News & Events


December 16, 2019

                                                                    By: Dudley Kimball and Bob Morgan

The wealth tax proposed by Senator Elizabeth Warren, a leading candidate for the Democratic presidential nomination in 2020, represents a new direction for United States taxation. Several other Democratic candidates, including Senator Bernie Sanders and Tom Steyer, also support a wealth tax, although their versions differ in certain respects from Senator Warren’s proposal. Other Democrats, such as Mayor Pete Buttigieg, have said that they are open to a wealth tax. This newsletter focuses on Senator Warren’s version.

At the outset it should be noted that Senator Warren’s proposal and certain components thereof will affect many taxpayers who are not ultimately subject to the tax. It is useful, therefore, for all well-to-do taxpayers to have a general understanding of the tax.

If enacted as currently proposed, Senator Warren’s wealth tax will impose a 2% annual tax on a taxpayer's net worth in excess of $50 million and a 6% annual tax on so much of a taxpayer’s net worth as exceeds $1 billion. A taxpayer’s net worth will be calculated by reference to all assets held anywhere in the world, including all bank accounts, equities, bonds and other financial instruments, residences and other real estate, closely held businesses, retirement assets, assets held in trust, assets held by a spouse and minor children, and art work and other personal property with an aggregate value in excess of $50,000. It is possible that other assets will also be taken into account, such as assets held in a private foundation over which the taxpayer retains any form of control and assets held by certain family members other than a spouse and minor children.

The tax can be substantial. For example, a taxpayer with a net worth of $100 million would have an annual wealth tax of $1 million, or 2 percent of net worth over $50 million. A taxpayer with $2 billion in net worth would have an annual wealth tax of $79 million, with $19 million of the tax being attributable to $950 million of net worth and $60 million of the tax being attributable to net worth in excess of $1 billion.

Since the wealth tax is imposed annually, a taxpayer’s assets will need to be valued each year. In addition to being an expensive and time consuming process, the annual valuation will inevitably create much room for argument about the current value of hard to value assets, including, for example, interests in closely held businesses, trusts, real estate, and art work. In addition, many taxpayers will be compelled to get an annual valuation in order to prove that their net worth falls below the $50 million threshold and that they are not, therefore, subject to the tax.

Senator Warren has indicated that she favors tightening the rules on valuing illiquid assets, such as stock in a closely held corporation. It is possible, therefore, that discounts due to minority ownership interests and lack of marketability will be eliminated or curtailed. Changes to the discount rules, as well as other possible changes, are likely to increase dramatically the number of taxpayers exposed to the wealth tax. Such changes would also apply to the valuation of assets for estate tax purposes, increasing the exposure to that tax as well.

Taxpayers whose wealth is primarily tied up in illiquid assets may have difficulty paying the tax. Senator Warren’s proposal will permit taxpayers to defer payment of the tax for up to five years, although interest will be charged. There has also been discussion of allowing taxpayers to pay the tax in kind by transferring ownership of illiquid assets to the government. There are innumerable problems with such an approach. Many assets, such as interests in a trust, cannot be transferred, and other interests, such as stock in a closely held corporation, might be transferable but presumably would not be of interest to the government. This approach also poses an interesting dilemma for the government, which could find itself arguing for a high valuation of illiquid assets to increase the tax but for a low valuation of the same assets to ensure that it gets more of them in payment.

To enhance compliance, Senator Warren is proposing several initiatives. She is calling for a significant increase in the enforcement budget of the Internal Revenue Service and a minimum audit rate for well-to-do taxpayers. She is also calling for more comprehensive, systematic third party reporting of asset ownership worldwide. Needless to say, all of these proposals will be intrusive and ensure much more governmental involvement in a taxpayer’s affairs than the income tax.

A wealth tax will, of course, prompt wealthy individuals to consider expatriation. Current law imposes a so-called “exit tax” upon expatriation, subjecting certain types of income such as unrealized capital gains and deferred compensation to tax. Because the current exit tax is unlikely to deter those who want to avoid the wealth tax, Senator Warren is proposing an immediate 40% tax on an expatriating individual’s net worth. Such a prohibitive tax may well have the desired effect and discourage expatriation.

A wealth tax poses many issues. First, the tax might not be constitutional. The U.S. Constitution requires that a federal “direct" tax (for example, a tax on real estate) must be apportioned among the states in proportion to their populations. For example, if a state has 12% of the U.S. population, then no more than12% of the revenue from a direct tax must come from that state. Given the concentration of wealth in states like California, New York, Connecticut and Florida, it is unlikely that wealth tax revenue percentages will match population percentages. Legal experts disagree as to whether a wealth tax is a direct tax, but if it is, it is almost certainly unconstitutional. If Congress were to pass a wealth tax, this issue will undoubtedly be litigated all the way to the Supreme Court.

Second, a wealth tax must be structured so as to limit exempt asset classes and a taxpayer’s efforts to disguise de facto ownership of assets through various machinations. The result, of course, will be complicated anti-avoidance rules and increased cost and decreased efficacy of enforcement.

Third, a wealth tax may alter investment habits, especially for taxpayers with a net worth in excess of $1 billion. If a 6 percent annual return is required just to maintain the same level of wealth after payment of the tax as before, affected taxpayers might turn away from low risk investments such as U.S. treasuries and municipal bonds in favor of higher risk, higher return investments such as private equity, a course that pension funds have already taken. Such a change might adversely affect certain markets and create bubbles in others.

Another possible effect is that taxpayers might borrow large sums of money to ensure that their net worth stays under the dollar thresholds at which the tax is imposed. Wealthy couples might also consider a divorce and splitting of assets in such a way that each one stays under the dollar thresholds.

The entry of an entirely new tax into political discourse does not happen often and its arrival can have unpredictable results. A wealth tax may never be enacted, but since it polls well with voters, it may signal a significant increase in other taxes targeting higher income taxpayers. For example, in lieu of a wealth tax, Congress might dramatically hike income tax rates, tax capital gains at ordinary income tax rates, impose a tax on unrealized appreciation, or make major changes in the estate tax, such as increasing the top rate from 40%, reducing the exemption from $11,400,000, and eliminating the step up in basis for appreciated assets. Alternatively, Congress might enact a wealth tax not to support a broad expansion in social programs but to buttress the current social security and Medicare programs.

Other than closely monitoring developments, there is little planning that taxpayers can do to ready themselves for a possible wealth tax. Suffice it to say, however, that if we elect a Democratic President and Congress in 2020, wealthier taxpayers are likely to face large tax increases, irrespective of whether a wealth tax is in the mix.