Top Democratic presidential candidates say they want a robust wealth tax with hard-line rules to prevent the wealthy from getting too clever with their tax planning. Wealth planners say they couldn’t be more excited.
“If it actually succeeds in getting enacted and surviving constitutional challenge, which is a big question, it would be a bonanza for our practice,” Austin Bramwell of Milbank LLP told Tax Notes. “This would be like doing an estate tax return, which is a mammoth effort that typically involves a protracted audit with dozens of issues coming up in just the ordinary course of an audit — and this would become routine work!”
Presidential candidates like Sen. Elizabeth Warren, D-Mass., and Sen. Bernie Sanders, I-Vt., have called for an annual tax on ultrawealthy taxpayers’ accumulated wealth. For Warren, the tax would kick in at $50 million for married couples; Sanders’s proposal would start at $32 million.
Both proposals call for a comprehensive tax on the assets of wealthy taxpayers. Sanders’s plan addresses opportunities for gaming through robust enforcement measures, like a national wealth registry with “significant additional third party reporting requirements,” and a major boost in IRS funding to perform audits.
Warren’s plan calls for similar measures, and specifically says the tax would apply on all household assets held anywhere in the world without exception, which she says would “reduce opportunities for avoidance behavior.”
Go Big or Go Home
Practitioners agreed that if a wealth tax is to be even remotely effective it would have to be free from exemptions, but they questioned whether such a pure regime is realistic.
“If they take a hard line, it’s going to be harder to avoid. If you create asset class preferences, people will respond to those preferences,” said Beth Shapiro Kaufman of Caplin & Drysdale Chtd. If a wealth tax carved out art, farms, or family-owned businesses from the tax, that would “cause the wealth to gravitate to those investments,” she explained.
Brad Dillon, a wealth manager with Brown Brothers Harriman, noted that a hard-line wealth tax raises “tricky issues,” like how it would treat charitable vehicles such as charitable remainder trusts commonly used by the wealthy for philanthropy. Even if a wealth tax had broad support, if charities take a big hit, it could be politically difficult to touch.
“That’s just one example of one of these things on the fringe, like, ‘Oh, well maybe there needs to be this tiny exemption over here’ — but there’s going to be a million of those,” Dillon said.
The wealth tax regimes employed by European countries over the past few decades were riddled with exemptions, and a big reason why many of those countries have repealed their wealth taxes is that it became too easy to avoid the tax, Kaufman said.
Closer to home, for example, Florida had a tax on intangible assets like stocks and bonds for many years that it eventually repealed in 2007 because it had gotten to the point where paying the tax almost became optional because there were so many well-known ways to avoid it, Kaufman said.
“When a tax becomes optional, then you can pretty much guarantee it’s going to go away, because it just becomes unfair, or everybody avoids it and you’re not collecting much revenue,” she explained.
Expectation Meets Reality
For Bramwell, the basic problem with the wealth tax proposals is that they won’t work anywhere close to how they’re intended to if there’s any compromise on making them comprehensive, and in his view compromise is highly likely.
“With a wealth tax, any deviation is intolerable, and deviation is inevitable,” he said.
According to Bramwell, there would be tremendous pressure to exempt family-owned businesses, farms, or the nonprofit sector, like universities and private foundations, that lawmakers in Congress simply won’t be able to avoid.
“To assume a world where you can achieve pure and effective tax legislation in the United States of America is a complete fantasy,” he said.
The economists who have developed the wealth tax proposals being debated today “live in a world of abstraction,” Bramwell said. They’ve explained how the proposal would work based on a litany of assumptions, but with a wealth tax, the “theory of second best” collapses if — and, according to Bramwell, when — politics interfere with the assumptions.
“If you want to go Hawaii for vacation, 99 percent of the way to Hawaii isn’t the next best thing — if that’s where you go, you drown,” he said.
Pick a Number
Both the Warren and Sanders proposals acknowledge that requiring annual valuations of the vast fortunes of the wealthy would be enormously burdensome to administer for both taxpayers and the IRS, so they propose to streamline the process.
Warren’s plan says the IRS would be authorized to employ “cutting-edge retrospective and prospective formulaic valuation methods for certain harder-to-value assets.” Sanders’s plan likewise calls for a formula-based approach to hard-to-value assets that would further allow taxpayers to elect to have appraisals done periodically, rather than annually, with an assumed appreciation rate based on average rates for that asset class.
Kaufman, who spent six years in Treasury’s Office of Tax Policy working on trust and estate matters, wasn’t impressed by Warren’s vision for modernized valuation methods as the ultimate solution. “That sounds like a pretty fanciful vision that she has there,” Kaufman said.
Valuation issues are already “one of the big bugaboos” affecting the estate tax, and many of those same issues would carry over to a wealth tax, despite the best efforts of lawmakers to try to mitigate them, Kaufman predicted. And unlike the estate tax, which is a one-time event, a wealth tax would be imposed annually, multiplying the administrative challenge considerably for the IRS.
