Brief commentary on recent cases, rulings, notices, and related federal tax guidance.
The Billionaire Minimum Income Tax in Biden’s 2023 Budget Proposal
Biden’s proposed “top-up” tax on wealthy individuals would ensure that households worth more than $100 million pay at least 20 percent on their total income, including unrealized gains. This proposal is competing with other proposals that take different approaches to taxing the wealthy, such as Sen. Wyden’s billionaire tax, Sen. Warren’s “Ultra-Millionaire Tax,” and Sen. Sanders’ tax “For the 99.5 Percent.” All of these proposals, however, face challenges in the Senate, particularly from Sen. Manchin who immediately voiced opposition to such taxes when Sen. Wyden offered his proposal. If ultimately taken up by Congress, Biden’s proposal may be altered to address various issues or concerns raised by the proposal.
Under current tax laws, gains are taxable only upon a realization event, such as the sale or other disposition of assets. The appreciation that accumulates while the taxpayer holds an asset is deferred. If the taxpayer has unrealized appreciation at death, the assets receive a basis adjustment that may eliminate federal income tax on the unrealized appreciation.
According to the Department of the Treasury, the preferential treatment for unrealized gains produces an incentive for taxpayers to inefficiently hold asset portfolios primarily for the purpose of avoiding capital gains tax on the appreciation, rather than reinvesting the capital in more economically productive investments. Additionally, Treasury believes that this preferential treatment for unrealized gains disproportionately benefits high-wealth taxpayers.
The proposed “Billionaire Minimum Income Tax” would impose a minimum tax of 20 percent on the sum of taxable income and unrealized gains of taxpayers with wealth greater than $100 million. If such a taxpayer pays less than what is calculated under this proposed tax, then the taxpayer will be required to make an additional payment under this proposal. Payments of the minimum tax will be treated as a prepayment of future taxes, which will be available to be credited against taxes due on realized gains. In the event that uncredited prepayments exceed the amount of taxes due on a realized gain (for example in situations that result in a realized loss, a step-up in basis upon death, or a disposition by charitable gift) refunds will be provided.
The proposal will also create new annual reporting requirements for taxpayers with wealth greater than $100 million. Taxpayers will be required to report the basis of each asset class, the total basis in assets, and the total estimated value of assets in each specified asset class. For tradable assets, value will be based on end-of-year market prices. For non-tradable assets, yearly valuations are not required, but a “conservative floating annual return” (for example, the 5-year Treasury rate plus 2 percentage points) will be used to calculate value between valuations.
Taxation of Cryptocurrencies in Biden’s 2023 Budget Proposal
Biden’s 2023 Budget Proposal provides a number of tax reforms, including several changes to the taxation of cryptocurrencies and other digital assets. These tax reforms include proposals for expanding current regimes to include digital assets and expanding reporting requirements. As with the Billionaire Minimum Income Tax discussed above, each of these proposals may be materially altered before they become effective, if they do become effective at all.
Lending of Digital Assets
The first proposal expands the rules regarding the lending of securities to include the lending of digital assets. As a common practice in the securities market, an owner of securities will lend their securities to a person wishing to take a trading position on the security (for example, to short the security as a hedge for another position or as a bet in the anticipated fall in price). If the loan meets certain requirements, a loan of securities is generally tax-free.
The proposal would expand the current loaned securities rules to apply to loans of actively traded digital assets recorded on cryptographically secured distributed ledgers. The Secretary would have authority to determine when a digital asset is actively traded, and the authority to extend the rules to non-actively traded digital assets.
Expanded Reporting Requirements
The second proposal includes the expansion of two reporting regimes. A broker’s reporting obligations, which were expanded with regards to digital assets in the Infrastructure Investment and Jobs Act of 2021, would be expanded to require brokers to report information relating to the substantial foreign owners of passive entities that hold digital assets. If adopted, the proposal would allow the U.S., pursuant to an international automatic exchange of information framework, to share information with appropriate partner jurisdictions and, in return, receive information on U.S. taxpayers that engage in digital asset transactions outside the U.S.
Additionally, the reporting requirements for individuals who hold an interest in certain specified foreign financial assets would be expanded to include foreign digital asset accounts. A foreign digital asset account would be defined based on where the digital asset exchange or digital asset service provider is organized or established. If a U.S. taxpayer hold an account maintained by a foreign exchange or foreign service provider, then the taxpayer will be required to file a Form 8938 with respect to such an account.
Mark-to-Market for Dealers and Traders
The third proposal expands the mark-to-market rules for dealers and traders to include digital assets. Current tax law requires dealers in securities to use the mark-to-market method of accounting for inventory and non-inventory securities held at year-end. Alternatively, dealers in commodities and traders in securities or commodities may elect to use the mark-to-market method. This proposal would expand the election to use the mark-to-market method to dealers and traders of actively traded digital assets and derivatives on, or hedges of, those digital assets. The Secretary would have the authority to determine which digital assets are treated as actively traded.