Yellen's idea to tax unrealized capital gains

[juliusa]

You still have to figure this out when you sell it. And since it's been 50 years(?) you can probably use a reasonable estimate

As of now, we have no need to determine the cost basis since we will hold it until death, and the basis will be the valuation on her date of death. I don't think the IRS accepts estimates - I think they use 0 as the basis unless you can show otherwise.

 

[juliusa]

IMO, a big tax gain would be just to eliminate the step-up cost basis upon death and that could be done pretty quickly.

I don't think that is part of the plan, since they are not raising taxes on people making less than $400,000.

 

[M3BlueGeorgia]

As of now, we have no need to determine the cost basis since we will hold it until death, and the basis will be the valuation on her date of death. I don't think the IRS accepts estimates - I think they use 0 as the basis unless you can show otherwise.

Zero is probably not too far from accurate after 50 years.

 

[Paracelsus]

 

[juliusa]

Eliminating the stepped-up basis for inherited stocks is another thing to consider to prevent the ultra-wealthy from escaping taxes. This could be done on a sliding scale similar to how the inheritance tax is done so that small estates might have a full stepped-up basis, larger ones could have some less-than 100% step and very large estates could have nearly no stepped-up basis.

I think you would have to include all assets, not just stocks. Why should Warren Buffet be subject to the tax, but not Donald Trump or Charles Koch?

Does anyone one know what the proposal being considered for removing the stepup in basis is? @cpa? The way I see it, it could work two ways (and probably other ways as well):

1. Basis is adjusted to value at death, and estate pays taxes on the gain.
2. Basis remains the same at death.

In the second scenario an asset (family farm for example) could pass from generation to generation without paying taxes on the gain, so long as the asset is not sold. Still subject to death tax.

In the first scenario, an asset could be gifted before death - in which case there would be no capital gain taxes due. I guess in that case they would change the law on gifts of appreciated assets, and make the unrealized gain subject to tax at time of gift.

 

[cpa]

I think you would have to include all assets, not just stocks. Why should Warren Buffet be subject to the tax, but not Donald Trump or Charles Koch?

Does anyone one know what the proposal being considered for removing the stepup in basis is? @cpa? The way I see it, it could work two ways (and probably other ways as well):

1. Basis is adjusted to value at death, and estate pays taxes on the gain.
2. Basis remains the same at death.

In the second scenario an asset (family farm for example) could pass from generation to generation without paying taxes on the gain, so long as the asset is not sold. Still subject to death tax.

In the first scenario, an asset could be gifted before death - in which case there would be no capital gain taxes due. I guess in that case they would change the law on gifts of appreciated assets, and make the unrealized gain subject to tax at time of gift.

I'm not aware of anything. In fact, I am letting my license expire in September, so I am not as diligent in seeing what is swirling about in Congress.

To me the most vexing problem about succession planning is that a typical family with two or more kids will have differing views with Mom and Dad's estate. All cash or liquid securities is easy. Cash, securities, primary home, vacation home, pension plan(s), rental real estate, family partnership with Uncle Joe and Cousin Sue, etc. etc. Ignore estate taxes. How ya gonna divvy up this estate when one kid wants money, one wants to own the partnership and keep the vacation home, and the third wants the rental with Denny's on the land and to live in the primary home? No matter what becomes of timing basis step-up, there are other more pressing issues in dealing with the dreaded family dynamic.

As of now, we have no need to determine the cost basis since we will hold it until death, and the basis will be the valuation on her date of death. I don't think the IRS accepts estimates - I think they use 0 as the basis unless you can show otherwise.

A good faith effort to establish basis for an asset purchased decades ago will always find sympathy with the Tax Court should it get that far. There are cases that have gone the way of the taxpayer if he lays out his logic, reasoning, and enough facts to establish a reasonable basis. Ordinary tax examiners will give the taxpayer short shrift upon audit. It is not their job to evaluate these matters. But you have the Appeals Office available to consider your arguments -- bearing in mind that the Appeals Office is to judge how successful the unagreed portion of an audit will be successful in court for the Service and for the taxpayer.