Still, a formula-based approach to valuations would be more administrable and isn’t totally unprecedented, according to Kaufman. She noted that there are already “rules of thumb” for valuations of assets like oil and gas interests, which she said are usually valued at three to five times their annual return.
Although it wouldn’t be particularly complicated to apply a formula to the years following an initial valuation, practitioners said there would be tremendous focus on the base value.
“The problem with that is it’s going to lead to arbitrary and manipulatable results,” Bramwell said. He explained that if the rule is to start with a value and then lock in the subsequent results with reasonable adjustments every year, the “simple solution” is to report a value that’s not consistent with the actual value.
“It’s already going down the path of compromise, which is going to vitiate the policy objective, and as a practitioner, I couldn’t be happier — music to my ears!” Bramwell said. “But it’s probably not what’s right for the tax system and the country as a whole,” he continued.
Dillon likewise said a wealth tax would drive the wealthy to shift their investments into hard-to-value assets like artwork. Another option would be to move public equities into more restrictive partnership interests that can get significant lack of marketability or lack of control discounts on valuations, so that “instead of $100, we make it look like it was $60 because of the restrictions,” he explained.
That’s something wealth planners already commonly do for the estate tax, and it’s “kosher and totally accepted by the IRS for the most part,” he said.
Carlyn S. McCaffrey of McDermott Will & Emery LLP also questioned what would happen if a client had the opportunity to prove that the true value was starkly different from what the formula came up with.
“If the [wealth tax] law gives the opportunity to challenge this formula, then anyone who thinks the formula produces a bizarre result to their detriment, if the stakes are high enough, they’re going to litigate it,” she said.
For billionaire clients with a wide variety of assets, “the thought of administering this every year is horrendous,” McCaffrey said. “It would be lots of good work for appraisers,” she mused, adding, “I wonder if there are any appraisal firms that are publicly traded that I can start investing in.”
Client Conversations
The reaction so far from wealthy clients to the prospect of a tax on everything they own has been varied.
Kaufman reported that her clients seem to view a wealth tax as politically infeasible, with little likelihood of actually taking effect. None of them have begun packing their belongings to expatriate just yet, though they may just be waiting to see the results of the Democratic primary, she joked.
Both Sanders’s and Warren’s proposals call for a 40 percent exit tax on the assets of wealthy taxpayers to try to discourage the wealthy from expatriating, but expatriation even now is already a “serious endeavor” subject to an exit tax, Kaufman noted.
Dillon said he’s had only one client ask about a wealth tax, and he said the client jokingly wondered whether he ought to shift his assets into bitcoin. “It was just a joke,” Dillon emphasized.
That client conversation led Dillon to poll his colleagues on whether their clients had expressed concern about a wealth tax, and the resounding result was that “no one seems to care about it just yet,” he said.
Not all wealth planners’ clients are as carefree over the thought of a wealth tax.
“People are very concerned . . . because these proposals are so explosive, they’re taking us back to the '60s,” said McCaffrey.
She said the heads of family offices sounded the most concerned, because they’re tasked with ensuring their families take the most tax-efficient actions at the right times. Those clients want to know what they should do, and what others are doing, she said.
Proactive Planning
Wealthy taxpayers will have a “window of opportunity” after the election if someone like Warren or Sanders wins the 2020 election and Democrats gain control of Congress, and those taxpayers need to be ready to move quickly as legislation with clearer parameters is developed, according to McCaffrey.
But in the meantime, the basic advice estate planners have been offering for the past two years still applies: Use the temporarily doubled estate and gift tax exemption to divide up your estate, which could then have the added benefit of reducing the amount of assets subject to a wealth tax.
While Dillon also noted that expatriation is a drastic move, if a taxpayer was already planning to expatriate or had already spent several years in another country for various reasons, “then you might want to think about doing that sooner rather than later.”
He noted that Warren’s proposal would impose an exit tax of 40 percent, which is significantly higher than the exit tax currently in effect and takes a kind of mark-to-market approach that “pretends like you just sold all your assets on the day of expatriating and you pay the tax then.”
If it looked like wealth tax legislation was going to materialize, Dillon said he’d advise some of his clients to invest in harder-to-value assets like artwork or antiques and avoid public equities.
Kaufman likewise said that proactive planning for a wealth tax would be premature, but that clients could divide family wealth assets among as many people as possible to multiply the number of thresholds at which such a tax would kick in. That advice stands true even if a wealth tax doesn’t materialize, she continued, because then clients can simultaneously take advantage of the much higher estate and gift tax exemptions currently in effect before they expire and decline precipitously in 2026 or potentially even earlier.
For now, though, the practitioners were in agreement that the default position is to watch and wait, rather than take drastic action.
“It’s a little too nebulous right now,” Dillon said.
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