million. Despite its $100 million threshold, the administration's fact sheet refers to it as a "billionaire minimum income tax."
Taxpayers could attempt to avoid the threshold by borrowing or otherwise rearranging their assets at year end, Sawyers said. "It is also unclear what happens when assets depreciate from year to year or when assets are subject to large but temporary increases in value at year end," he said. The Greenbook does not describe any provision comparable to the alternative valuation date that currently can be elected with respect to estate tax, he noted.
Payments on unrealized gain would be distinguished so that the gain would not be taxed a second time when the income is realized. These payments, moreover, may be deferred. The minimum tax liability for the first year could be paid in nine equal annual installments, and the minimum tax liability for subsequent years could be paid in five equal annual installments. The Greenbook refers to these payments as "uncredited prepayments," which would equal the cumulative minimum tax liability assessed for prior years (including future installment payments), less any amount credited against realized gains in those prior years.
Uncredited prepayments would be available to be credited against capital gain tax due upon the realization of gains, to the extent the total uncredited prepayments, reduced by the cumulative amount of unpaid installments of the minimum tax, exceed 20% of unrealized gains. This could result in a refund if these resulting net uncredited prepayments exceed the long-term capital gains rate multiplied by unrealized gains. Net losses and charitable gifts could reduce such gains, the Greenbook states.
"Although the proposal mentions unrealized gains and charitable gifts affecting how uncredited prepayments and refunds are handled, we have no practical guidance as to what that means or how it would work," Sawyers said.
Computing net wealth
Basing an income tax on net wealth rather than, as currently, on income, poses many considerations, some of which the Greenbook discusses. Perhaps the most obvious is the inherent difficulty of valuing many types of assets and liabilities to compute net wealth. For this purpose, the Greenbook distinguishes between tradeable and nontradeable assets but without explaining how those designations would apply to any particular type of asset. Existing Regs. Sec. 1.170A-13(c)(7)(xi) provides a definition of publicly traded securities for purposes of charitable contributions, but it is not clear to what extent, if any, that definition would apply or could be considered analogous to tradeable assets in the proposed measure.
According to the Greenbook, tradeable assets under the proposed minimum tax could be valued by their market price as of Dec. 31 of the tax year. These annual valuations would have to be reported annually to the IRS, separately by asset class and including total basis and total estimated year-end value.
Nontradeable assets would be valued by the greater of their original or adjusted cost basis. Alternatively, nontradeable assets could be valued from "the last valuation event from investment, borrowing, or financial statements," or other method approved by the IRS. Nontradeable asset valuations would not have to be made annually but would be increased by the five-year Treasury rate plus 2 percentage points for periods between valuation events.
"Although the proposal exempts illiquid assets from annual appraisals, unless a taxpayer is willing to accept an automatic increase in value, an appraisal would be prudent and necessary, particularly in a declining market," Sawyers said.
One problem estates of decedents sometimes encounter with respect to estate tax is being able to pay the tax when the assets giving rise to the tax liability are illiquid. This the minimum tax acknowledges by allowing taxpayers whose tradeable assets held directly or indirectly make up less than 20% of their wealth to elect to include only unrealized gain from tradeable assets in calculating minimum tax liability.
Moreover, these "illiquid" taxpayers would pay a deferral charge of up to 10% of the unrealized gain on nontradeable assets once the nontradeable assets' gains are realized.
The Greenbook explains, however, that the minimum tax liability does not figure into the current or prior tax year's tax liability for purposes of computing estimated tax payments or penalties for underpayment of estimated taxes.
Decedents' uncredited prepayments
Another potentially perplexing issue is addressed: What happens when a taxpayer dies while still having net uncredited prepayments of the minimum tax on unrealized gains? In that case, the uncredited prepayments would be refunded to a single decedent's estate, where they would be included in the decedent's gross estate for estate tax purposes. In the case of a decedent with a surviving spouse, they could be transferred to the spouse. Again, this could raise conundrums not explored in the Greenbook, such as whether the prepayments would be immediately refundable if the surviving spouse is not an applicable taxpayer subject to the minimum tax.
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