Yellen's idea to tax unrealized capital gains

[hacer]

So this was a verboten subject in the round table because it's political but I was surprised to hear that in her testimony and I think it deserves discussion.

On it's face it seems like a spectacularly bad idea that could destroy the entire capital markets. For example if they simply "marked to market" at the year end stock closing price then applied tax just as if the assets were sold it would be devastating for anything that was not yet long term which would mean going forward there would be no reason to want to invest. At the same time for long-term holders the massive selling that would be required across all holders having unrealized gains would greatly depress the stock price such that much more than 15% of holding would need to be sold because the idea that any amount of stock can be sold for the same price that the last single share traded at is pure fiction. Prices would collapse and those with the greatest unrealized capital gains might even by bankrupted because the forced selling could depress prices so much that even selling 100% of the position might not yield 15% of the ore-collapse market value. It would be the end of the stock market as we know it.

Because that direct approach is so certain to lead to catastrophe I'm confident it won't be proposed. But there are other possibilities. For example they could tax all unrealized capital gains (less any unrealized capital losses) at a low rate, say 1% and then reset the cost-basis to be equal to the "marked to market" price used to calculate the tax. That could bring in a one-time large windfall of tax revenue which may be the goal while actually providing a massive gift to the wealthy. I'm not sure this is a good idea either but it's an idea that might not be a non-starter.

I think there are more sensible ideas that could allow the wealthy to pay their fair share of taxes. One loop-hole that needs to be fixed is the way that the ultra-wealthy avoid taxes altogether by having no income and instead borrowing money against stocks (with massive unrealized capital gains) pledged as collateral. They get a fabulous low interest rate and have no income nor capital gains yet can effectively have a very large amount of money at their disposal. This problem could be solved by treating the act of pledging stocks as collateral for a loan (probably excluding margin loans used strictly for investment) as a "marked to market" sale (and resetting of the cost basis) of the stock for tax purposes. So you'd be hit with capital gains taxes if you monetize your stock but it's up to you if you want to do that. I think that would basically mean people would just have to sell stock if they want the money rather than borrow against it It seems a lot fairer and more reasonable than taxing unrealized capital gains.

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.

 

[TheTalkingMule]

The idea of taxation limiting the “desire to invest” is just silly. This would be a terrible idea to implement, but I don’t see it driving rich assholes into the actual workforce.

Edit: I say this of course as a TMC poster, aka a rich asshole.

 

[juliusa]

Eliminating the stepped-up basis for inherited stocks is another thing to consider to prevent the ultra-wealthy from escaping taxes.

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.

 

[hacer]

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.

Presently that's true but for a few years now brokers have been obligated to track (and report) cost basis. New regulations could mandate that everyone inform their broker of the cost basis of all of their positions that the broker is not already tracking (while they are still alive). A couple of years after that it shouldn't be difficult to determine the cost basis of securities in any estate.

But I take your point that the death tax could accomplish the same goal and it would be simpler.

 

[juliusa]

Well, if you have any ideas how I can get the cost basis of the mutual fund my MIL purchased 50 years ago, I'm all ears. How about assets other than securities?

My view is the people that will benefit from removing the step-up are the "helpers" - forensic accountants and lawyers.

 

[cpa]

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

The "death tax" (really it is a net worth tax) dovetails with the gift tax. They are two sides of the same coin. As the law stands today, a married couple can shelter over $23 million of net worth. In addition, there is the "deceased spouse unused exemption" provision. This effectively permits the surviving spouse to realize the entire $23 million exemption from inheritance tax upon death. The old rules did not permit this carryover. Hence all the complex marital trusts and other estate plans to push the amount subject to inheritance taxes into the future. Gifts of a present value merely eat into this exemption; all lifetime gifts made are included in the decedent's estate at the value on the date of the gift. (If I give a piece of property to my son that I paid $100 for and is worth $125 when I give it to him, that is the value that included in my estate when I die even though the property may have appreciated to $300 upon my death.)

The exemption amount in the '90s was $600,000. Under Bush II, it climbed from $1,000,000 to around $6 million (but don't hold me to the amount--that was long ago and far away for me.)

