Proposals for new taxes on the wealthy and the 2024 election

For financial advisors and tax professionals, potential changes to federal tax laws may represent one of the most important yet least talked-about issues looming in this year’s election.

The next occupant in the White House and the party controlling majorities in Congress will decide which of the many expiring provisions of the 2017 Tax Cuts and Jobs Act will stay in place after 2025 and whether Washington lawmakers will follow through on any of the frequent pledges from Democrats to raise taxes on the wealthy or ultrawealthy. Amid that backdrop, the industry and its clients are waiting on a Supreme Court decision later this year in a case that some conservatives hope may render the latter effort and many existing taxes unconstitutional.

To get a sense of the prospects for new levies on billionaires or other wealthy people often hiring industry professionals to manage their taxes or investments, Financial Planning spoke with three experts from nonpartisan organizations: Steve Wamhoff, the federal policy director of the Institute on Taxation and Economic Policy; Erica York, the senior economist and research manager with the Tax Foundation’s Center for Federal Tax Policy; and John Buhl, the senior communications manager with the Urban-Brookings Tax Policy Center. None of them expect Congress to act on taxes this year. But they each shed light on the proposals to watch.

“There are a huge amount of unknowns,” Buhl said in an interview, role-playing what he would tell wealthy clients as an advisor working for them. “You can expect people are going to raise your taxes, I just don’t know how or when.”

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Taxing unrealized income?
Two plans floated by Democrats — the “billionaires income tax act” from Sen. Ron Wyden of Oregon and the “billionaires’ minimum income tax” from President Joe Biden — would focus on ultrawealthy Americans’ unrealized income, according to a detailed report on them written by Wamhoff. In order to raise around roughly half a trillion dollars in revenue over the next decade, the measures would impose new taxes on certain assets before the realization of capital gains for some of the wealthiest households. Without getting too deeply into specifics, the proposals may hit those with $100 million in income or assets and would definitely tax the billionaires.

Asked in an email how these policies may affect the investment behavior of the ultrawealthy, Wamhoff said that they may perhaps donate more money to charities but he doubts that “the impact would be dramatic.” After spending on yachts, private jets or other luxury items, they will “at some point” no longer find any way “to consume that income and wealth, and it will be invested,” Wamhoff said.

“Both proposals are generally designed to have the same effect on unrealized gains regardless of what types of assets the taxpayer has,” he said. “It is true that, under both proposals, the gains on certain assets would be treated differently technically, and the rules are supposed to ensure that the result is roughly the same. Under Wyden’s proposal, the gains on non-tradable assets would not actually be included in income each year because they are difficult to value, so the taxpayer could defer the tax until selling the asset and then pay the tax plus a deferral charge that is meant to generally offset the benefit of deferring the tax. But perhaps some taxpayers figure that if they hold these kinds of assets they could defer the tax in the hopes that a future Congress will repeal the whole thing and they’ll never have to pay it. But even this is difficult to imagine taking place very often. Jeff Bezos is not going to shift dramatically to non-tradable assets in the hopes that Congress will repeal this tax in the future.”

Taxing unrealized income comes with “steep administrative and compliance costs, without serving as a stable source of revenue for the government because of the volatile nature of the stock market,” according to York. Citing “enforcement challenges” for the IRS and the expense to the agency and taxpayers, York argued in an email interview that the burdens “would significantly outweigh the additional revenue that would be raised.”

Other notable ideas for higher taxes on the wealthy from recent years include a Biden plan to hike the top federal income tax bracket to its previous level of 39.6% from 37% under the 2017 tax cuts and proposals to raise the capital gains rate from as much as 23.8% to something closer to the level assessed against wages, she noted. The tax system works in a more progressive way than some may think, York said. As evidence, she cited IRS data showing that the top 1% of taxpayers pay rates eight times as high as the bottom 50% and that the top half of households shell out nearly 98% of individual income tax revenue at the federal level.

“Many of the proposals are aimed at a common misconception that our current tax code is not progressive. They’re often also based on a more subjective argument about making the rich pay their fair share,” York said. “Another common reason for raising taxes on high earners is to offset the cost of new spending programs. However, there are limits to how much revenue can be raised by taxing a small segment of the population. It is not realistic to expect higher taxes on a narrow group to pay for significant expansions in government spending, let alone solve the already $2 trillion annual budget deficit.”

READ MORE: A tax on ‘unrealized’ income? A test for wealth laws at the Supreme Court

The big picture
Another Biden-backed idea to close the loophole for untaxed “step-up” appreciation in basis for large inheritances went through many different versions during the debate on the administration’s infrastructure plans, Buhl noted. Despite exemptions for small businesses and family farms, there was “a lot of pushback, even from the center left,” he said. Additional ideas have sought to tax some financial transactions, alter estate rules or introduce new duties at the state level. 

Current discussion of higher taxes on the wealthy continues to be a prominent debate that is nonetheless “stuck in this political loop of slippery slope theories,” Buhl said. The simple fact remains that “the world does not look the way it did when we first put the income tax in place” more than 100 years ago, he noted.

“We need to have a very clear, thoughtful discussion about the pros and cons,” Buhl said. “There are plenty of ways to do this. I just know that none of them are easy. That doesn’t mean we shouldn’t do it. … Policy is always about tradeoffs.”

The arguments at the Supreme Court last month in Moore v. U.S. suggested that the justices are “hesitant to call into question the constitutionality of existing law, but it’s unclear how far that concern extends,” Wamhoff said. 

“There is a real danger that the conservative justices on the Supreme Court could, frankly, abuse their power and interpret the 16th Amendment of the Constitution in a way that defies common sense,” he said. “The plaintiffs in this case are trying to convince the justices that the 16th Amendment’s grant to Congress the ‘power to lay and collect taxes on incomes, from whatever source derived’ is limited to income that meets some definition of ‘realized’ income mentioned nowhere in the Constitution. And the justices might fall for it and issue a ruling using reasoning that could be used to strike down the proposals that Wyden and President Biden are talking about to limit tax breaks for unrealized capital gains going to billionaires.”

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The upshot
Besides watching for the ruling from the Supreme Court in late spring or early summer, the industry and its clients will have their sights set on December of next year, York noted.

“Given divided control in Congress and that it’s an election year, proposals to increase taxes on higher earners will not make it into law in 2024,” she said. “After the end of 2025, taxes on virtually all Americans are scheduled to rise when the 2017 tax cuts sunset. Whether policymakers allow the tax increases to take place or whether they increase taxes further will ultimately depend on the makeup of Congress and who sits in the White House.”

For advisors and tax professionals, the many policy questions lead to a simple conclusion, according to Wamhoff.

“Taxes for ultrahigh net worth individuals have always been complicated,” he said. “We can have simple tax rules, in which case these individuals will continue to engage in complicated transactions to pay as little as possible in taxes. Or we can have more complicated rules to block these techniques, so we end up with more complex rules but fewer convoluted transactions used to avoid taxes. Either way, there’s plenty of work for financial advisors and wealth managers.”