In case you missed it, Monday (March 23, 2022), the Biden Administration and the Department of the Treasury issued a formal proposal (the “Proposal”) for its 2023 Federal Budget. The Proposal included a few items of keen interest to taxpayers and business owners.
The dubbed “billionaire wealth tax” is a slight misnomer in that the Proposal applies the tax to individuals with net worth in excess of $100 million. The novel tax would apply a 20% tax rate to income including unrealized capital gains. The Proposal makes a specific effort to address the issue of non-tradeable assets by offering an alternate valuation method using the maximum of cost, adjusted basis, or implied market prices from a valuation event. However, the Proposal does acknowledge that in a likely event of dispute between a taxpayer and the IRS, there will be an option to appeal with an appraisal.
This highlights the most mainstream effort at a wealth tax to date. This portion of the Proposal faces numerous political, legal, and constitutional hurdles and is not likely to pass into law as is. This idea has accelerated quickly from what was fringe ideology only a few years ago. Although unlikely in the immediate, a wealth tax similar to that in the Proposal is highly possible over the coming years. The Proposal gives insight into future legislation, namely the taxing of unrealized capital gains. The colloquial definition of “billionaire” has been stretched to 10% of its normal threshold with no indication that it may not be stretched further. The Proposal is silent on issues of control, marketability, and other complexities that are essential to understanding market values. A compliance burden can be avoided if one is happy accepting the IRS’s determination of value, but given the dollar amounts involved, a properly done appraisal could lead to significant savings.
For example, let’s take a business owner, Jane. She had run her own company for years and initially funded the business with a cash contribution and has since financed with various business loans. Jane’s business has had success over the years but could still face many challenges such as inflation, other macroeconomic factors, COVID-19 impacts, supply chain issues, industry or regulatory changes, employee shortages, recent loss of a major customer, and many more. Her business interest has specific circumstances of control and marketability that are material to understanding market value. A business valuation and accompanying appraisal report operate with foresight on the impacts of these issues. The IRS’s approach operates completely in hindsight and could ignore crucial information.
Consider John, a partner at a private equity firm. John’s general partner and/or limited partner interests in a fund may be estimated based on recent capital calls or the original investment. However, those interests are highly illiquid, a factor ignored in the IRS’s simplified approach. Further, John holds a carried interest in the fund which is impossible to value under the given methodology. An appraisal would consider the high risk nature and long-term timing of underlying investments coupled with the complex capital waterfall involved.
“Step-Up” in Basis at death, a key point under current estate tax law, would be eliminated and subject inheritors to higher future tax bills. The Proposal abruptly addresses this point with no alternatives, phase-ins, or time tables.
Grantor trusts would be highly disincentivized from their current standing in Federal tax law. Gift and estate planning would demand a much deeper analysis to determine optimized strategies and may rethink previous planning activities based on the Proposal.
What can taxpayers do? A great question in an ever‑changing landscape. The best action that a taxpayer can take is to plan early and plan often. The probability of successful planning decreases rapidly over time. DKB partners with clients as business advisors with experience in accounting, tax, and business valuation. Our expert team can help you to address uncertainty for yourself and your family. Please reach out to Anthony if you are interested in learning more about DKB’s solutions based approach.