In this article in our series on early 2021 tax proposals, we examine a proposed direct tax on the net value of wealthy individuals’ assets. As with all legislative proposals, it is not certain what aspects of the proposal will ultimately be enacted or if any part of the proposal will be enacted. This commentary, therefore, is speculative. 

As each person’s financial and tax situation is unique, before changing your plans based on proposed legislation, you should talk with your attorney, accountant and other tax and financial advisors.

Senator Elizabeth Warren (D. Mass.) has introduced a bill that would impose a tax on individuals’ wealth over a certain amount.[1] A companion bill was introduced in the House of Representatives by Representative Pramila Jayapal (D. Wash.).[2] While President Joseph Biden has not specifically proposed this type of tax, neither has he ruled out the enactment of such a tax.

Q: To whom does the Wealth Tax apply?

Senator Warren’s proposal, which has been captioned the “Ultra-Millionaire Tax Act of 2021” (hereinafter, Wealth Tax) would impose a tax of 2% on the net value of all taxable assets of an applicable taxpayer (defined as an individual or any non-exempt trust) in excess of $50 million to $1 billion. The tax would be increased to 3% on the net value of all taxable assets in excess of $1 billion, unless there is a single-payer government-funded healthcare system in place, in which case the tax on the net value of assets in excess of $1 billion will be 6%.

Q: How would the Wealth Tax apply if I am married? What if I have multiple trusts? 

Spouses would be treated as a single applicable taxpayer so that the thresholds would not be doubled. Multiple trusts having substantially the same beneficiaries[3] would be treated as a single applicable taxpayer so that the tax could not be avoided by multiplying threshold amounts. If after calendar year 2020 one trust transfers assets to a second trust by gift or decanting, both trusts shall be treated as a single applicable taxpayer for the year of the transfer. This would prevent a trust having assets in excess of the threshold from avoiding tax in the year of the transfer by being divided into multiple trusts.[4]

Q: How would the net value of assets be determined?

Essentially, the amount is the value of all property of the applicable taxpayer, wherever situated, other than tangible property having a value of $50,000 or less; provided that such property is not (i) property used in a trade or business, (ii) held for the production of income, or (iii) a collectible, a boat, an aircraft, a mobile home, a trailer, a vehicle, or an antique or other asset that maintains or increases its value over time, reduced by any debts owed by the taxpayer.[5] 

Property of the taxpayer includes, any property that would be included in the taxpayer’s gross estate if the taxpayer died, any property that is in a grantor trust of which the taxpayer is the deemed owner and gifts made to a member of the taxpayer’s family who has not attained the age of 18 years.

The Secretary of the Treasury is given broad latitude to set valuation rules and may require the use of valuation models and methodologies not currently in use or currently permitted (such as the consideration of post event transactions) and may issue regulations eliminating or otherwise dealing with valuation discounts.[6]

Q: What if I leave the United States and renounce my citizenship?

If you are a covered expatriate the Wealth Tax would be applied as if the year ended on the day before you expatriated and the tax rate would be 40% (as opposed to 2%, 3% or 6%, as the case may be).[7]

Q: If enacted as proposed, when would the new Wealth Tax take effect?

The new tax would apply to tax years beginning after December 31, 2022. Note, however, that trusts that are “divided” after 2020 would be treated as a single trust in the year of division. It is unclear how this would apply to trusts divided in 2021, or in 2022, if the Wealth Tax does not take effect until 2023.

Q: Is a Wealth Tax popular?

A majority of Americans favor imposing this type of tax on billionaires.[8] Moderate Senate Democrats are demanding that any new infrastructure bill be paid for, at least in part, by taxes on the wealthy. Even Senator Joseph Manchin (D. W.Va.) seems to agree that new taxes are necessary to pay for progressive programs (basing his rationale more on reducing deficit spending, and less on progressive grounds of wealth inequality).[9] Nevertheless, it is uncertain whether moderate Senate Democrats would vote for such a direct tax on wealth. During the 2020 U.S. presidential primary campaign, moderate Democrats, and even some of the progressive candidates, seemed wary of a direct tax on wealth.[10]

Other Senate Democrats have different ideas with respect to increasing taxes on the wealthy: Sen. Ron Wyden (D., Ore.), chairman of the Senate Finance Committee, has been exploring a “mark to market” plan that would impose annual income taxes on appreciated assets for the wealthiest households.[11]

President Biden hasn’t yet decided whether to pursue a wealth tax. “Treasury Secretary Janet Yellen said [on March 14, 2021] that the Biden administration hasn’t decided whether to pursue a wealth tax, and that while the administration intends to issue proposals to rein in deficits over time, U.S. borrowing costs are manageable right now.”[12] Secretary Yellen, indicated that while President Biden was willing to consider Senator Warren’s proposal, the White House has proposed other programs that are similar in impact to a wealth tax.[13] As noted by The Wall Street Journal:

Mr. Biden never endorsed annual wealth taxes advanced by Ms. Warren and Sen. Bernie Sanders of Vermont, instead offering a suite of tax increases on corporations and high-income households that would be significant but mark less of a structural change in U.S. taxation.