The tax rate on inheritances is 40%. (Ignore the lower rates; they are irrelevant because of the exemption.) So, a single person dying with an estate of $15,000,000 would effectively pay tax on the $3.5 million excess over the exemption at forty percent. (Note that the exemption takes the form of a tax credit. That means one calculates the estate tax using all the lower brackets, then subtracts the amount of the exemption credit to get the net tax owed.)

I think the inheritance tax exemption should be reduced to the $5 million range. I also think the rates should be lowered and the brackets larger. Have higher rates like the old days of 55% for estates > $25 million or so. Keep the step up. More estates would be subject to the tax, but would pay a lower overall tax rate at that amount.

Other taxpayers own businesses and real estate, not securities. Why should owners of securities be singled out but not an owner of the corner strip mall or the owners of a small business that is not publicly traded? Because it is easy to calculate and audit the value of 500 shares of TSLA; not so much with the apartment building or business partnership/LLC/S Corporation.

To effectuate this proposal would entail onerous record keeping; a massive sell-off at year-end to pay for this tax, perhaps furthering depressing the value only to see it bounce back in January; figuring out how to handle step-down in bases if they are allowed to reduce step-ups; and how this plays out in future years. Then there would be potential double-taxation on those who have paid tax on mark-to market securities followed by the estate tax upon death.

Bad idea.

 

[juliusa]

My comment on incorporating it in the death tax was related to step-up basis at death, not taxing unrealized gains.

For people that support eliminating the step-up basis, I'm simply suggesting leave that and raise the death tax to accomplish pretty much the same thing - simpler for everyone, but less money for the "helpers" - CPAs and lawyers - who have to find the basis is it is not known.

Other taxpayers own businesses and real estate, not securities. Why should owners of securities be singled out but not an owner of the corner strip mall or the owners of a small business that is not publicly traded?

Seems unfair to me, and taxing unrealized gains in publicly-traded securities only would probably have unintended consequences. Would companies go/stay private to avoid this and be owned by institutions and large investors, leaving the average investor out? TSLA owned by a few dozen large institutions and rich people, and not publicly traded?

Then there would be potential double-taxation on those who have paid tax on mark-to market securities followed by the estate tax upon death.

Isn't the death tax by definition double-taxation? Other than not double-taxing unrealized gains at death, isn't the rest of the estate tax a double-tax?

 

[cpa]

Isn't the death tax by definition double-taxation? Other than not double-taxing unrealized gains at death, isn't the rest of the estate tax a double-tax?

In essence, yes. But it is a net worth tax, so liabilities are deducted from the gross estate. In addition, deductions for bequests to surviving spouses can be deducted as can charitable bequests that are spelled out in the will or trust instrument. This concept has been why the Congress permitted a basis step-up at death. Real and personal property receive new bases, and the difference between the old tax basis and the new tax basis can be depreciated anew. So, there is a little bit of equity as the increase in value can be offset by increased depreciation deductions.

Moreover, there are certain items in decedents' estates that have zero income tax basis. These include qualified pension plans like IRAs and 401(k), installment sales, accrued interest and dividend income, and accounts receivable less payables on a cash basis taxpayer's business. There is a provision that permits the survivors who recognized these items of income to deduct the amount of estate taxes paid on that income as an itemized deduction not subject to the limits other than the standard deduction.

Seems unfair to me, and taxing unrealized gains in publicly-traded securities only would probably have unintended consequences. Would companies go/stay private to avoid this and be owned by institutions and large investors, leaving the average investor out? TSLA owned by a few dozen large institutions and rich people, and not publicly traded?

For as long as I have been putting numbers in boxes, shrewd lawyers and accountants have been finding loopholes and other means to profit from tweaks to income and estate taxation. Congress wises up decades later, and closes those loopholes only to have others open up. I think you are correct that this plan would only serve to divide further the widening chasm between the ultra wealthy and the rest of us plebs, not to mention the fifty percent of the population who only have $1,700 to their name at any given time with zero in any sort of retirement plans.

 

[uujjj2]

Stepped up basis should definitely be eliminated. However, it would be double taxation to simply reset the cost basis to zero when an asset holder dies, if the heirs are also paying substantial inheritance tax. So Congress will need to think hard about this problem. There's a clear economics argument to some sort of tax on wealth, but actually implementing such a tax without unintended consequences is a hard problem.

 

[hacer]

Well, if you have any ideas how I can get the cost basis of the mutual fund my MIL purchased 50 years ago, I'm all ears. How about assets other than securities?

