Wealth Tax – I Wouldn’t Lose Any Sleep Over It

Take-Away: Despite all of the angst caused earlier this year when Senator Elizabeth Warren proposed a wealth tax, it does not look like such a tax will be gaining any traction in the near future.

Background: Senator Warren proposed during her Presidential campaign a wealth tax of 2% on annual wealth tax on wealth in excess of more than $50 million, and a 4% annual tax on wealth in excess of one billion, i.e. a 6% tax on billionaires. Senator Bernie Sanders’ campaign proposal was a wealth tax on household net worth in excess of $32 million, with a 1% tax rate, increasing to 5% over $1.0 billion, and 8% on wealth above $10 billion. Neither of these proposals provided for any exception for real estate or closely held businesses. President-elect Biden adopted neither of these proposals in his campaign, nor has he proposed any wealth tax of his own.

Europe’s Experience with a Wealth Tax: Starting in 1990, twelve European countries adopted some form of a wealth tax. Today, only 4 of those countries have retained their wealth tax: Belgium, Norway, Spain and Switzerland.

• Norway taxes wealth above $174,000, but it includes some assets below their fair market value, e.g. a homestead is valued at 25% of its fair market value; shares in a company are valued at 65% to 75% of their fair market value;
• Belgium imposes a wealth tax on any securities (trading or brokerage) in excess of $543,000 per individual;
• Spain imposes a wealth tax on wealth above $774,000, but it excludes up to $350,000 of value of a primary residence; and
• Switzerland’s wealth tax varies with each canton; all assets, including real estate, are included, but with some allowances and social deductions depending upon which canton is imposing the tax.

The other countries that repealed their wealth tax did so due to the negative economic impact of the tax, limited revenue collections, and the predictable costs associated with enforcing compliance and dealing with clever tax avoidance strategies. By way of example, while France initially adopted a wealth tax, it is estimated that 42,000 millionaires left France between 2000 and 2012, which may explain why its wealth tax was repealed in France in 2018, with the stated goal to entice more foreign investment in the country.

Implementation Issues: A wealth tax is imposed annually. Does that mean that all assets included within the pool of assets that constitute the taxpayer’s wealth must be appraised each year? Maybe. Another concern is that an annually imposed wealth tax could harm taxpayers who derive much of their wealth from illiquid assets like a closely held business, or from real estate, or from illiquid alternative investments, where liquidity will be needed each year in order to pay the wealth tax. As some commentators have suggested, rather than providing economic relief to the country in desperate search of needed revenues, the wealth tax could actually mimic the European experience and actually cause even more economic distress to the country.

Trusts: Even more challenging would be how to assess the wealth tax against an irrevocable trust. Federal tax law usually defers to the states in how property is defined. The Warren and the Sanders wealth tax proposals both indicated that assets held in a trust would be taxed as if owned by the settlor of the trust, until the settlor’s death. The Brookings Institute suggested that a wealth tax be imposed on irrevocable trusts unless the beneficiary of the trust claimed a portion of the wealth tax owned by the trust. Yet, how would a wholly discretionary trust be taxed if the beneficiary’s discretionary interest in the trust is not treated as a property interest? [MCL 7007815(1).] If under the Michigan Trust Code a beneficiary of a discretionary trust has no property interest, how would any wealth tax apply to that beneficiary?

Alternatives:  Senator Ron Wyden, ranking member on the Senate Finance Committee, is working on a proposal that would impose an annual tax on the unrealized investment gains of wealthy individuals, i.e. mark to market. Other proposals floating around Washington are to tax gifts as income to the recipient, imposing a surcharge income tax on annual income above $10 million, along with President-elect Biden’s proposals to increase corporate income taxes, repeal the maximum 37% federal income tax rate under the 2017 Tax Act, and tighten the IRC 199A 20% income tax deduction for small, closely held businesses.

Conclusion: 2021 should prove to be an interesting year for taxes as Congress presumably begins to search for a way to start to pay the projected $8 trillion that will be added to the federal deficit that has resulted from the coronavirus pandemic. There is a pretty good chance that other tax changes will be tried before a wealth tax is considered.