Alternative Minimum Tax, Tax on unrealized capital gains

Tax reform should simplify the tax code. Instead, Congress is debating new ways to increase revenue that would make the tax code more complex and more difficult to administer. The new proposals – impose an alternative minimum tax on corporate accounting income, apply an excise tax on share buybacks, levy a surtax on top earners and, at some point this week, a tax on top earners. – latent values ​​for billionaires – are unreliable and highly complex ways of generating income.

Instead of relying on complicated ways to generate revenue, lawmakers should prioritize broadening the tax base and eliminating tax expenditures unrelated to cost recovery, international taxes and deferral. Income increases can be structured to improve the tax code by making it simpler and more neutral across industries and households.

Alternative minimum tax on corporate accounting income

A proposal announced this week is an accounting minimum tax that would require companies making at least $ 1 billion in profits per year to pay at least 15% of their accounting profits in taxes. According to the legislative description released by Senator Elizabeth Warren (D-MA), the tax could apply to approximately 200 businesses. The proposal is the latest of several taxes linked to book revenue, such as the minimum book tax proposed by President Biden earlier this year, as well as the surtax on book profits that Sen. Warren included in his presidential campaign platform.

There are two main ways of calculating business profits, generally defined as revenue minus costs. The first is to use financial accounting rules, designed to match deductions from costs to the income that the expenditure will generate, which will produce accounting income. The second is to use tax laws enacted by Congress designed to increase revenues from government activities and encourage or penalize certain behaviors, producing taxable income. The two approaches result in different measures of company profits and in some years result in some companies not paying tax even though they had book profits.

There are two main types of policies that can create differences between accounting income and taxable income. The first type is structural, such as faster deductions for physical capital investments that more accurately measure a company’s profits based on cash flow. Another common example is deductions for past losses to ensure that companies are taxed on profitability over time and not penalized for losses that do not match calendar years.

The second type of policy that creates tax differences on the books are tax subsidies or deductions and credits that Congress has adopted to encourage or discourage certain behaviors. These include policies such as the research and development (R&D) tax credit, the low-income housing tax credit (LIHTC), various credits for renewable energy and other tax breaks.

Unfortunately, the minimum book tax would limit the use of full and immediate deductions for the cost of the investment, while explicitly protecting the tax subsidy provisions. The plan would preserve the use of many types of credits under the accounting minimum tax, but would ban accelerated deductions for physical investments. There are several ways to reduce favoritism in the tax code, but the accounting minimum tax would severely disadvantage investments while keeping targeted subsidies in place, meaning that some companies with large financial profits would still not pay any money. taxes.

Excise tax on share buybacks

Another proposal under consideration would impose a 1 Where 2% excise tax on the value of shares that companies buy back net from shareholders, with some exceptions for shares paid into retirement accounts and stock-based compensation.

While intended to encourage companies to invest the cash used to buy back shares, the tax would not create additional investment opportunities for companies. Investments are continued based on their expected after-tax returns, not on the amount of additional cash available to companies.

When companies have excess liquidity, they can either return it to shareholders or keep it. Return of money can provide shareholders with liquidity to invest in more productive alternative investments. Taxing share buybacks would not encourage investment or raise wages, and would instead be a distraction from better ways to reduce the cost of making new investments, such as allowing companies to receive a full and immediate deduction. for these expenses.

An excise tax on share buybacks can also affect a company’s decision to issue dividends, which is another way for companies to send money to shareholders. It can also reduce the frequency and extent of share buybacks, thereby reducing the amount of income collected. Share buybacks can vary over time, making the excise tax an unreliable source of revenue to finance social spending.

Billionaire market value taxation

Under current law, an increase in the value of an asset, such as a stock or private company, is not taxed as the value increases; instead, it is taxed when an investor sells it for a profit and realizes a gain. The proposal for a “billionaires’ income tax” (which is now out of debate) would change this system for taxpayers with at least $ 1 billion in assets or who report $ 100 million in adjusted gross income (AGI ) for three consecutive years, such as unrealized gains, or “paper gains”, would be subject to capital gains tax through a mark-to-market system.

These taxpayers would be subject to a single transitional tax on existing unrealized gains payable over five years, which would represent a significant increase in income. In the future, however, mark-to-market would be a less stable source of income, as capital gains are a very volatile source of income, increasing and decreasing depending on the health of the economy and the market. other factors.

For example, if a billionaire started a business 20 years ago that has reached $ 3 billion in value today, he or she would have to pay a one-time transitional tax on that increase in value. (The proposal would allow $ 1 billion in shares of a single company to be treated as non-negotiable in an attempt to provide protections for business founders.) At the capital gains tax rate Current 23.8%, the tax bill on the $ 3 billion gain would be $ 714 million, spread over five years. Or, if the billionaire used the option of treating $ 1 billion in stocks as non-tradable, $ 2 billion of the gain would be subject to an immediate tax of $ 476 million spread over five years.

Going forward, publicly traded assets would be taxed annually on their increase in value, and non-traded assets would be subject to almost equivalent recovery costs when they are transferred, sold or when the taxpayer dies. Taxpayers with losses could carry them back for three years to offset past unrealized gains or carry them forward to offset future unrealized gains. In years when stock prices fall, this could mean the government is reducing rebate checks to billionaires as the value of their assets declines and they offset past taxes to mark-to-market, making the unreliable tax base.

To prevent avoidance, lawmakers have devised several enforcement rules such as lower tax thresholds for trusts and limits on the use of zones of opportunity established in 2017. It will be administratively costly anticipate and prevent taxpayer avoidance while measuring changes in asset values ​​each year.

Taxing earnings as they accumulate can also lead to situations where taxpayers do not have the cash or cash flow to pay their tax bill in any given year. This is of particular concern in the case of companies founders who may have to sell shares, and potentially lose control of their business, in order to foot the tax bill. It could also create market instability for owners of US stocks.

More broadly, the proposal would increase the tax burden on American savings. As domestic savers reduced their savings, this would be partially offset by foreign savers. US income could fall, as the income from these savings would instead be returned to foreigners.

Surtax on high income earners

The White House and House Rules Committee have proposed a new 5% surtax on modified adjusted gross income (MAGI) above $ 10 million, and an 8% surtax on MAGI above $ 25 million . It is similar to the surtax proposal in the original Build Back Better Act, but applies to a higher income threshold and charges higher rates.

While the ordinary income tax regime applies the schedule of tax rates to taxable income, the surcharge applies to MAGI, which is calculated before itemized deductions. This means that the surcharge cannot be reduced by taking larger itemized deductions, such as charitable contributions and state and local taxes paid, or by the pass-through deduction in Section 199A.

The surtax would bring the highest ordinary tax rate to 48.8% between 2022 and 2025 by including the net investment income tax (NIIT) of 3.8% and to 51.4% after 2025 when the the highest regular rate would drop from 37% to 39.6%. It would also bring the top marginal tax rate on long-term capital gains and eligible dividends to 31.8%.

Despite claims that tax rates on ordinary and skilled income are not raised in the package, the surtax would lead to a sharp increase in top marginal tax rates for high-income households. In combination with the proposed change to apply the 3.8% NIIT to income from active businesses, this proposal would result in much higher top rates on unincorporated business income (which is reported and taxed on tax returns). personal income) versus higher rates on corporate income – a differential that can distort the choice of some businesses to become C corporations or flow-through entities.

Using MAGI for the surtax base also introduces more complexity into the tax code, as taxpayers have to calculate their tax payable using taxable income and AGI.

Launch Resource Center: President Biden’s Tax Proposals