 

[hcsharp]

Does anyone one know what the proposal being considered for removing the stepup in basis is?

There is no proposal. The title of this thread is also wrong. Yellen never had any idea for taxing unrealized capital gains. In the interview she was asked by Sen. Ron Wyden about a potential proposal and all she said was she would consider it. What else could she say? She's never made any favorable comments about such an idea and I doubt if she ever will.

 

[hacer]

There is no proposal. The title of this thread is also wrong. Yellen never had any idea for taxing unrealized capital gains. In the interview she was asked by Sen. Ron Wyden about a potential proposal and all she said was she would consider it. What else could she say? She's never made any favorable comments about such an idea and I doubt if she ever will.

56. Do you support a wealth tax, and will you advocate for a wealth tax, including construction of an entirely new measurement and monitoring apparatus to track an entirely new tax base?

Answer: President Biden has proposed to tax the investment income of families making more than $1 million at the same rate they pay on their wages and to tax some previously untaxed capital gains on the final return of wealthy taxpayers. These reforms would remove biases in the tax code that favor wealth over work.
...
62. Some believe that, independent of revenue raised or lost because of implementation of a wealth tax, it is important to institute a wealth tax so “billionaires” and high-wealth individuals do not hoard such wealth. a. Do you support implementation of a wealth tax with the primary or sole intention of ensuring that there are fewer people with high wealth levels? b. If so, what social problem would you be intending to solve by implementing the wealth tax?

Answer: As noted above, President Biden has proposed to tax the investment income of families making more than $1 million at the same rate they pay on their wages and to tax some previously untaxed capital gains on the final return of wealthy taxpayers. These reforms would remove biases in the tax code that favor wealth over work. He has not proposed a wealth tax.

The questions didn't mention taxing unrealized capital gains, they were generically about "wealth tax". It's fair to say that Yellen credits Biden with the idea rather than herself but she is the one who brought up taxing unrealized capital gains herself, not the questioner. I think that these written question and answers were submitted prior to her live testimony. I think it's likely from the other questions like "do you think a wealth tax is constitutional?" show that the original questioner leading to this issue being discussed was not Sen. Ron Wyden.

In the actual hearing at about the 1:33:30 mark it is Sen. Pat Toomey who asks her about taxing unrealized capital gains, not Sen. Ron Wyden.

 

[jhm]

I tend to like the idea that a certain portion of unrealized cap gains must be added to basis and taxed each year. For example, suppose at the end of the year, I'm sitting on $11M in Tesla with a basis of $1M. Suppose the rule is to tax 10% of the unrealized. So I pay say 20% tax on the 10% of my $10M in unrealized gains, just $200k. But now my basis increases by $1M. So going into the next year my new basis on $2M on $11M. Suppose Tesla declines, and by the end of the year my position is worth $8M. Now my unrealized is $6M, so my tax is 20% on $600k, or $120k. Thus my tax bill has declined in the second year because my investment lost value. This makes it easier to buy more shares when the price down. But more importantly for tax policy, only taxing 10% of unrealized gains avoids the potential for unrealized losses, which would not be taxed in a given year. Investors that tend to hold positions long enough will tend to pay a reliable tax each year.

I also think we should get rid of the distinction between long-term and short-term cap gains and dividends. All should be taxed at the same rate to keep things simple. I don't believe we need to reduce rates to induce a preference to hold investments longer. Being able to differ 90% of your unrealized gains each year has a certain time value to it. If your portfolio grows at 20% year, being able to defer a $1 tax for one year has a present value of $0.833 = $1/1.20. So you're getting a 16.6% break on your taxes by not realizing your cap gains in a year. That ought to be incentive enough to keep holding the bulk of your investments.

We also see that forcing 10% of unrealized gains to be realized and taxed simply puts a limit on how long you can keep deferring your taxes. It means that on average you can defer cap gains 10 years ( = 1 / 10%). In terms of long-held estates, the unrealized gains will mostly be gains over just the last ten years, not multi-decade gains. Heirs will not inherit such large unpaid tax bills.