My view is the people that will benefit from removing the step-up are the "helpers" - forensic accountants and lawyers.

If you currently own them through inheritance then the basis was established on her date of death. If she still owns them herself then she's obligated (by IRS regulations) to keep track of her cost basis herself. I suppose there can be some cases where accidents, dementia, etc. could make cost basis for some shares unknown, so there must be some mechanism for a guardian with power of attorney who sell shares on behalf of such a person in order to provide care to the owner of said assets to be able to file their taxes too. I don't know how that's done presently but the same mechanism could be used to inform the broker of the cost-basis if a law were passed requiring it be provided to brokers.

 

[hacer]

My comment on incorporating it in the death tax was related to step-up basis at death, not taxing unrealized gains.

For people that support eliminating the step-up basis, I'm simply suggesting leave that and raise the death tax to accomplish pretty much the same thing - simpler for everyone, but less money for the "helpers" - CPAs and lawyers - who have to find the basis is it is not known.


Seems unfair to me, and taxing unrealized gains in publicly-traded securities only would probably have unintended consequences. Would companies go/stay private to avoid this and be owned by institutions and large investors, leaving the average investor out? TSLA owned by a few dozen large institutions and rich people, and not publicly traded?

Isn't the death tax by definition double-taxation? Other than not double-taxing unrealized gains at death, isn't the rest of the estate tax a double-tax?

I don't see the estate tax as double taxation at all. Normally speaking when money changes hands it is a taxable event. If I buy something with my post-tax dollars should the recipient not owe taxes on the income they get from that? By the same logic, my employer got all of it's revenue used to pay my salary from public customers who spent their post-tax money buying my employer's products. So if I pay income tax that's double taxation too. The reality is it's not double taxation.

Detecting double taxation is easy: if the marginal rates of the two taxes are made close to 100% and the resulting tax owed exceeds the original income total, then that is double taxation.

Example 1, a business earns $1000 net income and owes x% income tax. They pay the rest to shareholders as a dividend who then owe y% income tax. $1000(1-x) = amount shareholders get. $1000(1-x)*(1-y) is the amount shareholders keep. Let x = y = 1. The taxing authority gets it all, but not more than the original amount. Thus taxing dividends is NOT double taxation.

Example 2, the federal government caps the deductibility of state taxes. An individual earns $1e6 of taxable income. The state they live in taxes them at x% after a $d deduction. The federal government taxes them at y% after a $e deduction. Individual owes $(1e6 - d)*x to the state and $(1e6 - e)*y to the federal government. Total owed = $1e6*(x+y) - (dx + ey). Let x = y = 1. Individual owes $2e6 - (d + e). Let's be very generous on the deductions, d = e = $100k. Individual owes $1,800,000 tax even though they only earned $1,000,000 income. This is double taxation. So yes, the Republican party full of whiners about "dividends are double taxation" (which it's not) unilaterally passed federal income tax law that actually IS double taxation.

 

[hcsharp]

Isn't the death tax by definition double-taxation? Other than not double-taxing unrealized gains at death, isn't the rest of the estate tax a double-tax?

tl; dr summary: The estate tax is not double taxation, It is the most economically efficient tax that we currently assess, and is arguably the most fair. Most of what you've heard about it from politicians is probably not true.

When you consider that the vast majority of assets in most taxable estates is appreciated property that's never been taxed then it's clear the estate tax is NOT double taxation. Besides, once you are dead you don't pay taxes. The estate tax is effectively a tax on your heirs on the money they receive from your estate. The vast majority of estates are never taxed due to the large exemption. And those that are taxed contain mostly appreciated assets that have never been taxed in the first place. Where's the double taxation?

As far as tax policy is concerned, virtually every economist, especially those who specialize in taxation, regardless of political stripes, will tell you that the most efficient tax that we have is the estate tax. In this case "efficient" means it has the lowest impact on the economy for every dollar raised. Transaction taxes (such as capital gains) reduce economic efficiency by depressing asset sales that otherwise make economic sense. Income taxes reduce the incentives to generate income. Estate taxes, on the other hand, reinforce one of the most important aspects of our economic system. That is the fundamental concept (whether completely true or not) that every person has the same opportunity to succeed by innovation, hard work, or engage in whatever activities you believe will generate the most value. In other words, a system that rewards productivity. Is it a good idea to reward people who have done nothing more for our economy than to be born into the right family? No. In fact that policy has proven time and time again to be a destructive element of almost every economic system that uses it. Money and power should be transferred based on merit, not family ties. Much economic research suggests that estate taxes actually increase the amount of productive investment.

