Benefit of the rich as Democrats waive unrealized capital gains tax

Democrats appear to have rejected the idea of ​​taxing returns on unsold inventory and other assets, favoring other means of generating income amid a nearly $ 2 trillion social and climate bill.

The elimination of this tax on “unrealized capital gains” would mainly benefit the wealthiest Americans, who hold most of the country’s financial wealth.

The US tax system is designed to tax income, like the wages of a job. But gains on stocks and other assets don’t count as income unless they are sold or “realized”.

This means that asset owners can delay taxation by retaining the asset for years. They can sometimes escape tax altogether if they keep an investment until their death, because of the tax rules applicable to inheritance.

These workarounds lead many of the country’s wealthiest people to underpay their fair share of taxes, according to Richard Winchester, tax policy expert and associate professor at Seton Hall Law School.

“The ultra-rich can manipulate the timing of their tax bill, and they manipulate it in a way that never happens,” Winchester said.

According to the most recent data from the Federal Reserve, almost all households (98%) in the richest 10% have some sort of unrealized gains, as of 2019. These gains can come from assets like a home, vacation ownership, business, stocks and mutual funds.

By comparison, about 40% of families in the bottom 20% have unsold and valued assets.

And the value of their unrealized gains differs considerably – around $ 100,000 for the poorest 20% versus $ 1.7 million for the richest 10%, on average, according to the Federal Reserve.

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The richest 1% earned more than $ 6.5 trillion in company stocks and mutual funds during the market boom in the pandemic era, according to the latest data from the Federal Reserve. The bottom 90% added $ 1.2 trillion.

Unrealized capital gains are also concentrated among white households, according to the Institute on Taxation and Economic Policy, a left-wing think tank.

About 89% of earnings above $ 2 million are held by those households, compared to 1% each for black and Hispanic families, according to the Federal Reserve’s data group analysis.

Affluent households do not necessarily need to sell popular assets to finance their way of life. For example, they can borrow against their investments to avoid selling them and paying income tax.

Such strategies have helped some of the richest men in the country – including Warren Buffett, Jeff Bezos, Michael Bloomberg and Elon Musk – to pay little or no tax on their wealth in recent years, according to a ProPublica survey.

“The very rich don’t pay taxes on all of their real income every year like the rest of us,” wrote Steve Wamhoff, director of federal tax policy at the Institute on Taxation and Economic Policy.

When the wealthiest families pay capital gains taxes, they pay a 23.8% federal tax rate on the transaction, lower than the 37% rate on income like wages.

President Joe Biden and Congressional Democrats originally aimed to change the rules on capital gains to make the tax code fairer and increase revenues for their program, including investments for paid vacation, education, health care and childcare and to fight climate change.

There were many proposals, none of which resulted in the most recent Build Back Better plan. Among other things, the measure would instead create a surtax on people with an annual income of more than $ 10 million; however, because it is linked to income, it would not affect the wealth created by unsold investments.

An earlier Biden plan, for example, would have taxed an asset’s gain on the death of its owner. The plan was to prevent the super-rich from continually passing on financial assets to the next generation for little or no tax. (The first $ 2.5 million in earnings for married couples was exempt.)

Some families may ultimately owe inheritance tax (once a married couple’s cumulative estate exceeds $ 23.4 million). Techniques such as trusts can also help reduce this tax bill.

Biden also called for the highest capital gains tax rate to be the same as his highest proposed rate on other income, at 39.6%.

The Senate also briefly considered a “billionaire income tax,” proposed by Sen. Ron Wyden, D-Ore., Chairman of the finance committee. He would have taxed the investment gains of billionaires every year. (This would also apply to those who have more than $ 100 million in income for three consecutive years.)

The concept is similar to a wealth tax imposed by lawmakers such as Sens. Elizabeth Warren, D-Mass., And Bernie Sanders, I-Vt.

“The proposals differ a lot,” said William McBride, vice president of federal fiscal and economic policy at the Tax Foundation, of the various Democratic plans. “No one has determined the best way to do it.

“They’re sort of experimental.”

While there appears to be significant revenue potential from such policies, levying taxes on public stocks enjoyed by wealthy business founders could discourage entrepreneurship, McBride said. However, this effect is not well quantified and tax rates might not play a major role in such a decision, he added.

The taxation of unrealized capital gains could reappear in the Build Back Better legislative negotiations, which will last until 2022. Even if lawmakers abandon the policy for now, it could appear in the future, a McBride said.