 

[juliusa]

So I pay say 20% tax on the 10% of my $10M in unrealized gains, just $200k.

Do you sell stock to pay the tax? How about the shopping mall that you own - how do you get cash to pay tax on the unrealized gain? How do you value the shopping mall each year?

In comparison, the different tax treatment for short and long term realized capital gains is simple.

 

[thx1139]

This is already accomplished with the death tax. Just raise the death tax if you want, but keep the stepped-up basis.

It is too hard to figure out the basis of many assets after someone dies - if the dead person even knew. My MIL has a pretty simple investment portfolio, but it contains a mutual fund she has owned for 50 years with no basis information. The mutual fund company does not know it because it was an acquisition.

How is figuring the basis any more difficult the day before I die and the day my kids inherit the asset?

 

[juliusa]

How is figuring the basis any more difficult the day before I die and the day my kids inherit the asset?

If you have had a rental property for 40 years, it may be more difficult for your kids to figure out and document the basis than for you.

In my case, my MIL has a mutual fund and does not know the basis - so just as difficult for her as for her heirs. The mutual fund company, for a fee, "may" be able to produce 50 years of statements that we can use to calculate the basis.

 

[jhm]

Do you sell stock to pay the tax? How about the shopping mall that you own - how do you get cash to pay tax on the unrealized gain? How do you value the shopping mall each year?

In comparison, the different tax treatment for short and long term realized capital gains is simple.

This would be mark-to-market. Selling stock is only one option for raising cash needed to pay taxes. Dividends and ordinary income and cash also work.

If you own a business like a shopping mall, you'll want to set aside some cash from operations to pay taxes. Nothing new here. There are methods for valuing private equity, and real estate is routinely taxed already.

The accounting would be handles by brokerage. So it is pretty transparent. It is easer than short or long because you never have to think about those tax implications every time you trade. Of course if you don't care how big your tax bill is, you can disregard the distinction. By contrast, the tax method I'm proposing, you simply sell the tax lot with lowest unrealized gains (easy for brokerages to program as default). The rest is automatic and makes no difference to your tax bill. The current tax system is too complex for your broker to optimize it for a client as they would have to know about other tax liabilities not immediately within your brokerage account.

 

[juliusa]

Selling stock is only one option for raising cash needed to pay taxes. Dividends and ordinary income and cash also work.

So Elon would use his TSLA dividends to pay the tax on his unrealized TSLA gains?

The accounting would be handles by brokerage.

That works for assets held in brokerage accounts - at least going forward. Still have all the historical assets they hold where they don't know the cost basis. Paying an annual unrealized gain tax would make tracking the basis complicated, since I assume each year the tax basis would change as you pay tax on the unrealized gain. After 30 years of holding a stock there would be 30 adjustments to the tax basis.

What would you do for assets not held in brokerage accounts? Real estate valuations are complicated, especially with partial-ownership discounts. Right now they are typically valued at sale or death - not every year - and there is often litigation that can take years to resolve.

Seems complicated and subject to cheating to me. Though cheating on the valuation for the annual unrealized gains tax might defer the tax, but eventually it would get paid when the asset is sold.

 

[brkaus]

It is too hard to figure out the basis of many assets after someone dies - if the dead person even knew. My MIL has a pretty simple investment portfolio, but it contains a mutual fund she has owned for 50 years with no basis information. The mutual fund company does not know it because it was an acquisition.

This!!! I'm POA / executor for a relative w/ dementia. There is no way we can figure out the cost basis from her scribbles in notebooks. She's been investing small amounts since the 60-70s - well before brokers tracked anything like basis.

 

[juliusa]

This!!! I'm POA / executor for a relative w/ dementia. There is no way we can figure out the cost basis from her scribbles in notebooks. She's been investing small amounts since the 60-70s - well before brokers tracked anything like basis.

I'm sure a forensic accountant could figure it out for you. For a fee.

 

[brkaus]

I'm sure a forensic accountant could figure it out for you. For a fee.

not sure if I should reply - like, informative, or funny

I’m sensing lighter fluid getting spilled on that set of boxes...