Q: Could a Wealth Tax be enacted in 2021?

The political realities complicate the enactment of a Wealth Tax. Currently, the United States Senate is essentially divided 50/50.[14] This leaves Vice President Kamala Harris to break a tie vote in the Senate. It seems unlikely that a bill to increase (or enact new) taxes will succeed under regular order. The Filibuster Rule (Senate Rule 22) requires 60 votes to achieve cloture and move legislation forward. Although there has been considerable “talk” about ending the legislative filibuster, the rule is unlikely to be changed. It takes two-thirds of the Senate to change a standing rule, which, given the current complexion of the Senate, is unlikely to occur. It is possible to change a rule by creating a precedent (a precedent was created allowing judicial appointments to require only a majority vote in the Senate to be confirmed). This tactic has been called the “nuclear option.” However, Senators Manchin and Kyrsten Sinema (D. Ariz.) have openly stated their opposition to eliminating the legislative filibuster, making it unlikely that a new precedent doing away with it would be created.

Most of the recent tax legislation has moved forward through the budget reconciliation process. Budget reconciliation is a procedural process that (essentially) allows certain budgeting legislation to move forward with limited debate and without delay by a filibuster. 

Although this is an oversimplification, only a simple majority (51 votes) is required to approve reconciliation legislation. The United States’ fiscal year runs from October 1 to September 30. For the current fiscal year, Congress used the reconciliation process to pass the American Rescue Plan Act of 2021.[15] Before April 5, 2021, it was thought reconciliation may be used once in each fiscal year and that the earliest that the reconciliation process could be next used was October 1, 2021. However, on April 5, 2021 the Senate Parliamentarian ruled that it may be possible to revise the 2021 budget resolution to add additional reconciliation instructions and thereafter use the reconciliation process again this fiscal year, although details of how this might work had not been determined. That ruling opened the possibility of another reconciliation before October 1, 2021. Yet on April 7, 2021, Senator Manchin stated unequivocally, that “[he] simply do[es] not believe budget reconciliation should replace regular order in the Senate.”[16] As the Senate is evenly divided, Senator Manchin’s vote would be essential to pass legislation on a party line vote. Therefore, notwithstanding the Parliamentarian’s ruling, without Senator Manchin’s vote, a second budget reconciliation before October 1, 2021, seems unlikely.

Q: Is a Wealth Tax, such as the one proposed, constitutional?

There is an ongoing debate among scholars as to whether a Wealth Tax is constitutional. Senator Warren has gathered letters signed by many legal scholars indicating that the proposed tax is constitutional.[17] The original text of the U.S. Constitution provides:

Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons.[18]

The Thirteenth Amendment to the Constitution abolished slavery, and Native Americans are now taxed. Accordingly, apportionment now includes all people in the United States.

In 1895, during the so-called “Gilded Age,” another age with concentrated wealth and great inequality, the U.S. Supreme Court (SCOTUS) determined that a tax on incomes was an unconstitutional direct tax without apportionment. Additionally, the Court also found that the power to tax real and personal property was also a prohibited direct tax without an apportionment.

Prior to 1895, however, SCOTUS had upheld taxes on property. Accordingly, many scholars believe that the 1895 decision was an anomaly. Yet, the Sixteenth amendment clearly relates only to taxes on income and specifically states that such taxes may be imposed without apportionment.[19]

Some scholars believe that SCOTUS repudiated the Pollack decision when it upheld the imposition of an inheritance tax under the War Revenue Act of 1898. However, others assert that such a conclusion is inaccurate, concluding that SCOTUS upheld the inheritance tax under taxing power specifically conferred upon Congress by Section Eight of Article One of the Constitution, which grants Congress the power to “…lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense (sic) and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States”, finding the tax to be an excise tax on the transfer of property (not a tax on the property itself).

Q: Is there anything that I can do now to plan for a possible Wealth Tax?

