Billionaire tax proposed for wealthy individuals, estates and trusts

ARTICLE | October 28, 2021

Authored by RSM US LLP

The Senate Finance Committee released draft language of a bill that would require applicable taxpayers to mark liquid investments to market and create an interest charge for illiquid investments. This has been popularly termed The Billionaire Tax. Moderate Democrats have already voiced concern about the provisions making inclusion in the broader Budget Reconciliation Bill problematic. The proposal is summarized at a high-level below with an effective date for taxable years beginning after Dec. 31, 2021.

Applicable taxpayers

The proposed tax increases would only apply to ‘applicable taxpayers’ that meet either specified income or asset thresholds in the three preceding taxable years. For joint and single filers, the income threshold would be adjusted gross income (AGI) in excess of $100 million or aggregate covered assets in excess of $1 billion. For married filing separate filers, these thresholds are cut in half and if one spouse is deemed an applicable taxpayer, the other spouse would also be deemed an applicable taxpayer. Property held in a grantor trust is treated as if owned directly by the grantor for purposes of determining applicable taxpayer treatment. Nongrantor trusts (other than charitable trusts) are applicable taxpayers if there is at least $10 million in income before the income distribution deduction or $100 million in assets for the preceding three years. If an individual is deemed an applicable taxpayer in the year of death or any of the three preceding years, then the individual’s estate is also deemed an applicable taxpayer. In the first year a taxpayer becomes an applicable taxpayer, an election could be made to pay the net first-year tax liability over five years in equal installments. An applicable taxpayer’s income and assets would have to drop below one-half of the threshold amounts for three consecutive years before an election could be made to not be treated as an applicable taxpayer. 

Annual mark-to-market on tradable covered assets and disregarded nonrecognition events

The proposal would require applicable taxpayers to mark-to-market certain assets at year-end and recognize any gain or loss. This would only apply to ‘tradable covered assets’ which are those with a readily ascertainable value traded on an established securities market or readily tradable on a secondary market. Any capital gain or loss related to a tradable covered asset will receive long term treatment, regardless of holding period absent another provision in the tax code that stipulates otherwise. This would also apply to pass-through entities for which an applicable taxpayer holds a nontradable interest of at least 5% or whose ownership interest is valued at $50 million or more.  

In addition, any exchange to which section 351 (contribution to a corporation) or section 1031 (like-kind exchanges) applies or transfers of built-in-gain or loss property by C corporations would no longer be considered a disregarded nonrecognition event for applicable taxpayers.  

Deferral recapture on applicable transfers of covered nontradable assets 

Applicable taxpayers with nontradable assets would have a deferral recapture charged on the gain deferral once an applicable transfer occurred. A nontradable asset is defined as any asset not included in the tradable asset definition outlined above and an applicable transfer includes any sale, exchange, disposition or other transfer that results in recognized gain or loss outside the ordinary course of a trade or business. The deferral recapture is essentially an interest rate charge and would be equal to the short term applicable federal rate plus 1%. The proposal specifies that the total tax due upon sale of an asset, including any deferral recapture amount, would not exceed 49%. If the taxpayer has a net capital loss for the year, the loss may be used to offset any deferral recapture amount with some limitations. Similar to the mark-to-market rules, this would also apply to pass-through entities as outlined above.

Gifts, bequests and transfers in trust

Applicable taxpayers making gifts, bequests or transfers in trust would be treated as an applicable transfer for which gain recognition would occur. If the asset transferred is loss property, the loss would be disallowed. The proposal mentions exceptions for transfers to a U.S. spouse, surviving spouse or a former spouse incident to divorce as well as transfers to charity. Transfers of nontradable covered assets by an applicable taxpayer into a grantor trust are also deemed recognition events, unless made to a revocable grantor trust. Actual distributions and deemed distributions also result in gain or loss recognition. Deemed distributions include when an owner ceases to be treated as the owner for income tax purposes, when the property would no longer be included in the grantor’s estate or when the owner dies. There is also a proposal to prevent the indefinite deferral of gains in a dynasty trust.

RSM INSIGHTS

The thresholds for meeting the applicable taxpayer status seem to target a much broader group of taxpayers than only billionaires. The thresholds for nongrantor trusts are significantly reduced as compared to individuals and the income threshold would be applied before the income distribution deduction. This limitation would prevent trustees from utilizing income distributions to avoid being subject to the new tax. It should be noted that either threshold can be met from year to year to be deemed an applicable taxpayer.

The mark-to-market proposal would create an annual taxable event for applicable taxpayers which not only increases the tax burden but also increases the compliance burden each year. It would also remove the benefit of certain nonrecognition planning strategies that might be otherwise considered for this group of taxpayers such as the use of deferred compensation planning, private placement life insurance, exclusion of gain from the sale of certain small business stock and modification of qualified opportunity zone provisions. The burden on certain pass-through entities would also be significant as increased information reporting could be costly. Taxpayers considering taking advantage of nonrecognition strategies, dispositions, gifts or other transfers of appreciated assets may want to consider completing these transactions in 2021.

RSM will be carefully watching the development of this proposed legislation and providing further insights as appropriate.