Potential Constitutional Challenge: Biden Budget Proposes Mark-to-Market Valuation for High Net Worth Individuals | Cadwalader, Wickersham & Taft LLP

In his State of the Union address, President Biden called on all Americans to pay their “fair share.” The Treasury Department General explanations of the administration’s revenue proposals for the 2024 financial year (the “Green Paper”, available here) contains several proposals aimed at achieving this objective. A significant proposal would be to impose a minimum tax (with a built-in mark-to-market component) on high net worth taxpayers, essentially departing from the historic tax norm requiring a realization event. Other proposals take a more traditional approach to revenue collection by adjusting tax rates and eliminating preferential treatment of capital gains.

As previously reported here, various legislative proposals targeting high net worth individuals have been introduced at the federal and state level in recent years. See, for example, recent New York State legislative proposals to raise personal income tax rates here and here. The Green Paper continues this trend by making various proposals based on gradations of a taxpayer’s income or net worth. As explained in the Greenbook, some of the most notable proposals from the Biden administration would be:

  • Impose a minimum 25% income tax (with a mark-to-market component built in) on taxpayers with net worth over $100 million. This proposal would eliminate the deferral of income on unrealized gains for reporting taxpayers by effectively forcing periodic mark-to-market valuation without any realization event for appreciated assets. While illiquid assets would not require annual valuations, correlative rules would provide estimates, which would be used between actual valuation dates. In the first year, the taxpayer could pay his tax in nine equal installments. The minimum tax paid would be deducted from future regular taxes paid on the taxpayer’s income (which would include income generated by actual realization events in respect of the appreciated assets).
  • Eliminate capital gains rates for high earners and defer gains on certain gifts or transfers upon death. This proposal would tax long-term capital gains for taxpayers with income over $1 million at the top ordinary tax rate (For example, thereby increasing the marginal tax rate on capital gains from 23.8% to 40.8%, each including tax on net investment income). The proposal would also trigger a gain on certain gifts or transfers on death, which historically have been treated as non-recognition events. It is important to note that by treating death as a recognition event, the proposal would effectively eliminate a taxpayer’s ability to exempt assets whose value has appreciated from income tax using the so-called rules gross-up basis whereby the adjusted basis of a deceased person’s property in the hands of a transferee is increased to its fair market value at the time of the deceased’s death.
  • Extend the Net Investment Income Tax (“NIIT”) and increase it to 5%. This proposal would broaden the base of the NIIT, thereby limiting the use of flow-through entities to eliminate the NIIT of 3.8% on an owner’s income (For example, limited partners effectively claiming statutory self-employment tax exemptions on partnership distributions). Additionally, a separate proposal would increase the NIIT from 3.8% to 5% for taxpayers with more than $400,000 in income (the 3.8% rate would still apply to taxpayers with more than $200,000 in income). but less than $400,000).
  • Increase the top marginal tax rate from 37% to 39.6%. This proposal to increase the top marginal tax rate could further exacerbate the tax liabilities of high earners depending on whether other Biden tax proposals were also passed, such as eliminating capital gains rates for high earners. revenues, as well as the expansion of the NIIT.

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