As we do not have a full complete understanding of the rules regarding the Wealth Tax (in many places additional guidance would be necessary), it would be very difficult to plan for its enactment. Before thinking about planning strategies, it is important to remember that the proposed Wealth Tax impacts only taxpayers with net assets valued at $50,000,000 and above. The bill’s sponsors estimate that the Wealth Tax would only impact 100,000 households in America.[20] Nevertheless, if you would be impacted by the proposed tax, you may consider the following:

Use any Remaining Gift and Estate Tax Exclusion to Fund Trusts Now

Use any remaining exclusion from the estate and gift tax to fund trusts now. Although we do not yet know what would constitute trusts having “substantially the same beneficiaries”, it may be possible to create trusts today with sufficiently dissimilar beneficiaries and to divide assets among them to create multiple thresholds.

If You Have Used Your Entire Gift and Estate Tax Exclusion, Consider Freezing Your Estate

If you have used your entire exclusion from the gift and estate tax, consider using so-called estate tax “freezing” techniques to cap the growth of your assets and to move assets into the trusts that are separate applicable taxpayers.

Freezing Technique: Sell Assets to an Intentionally Defective Grantor Trust

Selling assets to an intentionally defective grantor trust (IDGT) could freeze the return on assets that you own, limiting the growth of your estate. In this type of transaction, you would sell assets to a grantor trust in exchange for a promissory note. Of course, after 2023 the assets in the trust would be treated as your assets for purposes of the Wealth Tax. However, once the note was satisfied, appreciation on those assets in excess of the interest rate charged on the note could remain in the trust. Thereupon, the powers causing the IDGT to be a grantor trust could be released, allowing the trust to become a separate applicable taxpayer. The release of the powers causing the IDGT to be a grantor trust may not be practical if other tax proposals are enacted by Congress. Members of Congress are considering introducing legislation that would cause some portion of a grantor trust to be treated as a gift subject to the federal gift tax when the trust ceases to be a grantor trust. If both the Wealth Tax and other proposed bills are enacted, grantor trusts created after the effective dates of the legislation may have limited utility for transfer tax reduction.

Freezing Technique: Use Grantor Retained Annuity Trust

Similarly, you could transfer assets to a grantor retained annuity trust (GRAT). Of course, after 2023 during the term of the annuity the assets of the GRAT would be considered your assets for purposes of the Wealth Tax. However, after the annuity term ends any appreciation in the GRAT in excess of the Section 7520 rate assuming the GRAT is properly “zeroed-out” (that is, structured so that the present value of all annuity payments required to be made to the grantor is equal, or nearly equal, to the value of assets transferred to the GRAT), could be paid to one or more trusts that are separate applicable taxpayers and spread among multiple thresholds. Members of Congress have proposed changing the rules with respect to GRATs by eliminating the so-called zeroed-out GRAT tactic, requiring a remainder equal to the greater of 25% of the value of the assets contributed to the GRAT or $500,000, as well as requiring the GRAT to have a minimum 10-year term. These changes would make using a GRAT strategy less attractive. Nevertheless, you may wish to consider creating a sizable GRAT now, in the event such changes are enacted later this year.

Freezing Technique: Long-term Loans to Family Members

Consider lending to family members on a long-term basis. Such loans should bear interest at the Applicable Federal Rate (AFR), which is presently very low, so as not to be treated as a gift. Although the note would be treated as your asset for purposes of the Wealth Tax, it will limit the growth of the portion of your estate lent to the interest rate charged on the note. If your family members invest the borrowed funds and earn a return in excess of the AFR, their estates will increase over time. Eventually, this will divide assets among multiple thresholds.

If You Own a Business (or Even If You Don’t): Divert Opportunity to Others

Divert opportunity to others. For example, if you own a business, consider creating a new entity with widely disbursed ownership among your family members and trusts for their benefit (creating the trusts to be separate applicable taxpayers). Over time, divert business opportunities from your old business entity to the new entity. This will divide wealth among multiple applicable taxpayers to take advantage of multiple thresholds. Additionally, the Wealth Tax as proposed directs the Secretary of the Treasury to make rules regarding valuation discounts. It is possible that valuation discounts would be limited or eliminated (particularly if an entity is owned by multiple family members). Nevertheless, if valuation discounts remain viable, dividing an enterprise into multiple non-controlling interests could serve to depress their value for purposes of the proposed tax.

Take Advantage of Tax Benefits for Giving to Charity

If you are charitably minded, you could reduce your estate by giving wealth to charity. A family foundation could be the recipient of such wealth, allowing your family to use that wealth for good purposes. Nevertheless, wealth given to charity is no longer available for your family’s non-charitable purposes. Life insurance held in many different trusts that are separate applicable taxpayers may be a way to replace some of the wealth given to charity. Financing the premiums for large policies of insurance by borrowing from a commercial lender (or other sources) might be one way to add debt to your estate and reduce your net amount subject to the Wealth Tax.