Tax the rich has become a rallying cry for progressives highlighting issues of inequality in the U.S., but only in the last few years has the idea of a wealth tax truly permeated the public discourse.
Just last week, the Biden administration revealed a Build Back Better framework that proposes a new surtax on high-income taxpayers and other tax code reforms to pay for $550 billion of spending related to climate change, the extension of the expanded Child Tax Credit, free preschool and more for a package totaling $1.75 trillion.
Taxes on the wealthy could come in various forms, often aiming to close loopholes and tap into unrealized gains that could otherwise escape taxation. Today, the wealthy few can avoid paying taxes by following a strategy that Greg White, CPA and adjunct professor at Golden Gate University, summarizes as “buy, borrow, die.”
“In America, we have this realization system, which means that until you actually sell your stock, you don’t have to pay tax,” White says. “You need cash to be a billionaire, you want to buy yachts and jet set around, but really wealthy people borrow money instead of selling stock. They don’t take wages, because people who take wages have to pay ordinary income taxes, which are higher than the capital gains taxes they pay when they do sell stock.”
Frank Clemente, executive director of Americans for Tax Fairness, says only in recent years have Americans become widely aware of the ways billionaires avoid paying taxes, and that awareness, he says, can, in part, be traced back to the 2020 Democratic primaries.
“There was Bernie’s plan, Warren’s plan, Biden had a plan, Bloomberg had a plan — all the Democrats were saying they wanted to tax wealth like work, and we’d never seen that before,” Clemente says. “It’s really only been the last two years that this has been a significant public debate. It’s certainly been a debate among academics and think tank type people, but not like this until recently.”
Examples of strategies to tax the rich include:
— Add a surtax for wealthy individuals.
— Increase ordinary income and capital gains tax rates.
— Create a tax on net worth (the billionaire tax).
— Increased IRS funding aimed at improved enforcement.
— Eliminate the step up in basis.
— Suspend the backdoor Roth IRA.
Some of these efforts to tax the wealthy found their way into the final bill framework announced last week, but most didn’t. Before writing them off, however, Jeff Levine, chief planning officer, Buckingham Wealth Partners, says the push to tax the rich doesn’t end with Build Back Better.
“The two biggest things the average taxpayer should know is No. 1: You largely got away unscathed and this is going to impact you quite minimally,” Levine says. “No. 2: The provisions on retirement counts, like the backdoor Roth, appear to be left out of this but we’ve got the SECURE Act 2.0 coming up later this year or next year, and there is bipartisan support for that. I could see some of these things getting tossed back in or making their way into something else in the future.”
Add a Surtax for Wealthy Individuals
The Build Back Better framework released Oct. 29 includes a new 5% surtax on modified adjusted gross income above $10 million and an additional 3% surtax on modified adjusted gross income above $25 million. This surtax, applied in addition to the existing maximum ordinary income tax rate of 37%, aims to hit multimillionaires and billionaires.
In addition, the bill would close a loophole that allows some taxpayers to avoid the 3.8% Medicare tax on their earnings.
Totaled, the top federal tax rate would be: 37% + 5% + 3% + 3.8% = 48.8%.
Increased IRS Funding Aimed at Improved Enforcement
Proper enforcement is necessary to carry out changes to the tax code. The Build Back Better framework allocates an additional $44 billion to the Internal Revenue Service over the next decade to support enforcement efforts.
Increase Ordinary Income and Capital Gains Tax Rates
Excluded from the final bill text released last week is an increase to ordinary income tax rates and capital gains tax rates.
Earlier proposals included an increase in the top income tax rate from 37% to 39.6% with the top tax bracket starting at $400,000 for individuals and $450,000 for married couples filing jointly. Democrats also considered an increase to top long-term capital gains tax rates from 20% to 25%.
Create a Tax on Net Worth (the Billionaire Tax)
A tax on wealth functions by taxing asset gains before the gain has been realized.
For example, White says, “Let’s say at the end of the year, Elon Musk’s stock was worth $100 million and at the beginning of the year it was only worth $90 million, so it’s gone up $10 million in value. He’d pay tax on that $10 million even though he hasn’t sold the stock yet.”
This method of taxing the rich could be highly effective at tapping into wealth otherwise shielded from taxation, but critics note that a wealth tax could be difficult to implement and possibly unconstitutional.
“I’m bearish on a true wealth tax. It’s a perfectly legitimate thing to say wealth inequality needs to be addressed,” Levine says, however, “I am confident a wealth tax would not pass constitutional muster. Let’s say somehow it did, it also from an operational perspective would be a complete and total nightmare.”
Eliminate the Step Up in Basis
The step up in basis allows individuals to pass certain assets to their heirs when they die without having to pay capital gains tax. Instead, heirs who receive an inheritance consisting of assets like a house purchased for $500,000 and now worth $5 million would avoid capital gains taxes on the $4.5 million of appreciation.
In an effort to tax the wealthy, President Joe Biden proposed eliminating the step up in basis for gains in excess of $1 million or $2.5 million for couples.
Suspend the Backdoor Roth IRA
Closing the backdoor Roth IRA and mega-backdoor Roth IRA option is the one strategy that could affect the most Americans, as it could hit not just billionaires but also upper-middle-income and upper-income households.
Roth IRAs limit direct contributions from high-income individuals — defined in 2021 as those earning more than $140,000 for single filers and $208,000 for those married filing jointly. However, using maneuvers like the backdoor Roth and mega-backdoor Roth allow high earners to fund a traditional IRA using after tax dollars, then convert those contributions to a Roth and potentially avoid paying taxes on the conversion.
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