Major Tax Increases Coming? WHITE HOUSE PROPOSING MAJOR TAX INCREASES: WHAT YOU NEED TO KNOW

May 12th, 2022 | By Eric Annett and Sahand Elmtalab

Opening Remarks

President Biden released his proposed budget for Fiscal Year 2023 on Monday, March 28, to great fanfare and raised eyebrows. Trumpeting his proposed new rules, the President said this budget would “make prudent investment and economic growth, a more equitable economy, while making sure corporations and the very wealthy pay their fair share.” While the President’s budget proposal is more so a political messaging opportunity than a reflection of any imminent or pending changes to the law, President Biden and other high-profile members of the Democratic Party have also thrown

considerable support behind these ideas, signaling increasing traction and their potential to become a top legislative priority for the party’s lawmakers. This article is intended to give a briefing of the major items being proposed and general impacts they may create broadly; for advice pertaining how they may impact your personal tax situation; you should consult with your tax professional(s).

THE "BILLONAIRE INCOME TAX"

The headliner amongst the proposed tax changes was without a doubt the “Billionaire Minimum Income Tax.” Despite its name, the tax would apply neither to strictly billionaires nor to earned income. It would assess a minimum 20% tax rate on all households worth more than $100 million. If such a household is already paying 20% or more on their full income, no additional payment would be due under this tax. But if they pay less than 20%, they will owe a “top up” payment to meet the new threshold.

The most controversial component of this proposed tax is that it would levy a tax on unrealized capital gains, not just on the taxpayer’s income. Under current tax law, capital gains or losses are not recognized until the point in time when the asset is sold or otherwise dispositioned. Under this new plan, the federal government would tax unrealized gains based on the year-end values under the guise of it being “unrealized income” to the owner of the asset. Any payments made under this tax would be treated as a pre-payment of capital gains taxes that would be owed whenever the gain is finally realized, with refunds to be issued if the prepayments made end up exceeding what is due when a gain is eventually realized.

Tax experts are skeptical of the feasibility of this plan.

For one, it would create a massive administrative burden on both taxpayers and the IRS. It is believed this tax would apply to over 30,000 households, who would now need to begin compiling and reporting their net worth to the IRS, who would then need to implement some way to verify the accuracy of the reports.

Taxpayers would now be required to report the basis of each asset class, the total basis in assets, and the total estimated value of assets within each specified asset class. For tradeable assets like stocks and bonds, this could be simple enough using year-end prices, but it is also very common with shares of stock that have been passed down across multiple generations for the current shareholders to have no idea what their basis is. Further, extensive appraisal work will need to be done to establish a basis and valuation in illiquid assets. The tax would not require these illiquid assets to be re-appraised each year but would assume growth at a “conservative floating annual return” of the 5-year Treasury rate plus 2 percentage points, so anything growing at a slower rate would be getting overtaxed. It is not clear how this would be applied with intangible assets or those that depreciate such as buildings or equipment.

It can be an onerous and costly task to get an estate or business properly valued once for estate tax or business transition purposes, and that’s with less than 1% of the population even being subject to estate taxes. To expect there to be enough capacity to provide these types of services to as many as 30,000 households on an annual basis seems like wishful thinking, at best.

Proponents argue this tax is necessary because of corporate executives’ ability to pay themselves in company stock with little to nothing in the way of a traditional salary, while borrowing against the value of their highly appreciated shares to finance their living costs. They argue this essentially constitutes tax evasion by shifting more of their tax burden from the higher income tax rate to the lower long term capital gains rate. Or, if the shares in question are held until the owner’s death, they can then pass them on to heirs who will receive a step-up in cost basis equal to the value of the shares when they are received, thus eliminating what would have been a taxable gain because it had never been realized.

Politically, this proposed tax has competition from Biden’s left flank, as Senators Sanders, Warren, and Wyden have each put forth their own proposals, all of which contain provisions above and beyond President Biden’s proposed version. President Biden’s proposal appears to be the most popular version of the bunch, though it still seems extremely unlikely to pass in this Congress due to opposition from the GOP and moderate Democrats. It has not garnered any support at all from Congressional Republicans, and it does not appear enough moderate Democrats would get behind the measure to secure Vice President Kamala Harris’ tie-breaking vote that would be needed to get the proposal through the Senate without Republican votes.

