Month: May 2022

Recently, an idea has been proposed by our political “leaders” (cough, overlords, cough) that the unrealized capital gains of “billionaires” should be subject to a minimum level of income tax because they “aren’t paying their fair share” on these record levels of profits. See Comments by Secretary Yellen. Today class, we are going to be discussing why this is a bad idea and complete

As everyone who wants money knows, the best place to get money is from those that already have it. And who has so much money that they don’t even notice the Benjis falling out of their pockets? Billionaires.  Problem and solution, right? What’s the big deal?  This article is going to, at first glance, come off like I’m trying to protect billionaires, who admittedly have a lot people smarter than I am to do that, but as you will see, I’m talking about issues that affect all of us.  Also, in an effort to be honest with my tens of faithful readers, full disclosure, I am not a billionaire.

If any of you feel very strongly about rectifying this, you can Venmo me at #accountantsneedmoneytoo.

Since I don’t have much faith in our public school system, we are first going to discuss a few terms we will be using quite a bit so that we all have a working knowledge in common.  We will be talking about capital gains in this article and there categories of them – unrealized, realized, and recognized.  Unrealized gains occur when the value of an asset, whether it be a publicly traded stock, piece of real estate, business interest or piece of art, increases in value above what you bought that asset for plus any additional expenses incurred in maintaining it.  Your cost plus expenses is called basis. The difference between the increased value of the asset and your basis is the unrealized gain.   For example, if you bought a house 10 years ago for $250,000 and then you added a sweet fire pit and pool to the back yard, for $100,000.  Your basis is now $350,000.  Since our real estate market is white hot (for now), if an appraiser says your property is now worth $2,000,000, you would have an unrealized gain of $1,650,000 but not have any actual cash in your hands.

Realized gains and recognized gains often occur together but not necessarily.  A realized gain occurs when you actually sell that house and get cash (or other property) in your pocket.  Say you only sell it for $1,800,000.  Your realized gain is $1,450,000.  Your recognized gain is what you have to tax on after your gain is realized.  If you read a great blog post like this one: Sell your house and pay $0 tax, your recognized gain to calculate tax on would only be $950,000.  The proposed tax change seeks to collapse these categories and have just the unrealized gain of $1,650,000 be taxable. 

Why it is a bad idea

Fluctuating Nature of Value. One of the main reasons recognized gain is tied to the realization of gain is that realization of gain defines the value by converting your asset into dollars, generally.  Assets are only worth what another buyer is willing to pay and until you actually transfer the asset, that value is subject to fluctuation. 

We all know that stock values go up and down based general economic factors as well as circumstances specific to each company, real estate prices continuously fluctuate, and interest in a private business can change depending on a wide variety of factors.  How would the fluctuating value of the assets affect payment of the tax from year to year?  If the value of your asset goes down but you paid tax based on the value 12 months ago, are you able to request a refund the next year?

Another reason recognized gain (taxable gain) is tied with realized gain is that you actually have a liquid, trade-able asset (cash) to pay the tax, rather than something that may be without a ready market, like real estate.  If tax is calculated on your unrealized gain, you don’t have a way to pay the tax since all of the value is still locked in the asset.  This sounds like a great deal either for banks for financing or transactions markets as it could force liquidation of the very asset for the which you are paying tax.   

Not applicable to just billionaires. This “billionaire” tax isn’t applied to just billionaires, even though, if it was, I would still have an issue with it.  The tax would be applied to anyone worth $100 million dollars.  I get it, these folks aren’t hurting for cash either, but calling it a billionaire tax and applying it to people with 10% of that level wealth is at best disingenuous and seems like an out right lie to make the public OK with the law.  On to the next point. 

Trickle down effects.  Not talking about the economic effects on this one.  This blog is about tax.  Did you know our current income taxing system when it was ratified in 1913 (let’s not even bring up the income tax during the Civil War) was designed to “force the wealthy to take a on a fairer share of the federal tax burden”?  Less than 4 percent of American families made an annual income of $3,000 or more, the floor to even be eligible for the tax¹.  After deductions permitted, the pool of taxpayers was even smaller.  Does this sound like anything you may have heard of?   As we know it now, the general income tax affects at least 50% of American households.  Our government has an incredibly poor history of instituting a tax under the guise that it will only affect a few and then expanding it once it is passed.  See nearly every federal tax currently in existence.  It seems foolhardy to expect that this tax would stay limited to the “few who need to pay their fair share”.  If this is your expectation, History would like a word.

Establishing Value.  Establishing value and basis in order to calculate these unrealized gains will be annual valuation headaches at best and nightmares at worst.  Sure, some things like a publicly traded stock are easier to determine value, but what about the other component, the basis?  For some stocks it will be quite simple, but for others, who maybe were owned privately before being taken public, have been paid in various types of restricted stock options or other types transaction, establishing basis can be involved.  What about business interests that aren’t publicly traded.  Will annual valuations by qualified professionals be required? Same for real estate and collectibles.  Will annual appraisals of theses assets be necessary to determine the fair market value each year?  Will basis be increased since tax has been paid on the gain moving forward?  These are accounting questions primarily (adjusts nerd glasses) but they can get expensive and time consuming very quickly.

How does the Government know.  I saved this point for last but considered putting it first.  How does the Federal Government know who the $100 millionaires are?  Sure, some investments are required to be disclosed to regulatory agencies, but not nearly all of them.  Currently, the IRS is privy to primarily income documentation and reporting since that is what our tax is based on.  Sure, income can give you an idea of who might be liable for the tax, but it has little to do with unrealized gains. That is the entire reason the government has proposed this idea in the first place.  Will all taxpayers be required to assert that they are not liable for this tax via disclosure of their asset holdings and values?  Will the IRS actively be reviewing this treasure trove of new data?  They are limited in their ability to audit as it is.  This would seem like a huge invasion of privacy of every tax payer in order to assess a tax that will initially be levied on less than 1% of Americans.  These actions fall right in line with the previous proposal of requiring banks to report all transaction in excess of $600 to the government.  That went over really well. 

The Federal Government was designed to have limited ability to invade the privacy of the individual.  The income tax already provides a greater window than many would like.  This new unrealized gain tax would bust down the wall like the Kool-Aid man demanding that you give him your data.

So this ended up a pretty long post:  In summary, it’s a bad idea for the following reasons:

1. Fluctuating asset values and liquidity to pay the tax
2. Not just billionaires
3.  Trickle down effects
4. Establish value headaches
5. Huge privacy issues

For a shorter summary, see comments by Iceman.