“When you buy something for one price, and later sell it for a higher price, that’s called a “capital gain.” In tax lingo, you “realize” a capital gain when you ultimately sell the asset. If the asset gains in value without you selling it (e.g., a stock you own rises in price), those gains are “unrealized.”
The capital gains tax in the US has a “realization requirement”: You have to actually sell the asset to be taxed. This creates an easy way for rich people to avoid taxes, by simply waiting to sell.
Imagine a 20-something who starts an internet company called FriendCo with his college roommates. Let’s call him Mark. (While I’m obviously basing Mark on somebody real, I’m going to simplify the real numbers a lot to make it easier to follow.)
At FriendCo’s founding in 2004, Mark and his four roommates each took 10 percent of the company, with the other half to be sold to investors. At the start, their shares were worth $0. But their website took off fast and soon had 1 billion users. The company went public in 2012, at a market value of $100 billion. Mark and his roommates’ shares were worth $10 billion each.
At this point, the company stands still and remains worth $100 billion forevermore (I told you I was going to simplify).
If Mark sells all his shares in 2012 after the company goes public, he’d pay taxes on the amount that the shares increased. They were worth $0 at first, and are now worth $10 billion. The top rate on capital gains in the US is 23.8 percent, so he’d pay $2.38 billion in taxes.
Suppose, instead, Mark decides to keep all his shares until he retires 40 years later, in 2052. Assuming the tax code doesn’t change, he’d still pay $2.38 billion. That, right there, is the problem.
Being able to pay a tax bill decades in the future, instead of right now, is a huge benefit. If I told my landlord that I would prefer to pay my rent 40 years from now, she would not find that very amusing. At the very least she would demand that I pay a lot of interest for paying so late. Other big purchases, like houses and cars, usually do involve paying a ton of interest in exchange for later payments. Capital gains taxes don’t.
The “realization requirement” of the capital gains tax thus functions like a massive, zero-interest government loan to people who’ve gained money on their investments. They’re able to save huge sums in taxes merely by waiting to sell their assets, and not paying any interest while they wait.
This is unfair; if you can afford to wait and not sell, you get a big tax break, but if you can’t afford that, you don’t. But the rule can also cause serious economic harm. By pushing people to hold onto investments longer than they normally would, it keeps them from moving their money to newer investments. That makes it harder for startups and other innovative firms to get the money they need to grow, leading to less innovation and slower economic growth.
The problem is compounded by other aspects of the US tax code. If Mark were to never sell his shares and instead pass them along to his children, they would not have to pay capital gains tax on the gain. In fact, if they were to later sell the shares, they would only pay tax on the difference between the value of the shares when they sell, and the value when they inherited them. (This is called “step-up in basis” or, more evocatively, the “angel of death loophole.”) So if the shares remain at $10 billion, the children can sell them and not pay a dime in capital gains tax. The rich are talented at evading the estate tax, too, so it’s very possible that Mark’s fortune will be completely untaxed.”
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“The Biden proposal is meant to make the ultra-rich pay more. The strategy is simple: get rid of the realization rule.
For people with over $100 million in assets, the proposal would put in place a new tax regime. For easily sold assets with clear prices, like stocks and bonds and crypto, gains in value would be taxed during the year they happen, whether or not the assets are actually sold. Taxpayers would be able to get refunds if the assets later fell in value.
Andreessen, Horowitz, and other Silicon Valley types fret about what this would mean for startup founders whose companies haven’t gone public yet. These founders may be billionaires on paper but do not have any actual cash with which to pay taxes.
If these VCs had read the fine print of the plan, they’d see that someone in this situation would not have to pay taxes yet. If more than 80 percent of a person’s net worth is in “illiquid assets” like private company shares, they would not have to pay annual tax on those assets. If they sold the assets, they’d pay the tax plus a “deferral charge,” a kind of interest for paying the tax years after they gained the money. Should the company go public or be acquired, the situation would change — but also the newly minted billionaire would suddenly have liquid assets with which to pay their tax bill.
This is all somewhat academic, though, after the Supreme Court’s June 20 ruling in Moore v. United States. While the decision itself concerned a minor provision in the Trump tax cuts, one justice, Amy Coney Barrett, wrote a concurring opinion arguing that realization is required for a capital gains tax to be constitutional. As my colleague Ian Millhiser notes, Justice Brett Kavanaugh’s majority opinion hinted pretty strongly that he’d side with Barrett on the matter, while deferring on a ruling for now.
If the Barrett view has at least five supporters on the Supreme Court, then the Billionaire Minimum Income Tax is dead in the water.”
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“I do not know of a single honest defense of the angel of death loophole, but unfortunately there are many deeply dishonest defenses. Former Sen. Heidi Heitkamp (D-ND) spent much of 2021 claiming that realization at death would obliterate family farms in the Plains, for which she offered literally zero evidence. Alas, the gambit worked.
In theory, though, a future Congress could still close the loophole. They could go further still and pass law professors Edward Fox and Zachary Liscow’s plan to tax the loans billionaires currently use to generate tax-free cash. The most ambitious option would be to add deferral charges to the capital gains tax, so the rich have to pay the government interest when they defer taxes by not selling their assets.”
https://www.vox.com/future-perfect/362399/billionaire-minimum-tax-andreessen-biden