PRESIDENT JOE BIDEN

Nonetheless, it remains noteworthy that the idea seems to be gaining traction, as President Biden himself represents the moderate wing of the party and has been pushed hard enough by the party’s left wing to propose a wealth tax, which would be the first of its kind in the nation’s history. As these ideas continue to pick up steam and get adopted by the mainstream, the risk rises of such provisions eventually becoming law.

If passed, this type of tax could have a profound negative impact on businesses of all kinds, from closely held private companies to publicly traded Big Tech, but Big Tech especially seems to be at risk. Not only would selling shares for tax purposes exert downward pressure on the stock market, eliminating tax preference for capital gains would also reduce the incentive for new buyers to even invest in the first place. Especially in the small & micro-cap and venture capital spaces, the investment calculus may become vastly different and suffer a large increase in foregone investment that may have occurred in absence of the tax.

So long as proposals of this nature are being talked about, there is risk to the technology sector in particular that may threaten its ability to keep delivering the kind of outsized returns that have become the norm over the past decade. But because those returns also created such a heavy concentration in tech companies in the market cap-weighted S&P 500 index, many everyday Americans’ investment returns could potentially become collateral damage as an unintended consequence from a massive tech selloff. Finally, foregone investment in new or young companies would threaten growth prospects to the upside, because substantially fewer of them would exist.

The two adverse consequences acting in concert could seriously mute stock returns and wealth creation in the long run.

IRA CONVERSIONS FOR HIGH-INCOME TAXPAYERS

One feature of President Biden’s Build Back Better bill that failed to make it into the budget proposal was the provision to end IRA conversions for high-income taxpayers. Because Roth IRAs are funded with after-tax dollars, they are generally not taxed again upon withdrawal in retirement. However, there is also a maximum income one can make to be eligible to contribute to a Roth IRA. A common way around this exists, where an individual who makes too much to directly contribute to a Roth instead makes a non-deductible IRA contribution, and then converts it to Roth.

There is appetite in Congress to end this provision by immediately prohibiting after-tax IRA contributions from being converted, as well as prohibiting high income earners from converting any pre-tax IRA contributions to Roth. These measures were part of the Build Back Better legislation passed by the House in November of 2021, though as of this writing have not made it

through the Senate and did not appear in President Biden’s budget proposal. It is unclear now if the proposed restrictions on future Roth conversions will be revisited, but it is possible the days could be numbered for this strategy.

PROPOSED TAX CHANGES FOR CRYPTOCURRENCIES & DIGITAL ASSETS

Finally, there are several proposed changes to the taxation of cryptocurrencies and other digital assets like NFT’s. In essence, since digital assets currently exist in a kind of gray area where securities laws largely don’t apply to them, the proposal is to expand jurisdiction of security laws to apply to digital assets as well. Some proposed changes include:

• Expanding current rules surrounding loaned securities to digital assets
• Requiring brokers to report information relating to substantial foreign ownership of passive entities holding digital assets
• Expanding reporting requirements so US individuals who hold an interest in foreign financial assets would have to include foreign digital asset accounts
• Requiring dealers and traders of digital assets to use mark-to-market accounting

closing remarks

Under the President’s proposed budget, it is said the federal deficit would shrink by more than $1 trillion over the next decade thanks in part to revenues raised by these new tax proposals, which would raise taxes by an estimated $2.5 trillion. This would be the largest tax increase in history, but to be perfectly clear these measures are all still merely proposals. What they eventually look like as laws, if they even get passed into law at all, could wind up being very different from what they look like now. For the time being, there is no denying that President Biden is aiming high in his messaging and hoping to dramatically overhaul the tax system in a way that could set new precedents and open doors for expanded forms of taxation in the future, such as a direct tax on wealth.

The opinions herein are those of M&E Catalyst Group as of the date of writing and are subject to change. This commentary is brought to you courtesy of M&E Catalyst Group which offers securities and investment advisory services through registered representatives of MML Investors Services, LLC (Member FINRA, Member SIPC). Past performance is not indicative of future performance. Information presented herein is meant for informational purposes only and should not be constituted as specific tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary, therefore, the information should only be relied upon when coordinated with individual professional advice. This material may contain forward looking statements that are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Referenced indexes, such as the S&P 500, are unmanaged and their performance reflects the reinvestment of dividends and interest. Individuals cannot invest directly in an index. CRN202405-2133914 This material is being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific product, strategy, or service.