In many cases, the underlying asset cannot be borrowed against (e.g., owners of sports franchises often cannot use their teams as colleterial) and shares cannot be realistically sold at fair market value outside of a formal and costly SEC-registered public offering. It also might present liquidity issues to taxpayers who are unable to make the annual tax payment without first realizing their gains. But it also raises practical concerns over the ability of the IRS to assess the value of illiquid assets without a public market price. ![]() Mark-to-market taxation completely removes taxpayer discretion thus limiting avoidance opportunities. One approach to removing the lock-in effect is accrual (or “mark-to-market") taxation wherein price appreciation is taxed annually. PWBM has analyzed these proposals and issued related research briefs, both for stepped-up basis ( I, II, III) and more fundamental approaches ( I, II) including the provision of estimates for academic researchers ( Saez et al 2021).īefore Taxpayer’s Death: Mark-to-Market vs Lookback Charges At the executive level, the FY2022 President’s Budget included a reform to stepped-up basis at death under which, for certain gains, death would be treated as a realization event for tax purposes. Senator Wyden authored a 2021 bill that would impose “anti-deferral” tax accounting for billionaires. In 2019, Senator Ron Wyden (D-OR) issued a white paper exploring options for implementing a system of progressive mark-to-market taxation and/or lookback taxation of capital gains, wherein investors face an interest penalty for deferring gains. In 2020, Senator Michael Bennet (D-CO) explored accrual taxation of capital gains. Lawmakers have recently been exploring reforms aimed at limiting the tax benefit of capital gains deferral. ![]() Scholars and lawmakers have proposed reforms aimed at limiting the tax benefit of capital gains deferral, ranging from reforming stepped-up basis at death to taxing all gains on an accrual basis. Second, asset basis is “stepped up” to its market value at the time of death or charitable donation, so those who plan to leave an asset in an estate to their children can avoid capital gains tax entirely.Īll else equal, the tax benefit of deferral is economically inefficient: it encourages investors to make portfolio allocation decisions based on tax considerations unrelated to real production. First, due to the time value of money, taxpayers can reduce the net present value of tax liability by choosing to defer realizations. The lock-in effect arises for two reasons. ![]() The discretionary nature of capital gains taxation thus creates a “lock-in effect” because the longer an investor holds appreciating property before selling, the lower the real tax burden on investment returns. Investors decide when, and in some cases whether, to pay taxes on investment gains. The tax treatment of capital gains differs from that of other income types because taxation occurs upon realization rather than accrual.
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