 

[cpa]

This would be mark-to-market. Selling stock is only one option for raising cash needed to pay taxes. Dividends and ordinary income and cash also work.

If you own a business like a shopping mall, you'll want to set aside some cash from operations to pay taxes. Nothing new here. There are methods for valuing private equity, and real estate is routinely taxed already.

The accounting would be handles by brokerage. So it is pretty transparent. It is easer than short or long because you never have to think about those tax implications every time you trade. Of course if you don't care how big your tax bill is, you can disregard the distinction. By contrast, the tax method I'm proposing, you simply sell the tax lot with lowest unrealized gains (easy for brokerages to program as default). The rest is automatic and makes no difference to your tax bill. The current tax system is too complex for your broker to optimize it for a client as they would have to know about other tax liabilities not immediately within your brokerage account.

The Code permits investors to elect the shares that they sold when they hold multiple lots. They can elect different methods for different stocks. But this election is irrevocable. So, it is correct that the taxpayer can opt to use the lot with the lowest capital gains when computing your proposal. But then you are stuck with it forever.

For large investors, like your example of the person with $11 million of TSLA, is that there will be a time when they recognize a huge capital loss in another investment years later. This person could not decide to change his accounting method for TSLA in order to recognize a larger capital gain in order to capture most if not all of the recognized loss in the other transaction.

Then we have to deal with the shorts. Most of those folks don't keep a lot of spare cash lying around.

And we also have to deal with the mutual funds, especially those who reinvest their capital gain distributions. It might get a little awkward!

One of the proposals in the 2017 act was to require option traders to mark-to-market their positions at year-end. It was quickly scrapped when Congress received a ginormous blow back from everybody and his cousin.

 

[bkp_duke]

I tend to like the idea that a certain portion of unrealized cap gains must be added to basis and taxed each year. For example, suppose at the end of the year, I'm sitting on $11M in Tesla with a basis of $1M. Suppose the rule is to tax 10% of the unrealized. So I pay say 20% tax on the 10% of my $10M in unrealized gains, just $200k. But now my basis increases by $1M. So going into the next year my new basis on $2M on $11M. Suppose Tesla declines, and by the end of the year my position is worth $8M. Now my unrealized is $6M, so my tax is 20% on $600k, or $120k. Thus my tax bill has declined in the second year because my investment lost value. This makes it easier to buy more shares when the price down. But more importantly for tax policy, only taxing 10% of unrealized gains avoids the potential for unrealized losses, which would not be taxed in a given year. Investors that tend to hold positions long enough will tend to pay a reliable tax each year.

I also think we should get rid of the distinction between long-term and short-term cap gains and dividends. All should be taxed at the same rate to keep things simple. I don't believe we need to reduce rates to induce a preference to hold investments longer. Being able to differ 90% of your unrealized gains each year has a certain time value to it. If your portfolio grows at 20% year, being able to defer a $1 tax for one year has a present value of $0.833 = $1/1.20. So you're getting a 16.6% break on your taxes by not realizing your cap gains in a year. That ought to be incentive enough to keep holding the bulk of your investments.

We also see that forcing 10% of unrealized gains to be realized and taxed simply puts a limit on how long you can keep deferring your taxes. It means that on average you can defer cap gains 10 years ( = 1 / 10%). In terms of long-held estates, the unrealized gains will mostly be gains over just the last ten years, not multi-decade gains. Heirs will not inherit such large unpaid tax bills.

Horrible idea. You would see guys like Elon selling BILLIONS of dollars in stock each year to cover the taxes. There would be massive drops in the stock market, and subsequently the economic output of companies.

Think about this: Elon moved out of CA, and most likely because of their high tax rate. You want him to move himself and Tesla out of the country because of "unfavorable tax environments"? The economic consequences if just 10% of large companies did something like this would be devastating to our country.

I'm already considering moving out of CA because of the tax rates. If the US Gov did something similar, I would sure consider moving out of country too, and I don't employ nearly as many people.

 

[Uncle Paul]

Elon may claim he is a citizen of Mars, and pay his taxes there.