The Billionaire Minimum Income Tax: Is an Unrealized Capital Gains Tax in sight?


Here’s a chewing question. It’s more of a puzzle actually: Can you be taxed on something that’s not really real? Thanks to White House and congressional officials, we may soon find the answer to this riddle.

Last March, President Joe Biden said he wanted to introduce a new tax targeting the nation’s wealthiest families.1 It’s called the Billionaires Minimum Income Tax– except it’s not only taxing billionaires is not a minimum tax, nor is it really an “income” tax. But he is a tax . . . so at least they got that part right!

So what exactly is this tax on the minimum income of billionaires? In a nutshell, it’s a 20% tax on the unrealized capital gains (hold on to that thought) US households worth at least $100 million.

To understand how this works – and whether this tax has any real chance of becoming a reality – we must first talk about unrealized capital gains. Let’s dive in!

What are unrealized capital gains?

Capital gains, which are profits (or potential profits) from an investment that increases in value after you buy it – may or may not be realized.

Taxes shouldn’t be so complicated. Contact a RamseyTrusted tax advisor.

Unrealized capital gains show you how much your investment has increased in value before you sell it. Once you have sold an investment for a profit, you have realized capital gains.

The difference is that unrealized gains are only on paper—they’re not really real (again) – while the winnings made represent real money that is now in your pocket. Simple enough, right?

How do unrealized capital gains work?

Let’s say you bought a stock today that is worth $1 and you let it sit in your account for a while. You come back exactly one year later to take a look at your account and find that it is now worth $11.

Whenever a stock or investment you own is worth more than you bought it for, you can sell it for a profit – and these profits are called capital gains. Congratulations!

If you decide to keep the stock and not sell it, then what you have is unrealized capital gains. After all, you can’t just walk up to your grocery store checkout and pay for milk and eggs with your stock, no matter how much it’s worth on paper.

But if you decide to sell that stock and someone buys it from you for $11, you no longer have any unrealized gains. Now you have $10 of realized capital gains. . . which means you will now have to pay tax on those profits.

How are capital gains taxed?

Under current tax law, you only pay tax on the profits you get from an investment after you sell it. In other words, you can only be taxed on realized capital gains. As long as you keep your investment, your unrealized capital gains remain out of Uncle Sam’s reach.

In most cases, you will have to pay capital gains tax on any profits you make from the sale of an investment, and the amount you will have to pay will depend on your income and how long you have held your investment before selling it.

For example, if you sold a stock within a year of buying it, you would pay the short-term rate of appreciation— which is the same as your ordinary tax rate. But if you waited a year or more before selling it, you would pay the long-term rate of appreciation— which could be 0%, 15% or 20%, depending on your income.

But if President Biden has his way, unrealized capital gains will no longer be prohibited for the IRS, at least not for the roughly 30,000 American households currently worth at least $100 million.2

How would an unrealized capital gains tax work?

Let’s say you’re one of those Americans with a household net worth of $100 million or more. Again, this stock has gone up $10 in one year since you bought it, so you have $10 of unrealized capital gains on this stock.

You decide to keep the stock and not sell it, which should save you paying tax on those gains, right? Bad! Under this new plan, you will have to pay 20% tax on these unrealized gains in the year these gains occur. In this case, you would owe the IRS $2.

Does this mean you would be taxed on those capital gains Again if you decide to sell the stock? No, not exactly. You see, the Treasury Department says this tax would act as a “cash advance” on any capital gains tax you may owe when you sell your investments in the future.

For example, suppose another year passes and the stock we talked about is now worth $15. If you decide to sell, you will now have $14 in realized capital gains. At a long-term capital gains tax rate of 20%, you would pay $2.80 in tax on those gains. But since you already paid $2 in tax on those gains when they weren’t realized, you’d only have to pay 80 cents to make up the difference.

The Problems of an Unrealized Capital Gains Tax

Now that we have seen what an unrealized capital gains tax is could be like, it’s time to highlight three important reasons why any proposal to make it a reality is unlikely to go too far.

1. A new unrealized capital gains tax would be a headache to apply.

For a tax like this to work, thousands of taxpayers would have to assess the value of all their assets every year. This raises the question: how on earth could the IRS, which is already understaffed and overburdened, check all these documents?3

Of course, investments like stocks and mutual funds are simple because they have a fixed market price. But things get much more complicated when we start talking about things like rental properties and businesses, which are the main source of wealth for many wealthy people. These types of assets are much more difficult to value. And we haven’t even talked about collectibles, jewelry, and other illiquid assets that are also part of your net worth. (If you’re curious, you can use our net worth calculator to help you figure out your net worth!)

Also, some people won’t have the cash to pay the millions of dollars in taxes they might owe on unrealized gains from their assets, which would force them to sell some of those assets in order to pay the bill. tax. And what if those assets lose value in another year? Will they be entitled to a refund from the federal government?

This is one of the many reasons why so many European countries have dropped similar taxes – the administrative headaches just aren’t worth it.

2. The proposed tax probably doesn’t have enough support in Congress.

This isn’t the first time that lawmakers in Washington have tried to pass a similar type of “wealth tax” — and those proposals hit a brick wall each time. It doesn’t look like this one is any different.

It’s important to remember that Congress treats the release of the White House budget more like a list of suggestions than something written in stone. In reality, Republicans are unlikely to accept a tax on unrealized gains, while a handful of Democrats have already said they won’t support it – or at least have cast doubts on whether it will. is a practical idea to start with. .4,5

That could be enough to sink this latest attempt to pass a wealth tax before it even leaves port.

3. An unrealized capital gains tax could be unconstitutional.

And then there’s the question of whether it’s even legal tax unrealized capital gains. You see, the Constitution makes it extremely difficult for the government to impose direct taxes. In fact, Congress had to pass a constitutional amendment just to implement a federal income tax.6

Without delving too deeply into legal gibberish, this basically means that any tax imposed must be distributed evenly among every person in every state. And an unrealized capital gains tax could be considered a direct tax because it is a tax on the personal property of a select group of people.

Lawyers and politicians can debate the matter all they want, but it’s almost a safe bet that if Congress were to pass an unrealized capital gains tax, lawsuits would follow right away. It is likely that the Supreme Court will eventually rule on the matter and it is very possible that they will invalidate it.

Speak with a tax professional

Realized or not, trying to understand capital gains taxes (or any kind of taxes, really) is hard enough without politicians getting involved. That’s why you should always work with a qualified tax professional, like one of the pros in our Approved Local Provider Program (ELP).

Whether you manage hundreds of thousands or even millions dollars in investments, our RamseyTrusted professionals can help you do your taxes right. A mistake or oversight on your tax return could land you in hot water with the IRS – and it’s just not worth the headache.

Find a tax advisor in your area today!

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