Shining a light on the US billionaire tax proposal

Reports today (28th October) suggest that there is doubt in both the Senate and the House.   Sen. Joe Manchin made statements in opposition to the proposed billionaire’s tax.  House Ways and Means Committee Chair Richard Neal said the idea appeared to be too complex to succeed.

Spanning 107 pages, the US Senate has released a tax proposal that creates a new capital gains tax regime for certain taxpayers. 

Generally speaking, these taxpayers would be the wealthiest in the US, generally applying to those with more than $1 billion in assets or more than $100 million of adjusted gross income (for those taxpayers married filing jointly, but lowered for those filing separately).  

Family enterprises will face challenges in organizing, managing, updating and keeping records of their various investments and ownership structures

There are lower thresholds for trusts, applying an asset test threshold of $100 million and adjusted gross income of $10 million.  Both of these tests – the asset test and income test – are applied on a rolling three-year basis, except that the proposed rules suggest that each test shall be applied by substituting an amount equal to 1/2 for each such a preceding taxable year, in order to terminate the classification as an “applicable taxpayer” or “applicable trust”.  

The lawmakers have proposed creating a new Part V in subchapter E of the Internal Revenue Code. It would be effective starting January 1, 2022.  

 For those who meet either this asset test or income test, they would be characterized as an “applicable taxpayer” (or “applicable trust” as the case may be) and would need to evaluate entities (“applicable entities”) for which they are a significant owner (owning over 5%) and trusts created by them.

 As a broad summary, this new tax regime falls somewhere between an income tax and a wealth tax. It creates a mark-to-market requirement for “applicable taxpayers” (including relevant trusts) and requires that built–in gains be recognized and subject to tax.  

For liquid assets such as publicly-traded securities, the valuation is recognized as being easy to determine. For illiquid assets such as collections, art, and real estate, the rules propose recognizing the gain when the asset is sold but applying an interest charge to the holding in order to approximate this new capital gains tax on what would have been collected in each year of the holding period.

The proposed rules also apply look through rules for entities such as partnerships, S-corporations, and other pass-through entities. While it would not apply to all pass-through entities owned by applicable taxpayers, it would apply to any of where the applicable taxpayer is a “significant owner.” 

An applicable taxpayer is a significant owner if the taxpayer holds a 5% interest in the entity or if the value of the interest is $50 million or more. 

This also applies on a tiered entity by entity basis and is monitored and applied through a new notice requirement. Transfers in trust by an applicable taxpayer are also generally treated as taxable recognition events (unless there is a loss).

Finally, the proposed rules also include a series of limitations on previously tax-free transactions such as special limitations relating to Section 1031 like kind exchanges, Section 351 tax-free contributions to corporations, limitations on the qualified opportunity zone benefits or the benefits provided under Section 1202 for qualified small business stock acquired after today. 

Also, as a concluding provision on page 107, these rules propose additional limitations to the Section 877A expatriation tax regime (the US exit tax applied to covered expatriates) by eliminating the ability of expatriates to defer taxable income.  

These rules will, no doubt, place great emphasis on valuation and factors influencing tiered structures and illiquid assets.  They will also influence investment decisions where they relate to a possible interest charge.  

While it may only apply to a projected small number of actual individuals and their families, it will have a ripple effect throughout society. Family enterprises will face challenges in organizing, managing, updating and keeping records of their various investments and ownership structures. 

The tiered entity rules will present great challenges to investment managers, joint ventures, pooled funds and other collaborative efforts in business and investment developments. 

 Where will the responsibilities fall? We anticipate that trustees and fiduciaries will be tasked with having even greater responsibilities for oversight and valuation.  Greater efforts will also be required of those in a family office, as well as their investment managers to manage each family member’s share of assets and risk of exposure to these new rules.   Additionally, accountants serving family enterprises and individuals who could be classified as “applicable taxpayers” or “applicable trusts” will come under greater scrutiny when calculating a taxpayer’s adjusted gross income.  

Lawyers doing personal planning for current or potential “applicable taxpayers”, their trusts, or entities that could potentially become “applicable entities” will need to anticipate these provisions and navigate appropriately. 

William Kambas is a partner in Withers US private client and tax team