The 2020 Campaign and Taxes Part 1: The Starting Proposals (article)
As every presidential election approaches, it feels like the cycle starts earlier and earlier. And this year is no exception with several candidates announcing their intention or consideration to run in 2020. Some of the potential candidates have already laid out plans that include further changes to the tax code. Howard Schultz (I) has stated that he would prefer revenue neutral tax legislation that did not increase taxes on the wealthy. But there are far more ambitious tax proposals being proposed by progressive candidates. One, which has already been a major source of discussion, comes from first-term Congressperson Rep. Alexandria Ocasio-Cortez (D NY). Although Ocasio-Cortez is ineligible to run for president in 2020 (she won’t be 35).
We start with this proposal because it appears to have set a baseline for the conversations about future tax law changes within the Democratic Party. This proposal is light on details, but its call for a 70 percent tax rate on individual income above $10 million garnered significant attention. The rate itself has raised a few eyebrows, but it is interesting to note that the top tax rate did not dip below 70 percent from the 1950s until it was reduced to 50 percent by the Economic Recovery Act of 1981.
The details of Ocasio-Cortez’s plan lack critical guidance about its application, such as the types of income that would be subject to this high rate. If a 70 percent tax rate is only imposed on wages and other forms of earned income, creative tax planning strategies could emerge to reclassify earned income into a different category that is exempt from the high rate.
For example, a taxpayer who is a partner in a large hedge fund could benefit significantly by arranging to receive a profits interest in exchange for services rendered to the hedge fund. Income allocated by hedge funds often takes the form of capital gains. As such, capital gains allocations attributable to the profits interest from the hedge fund that are above the 70 percent tax threshold could escape the 70 percent rate, assuming the capital gains rates remain unchanged. Moreover, a partner receiving $2 million in compensation above the $10 million threshold ordinarily (under this plan) would net an additional $600,000 of “take home” income. But if that income could be structured as capital gains, then the partner could net $1.6 million of take home income. This partner would need to navigate the current provisions for the taxation of carried interests as well, which generally provide that the interest and any property held by the partnership must be held for 3 years before the gains can receive favorable tax status.
As the election cycle progresses, the candidates’ proposals should become more concrete and will, hopefully, provide more details so that taxpayers and tax planners can understand the candidates’ positions.
Warren’s Wealth Tax Proposal
The first candidate’s proposal that we will look at is Sen. Elizabeth Warren’s (D MA) Wealth Tax proposal. This proposal goes further than Ocasio-Cortez’s proposal in some ways, even though the rate is drastically lower. Under Warren’s proposal, households with net worth between $50 million and $1 billion would be subject to an annual tax of 2 percent on the amount of such net worth. For households with net worth exceeding $1 billion, the tax would be raised to 3 percent on the amount of the excess.
Under this plan the calculation of “net worth” would be a key consideration. This raises many important questions, including:
- Would debt reduce net worth? If so, how would a loan be analyzed to determine if it were incurred as part of a strategy to avoid the wealth tax?
- How would the value of assets be determined? Certain assets such as real estate and privately-held stock are notoriously difficult to value. And once determined, how would the value be tracked over time and what adjustments would or could be allowed?
- How would the distribution of wealth among family members be accounted for? Would the estate tax and or the gift tax need to be reconsidered to prevent transactions undertaken to avoid the wealth tax?
- How would assets held in trust(s) be factored into the wealth tax?
- How would overseas assets be dealt with and would the wealthy avoid the tax by moving tangible personal property overseas? For example, could a wealthy individual reduce their wealth tax burden by moving their personal art collection overseas?
These and other considerations will have to be accounted for as part of the development of this tax plan, and they will have to be understood by tax planners seeking to assist their clients.
There are also questions about the constitutionality of this plan. The 16th Amendment to the Constitution permits the imposition of an income tax. Prior to the passage of the 16th Amendment, direct taxes (such as an income tax) were only permitted if imposed equally based on state populations. If two states had the same population, the amount of tax raised in one state would have to be equal to the tax raised in the other, even if one state’s population earned considerably higher income per capita. The 16th Amendment removed this barrier for income taxes by specifically permitting Congress to impose an income tax. But the question remains about whether a wealth tax would be covered by the 16th Amendment, or not otherwise considered a direct tax. This potential issue could create further uncertainty for individuals and tax planners.
One key difference between the plans of both Ocasio-Cortez and Warren (and most of the tax proposals of the last 40 years) is that both are specifically designed to increase government revenue. The goal of these tax increases on the wealthy are to finance other policy initiatives and programs. However, the amount of revenue that would be generated remains unclear as each plan lacks the details necessary for economists to make firm predictions.
More to Come
As the 2020 presidential election cycle progresses, we will offer additional insights regarding the candidates’ tax proposals. Also, we would be remiss if we didn’t mention that President Trump is also an announced candidate for president, and if he announces a new tax plan we will, of course, analyze it as a part of this series. For more information on these proposals and other tax related issues, please contact your local CBIZ MHM tax professional.
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