These facts support the arguments that we should lower the floor (exemption) much lower than it is, and raise the rates substantially.

I could continue with multiple examples but time, death, and taxes are catching up with me.

 

[juliusa]

When you consider that the vast majority of assets in most taxable estates is appreciated property that's never been taxed then it's clear the estate tax is NOT double taxation.

Is the converse true - if we tax appreciated property, and the remainder with an estate tax, that would be double-taxation? Death tax on non-appreciated property is a double-tax?

Government will steal money through taxation at death one way or another. I'm simply saying let them steal it with a higher death tax rather than remove the step-up in basis as a simplified way of stealing the same amount of money. Getting the cost basis for all assets accumulated over the lifetime of someone that is dead is often difficult.

 

[hcsharp]

Is the converse true - if we tax appreciated property, and the remainder with an estate tax, that would be double-taxation? Death tax on non-appreciated property is a double-tax?

Government will steal money through taxation at death one way or another. I'm simply saying let them steal it with a higher death tax rather than remove the step-up in basis as a simplified way of stealing the same amount of money. Getting the cost basis for all assets accumulated over the lifetime of someone that is dead is often difficult.

I agree that removing the step-up in basis is problematic and a strong estate tax is a much better approach. The estate tax is effectively a tax levied on the income to the heirs of the estate. It's not a tax on the decedent (who is dead at that point). From that perspective it's not possible that any of it could be double-taxation.

It's also true that taxing unrealized capital gains is usually bad tax policy, unless you consider the estate tax to be that. Janet Yellen knows this and I suspect her statements were misinterpreted.

 

[juliusa]

The estate tax is effectively a tax levied on the income to the heirs of the estate. It's not a tax on the decedent (who is dead at that point).

Isn't the death tax levied on the estate, at a rate determined by the size of the estate, and paid by the estate? If it were a tax on the heirs, wouldn't the heirs pay the tax?

That would be another way of taxing - an inheritance tax instead of an estate tax. My guess is if they create an inheritance tax it will be in addition to the death tax - seems taxes, like regulations, are always added and never go away.

 

[UrsS]

What about taxing every financial transaction with something like 1/100 of 1%? Deducted by the broker at the time of the transaction.
You sell $10,000 of stock and you pay $1 in taxes, you buy some other stock with that $10,000 and you pay another $1 in taxes.

 

[juliusa]

No limit to the creative ways the government can steal your money.

But I think this thread was more about taxing unrealized capital gains during a person's lifetime and at death.

 

[Uncle Paul]

Yellen claims that not taxing unrealized stock and RealEstate value gains would be like not taxing personal income from employment if you did not yet cash your paycheck

Newly elected officials have lots of places they want to spend money. They want to begin spending as quickly as possible for their projectrs, before resistance can get organized. Only way to get all that money will be either to borrow it (let the kids pay for it) or increases every tax they can. You can see this happening in more Socialistic communities, where the taxes are much higher than the USA, and the government gives more services in exchange (No charge health care, subsided mass transportation, larger governments with better paid employees etc.)

Not making an argument which system is better, but for years many governments have been using a combination of debt plus taxes to provide for their expenses.

Governments tend to spend more than they have coming in. They have relatively little income they earn themselves, so all programs they enact must be paid for with either Taxes or debt on their citizens. Politicians spend lots more time on increasing their spending than in making decreases.

 

[Uncle Paul]

Boomers have been highly successful in building substantial estates. They want to pass this down to their families, while of course the government would like all that money transfered to them on death. The kids want that money to pay off their student loans, buy a house, start a business or start a family. Then they will want to pass some of it to their own kids to keep them from poverty.

People with poor parents want the wealthy taxed heavily. People with wealthy parents would like to get that as an inheritance.

 

[Beltsbear]

This is just posturing to impress some constituents and get a better bargaining position for other things. There absolutely will not be a unrealized capital gains tax. There could be a tax on stock transactions.