March 9, 2021
Sen. Warren proposes 2%-3% wealth tax on wealthy individuals and trusts
Senator Elizabeth Warren (D-MA), a member of the Senate Finance Committee, has proposed a bill (S.510) (Ultra-Millionaire Tax Bill of 2021) that would impose an annual tax on the assets held by certain wealthy individuals and trust owning more than $50 million of taxable assets (Wealth Tax). The bill would apply to calendar years beginning after December 31, 2022.
Wealth tax proposal generally
The Wealth Tax, which affects individuals (including their grantor trusts) and non-grantor trusts, is (1) a 2% annual tax on the "net value of taxable assets" (i.e., net worth) between $50 million and $1 billion; and (2) a 3% tax on the net worth exceeding $1 billion (or 6% if the US ever implements a comprehensive national health insurance program). The "net value of taxable assets" is determined on the last day of the calendar year. (For individuals who die during the calendar year, the determination date is the date of death and the Wealth Tax is prorated.) Individuals and trusts whose net worth does not exceed $50 million would not be subject to the Wealth Tax.
Senator Warren's bill proposes to tax the net value of all taxable assets held by the applicable taxpayer on the last day of the calendar year. To be taxed, the net value of those assets would have to exceed $50 million. An applicable taxpayer is defined as any individual or trust, except a trust described in IRC Section 401(a) that is tax-exempt under IRC Section 501(a). Married individuals are treated as one applicable taxpayer, as are trusts with substantially the same beneficiaries. If one trust gives property to another trust in 2021 or any later calendar year, the transferor and the transferee will be treated as a single applicable taxpayer for that calendar year. The Wealth Tax is not deductible for purposes of either federal income tax or federal estate tax.
Tax base for the Wealth Tax
The Wealth Tax applies to the "net value of taxable assets." Essentially, the tax base is as follows:
Nonresidents/noncitizens and expatriates
Individuals whose total assets meet these thresholds would be subject to tax, even if they are nonresidents and non-US citizens or have expatriated during the tax year at issue. For an individual who is a nonresident and not a US citizen, the bill would apply only to the individual's property situated in the United States. And, the bill would impose a 40% tax on the assets of a "covered expatriate," defined under IRC Section 877A, as if the calendar year ended on the day before the person expatriated.
The bill would require the Treasury Secretary to issue regulations and establish valuation rules and methods within one year of the bill's enactment into law. Taxpayers would be required to report their liability for the Wealth Tax as part of existing income reporting and the IRS would be required to audit at least 30% of the taxpayers required to pay the tax.
The Treasury Secretary would have discretion to provide up to a five-year extension of time to pay the tax if the taxpayer "has severe liquidity constraints" or if being required to pay on time "would cause undue hardship on an ongoing enterprise." Penalties could be imposed for inaccurate returns and substantial understatement.
The Treasury Secretary would be required to submit a report on the tax to Congress by January 1, 2025, and every two years thereafter. Finally, the bill would add substantial IRS funding for each fiscal year from 2022 through 2032 (i.e., $70 billion for enforcing the bill; $10 billion for taxpayer services, and $20 billion for business system modernization).
The Wealth Tax would create a "marriage penalty" because it would apply to the aggregated assets of a married couple. For example, if each spouse in a married couple had a net worth of $50 million ($100 million total), the couple would be subject to a $1 million annual Wealth Tax. If that couple were not married, the two individuals would not be subject to Wealth Tax.
Application to non-grantor trusts
The Wealth Tax would apply to "any trust," thereby imposing the 2%-3% tax on assets held in a non-grantor trust. The language "any trust" may be read to include both domestic and foreign non-grantor trusts, as the draft legislation does not explicitly exclude foreign non-grantor trusts from the Wealth Tax. Of note, the draft legislation could be read to apply the Wealth Tax to all worldwide assets held in a non-grantor trust, whether foreign or domestic. This is because Wealth Tax would apply to "all property of the taxpayer … wherever situated." Although the Wealth Tax legislation clarifies, in certain provisions applicable to individuals, that the tax base is limited to assets that would be subject to US estate tax (plus grantor trust assets) if the taxpayer died, the legislation does not contain similar rules for non-grantor trusts. A logical question is whether the IRS could enforce the Wealth Tax against non-grantor trusts established in a foreign jurisdiction.
Nonresidents and covered expatriates
For nonresidents holding substantial US situs assets, the Wealth Tax could afford the US taxation rights that were not previously part of the US tax code. For example, the Wealth Tax could be applied to nonresidents holding stock in US companies.
The Wealth Tax would impose a 40% tax on net worth over $50 million immediately before expatriation. Essentially, a covered expatriate would be subject to two taxes upon expatriation (the Wealth Tax and Exit Tax), and his/her heirs could be subject to a third tax upon receipt of certain gifts/bequests from the covered expatriate (IRC Section 2801 tax). For those planning to expatriate, the Wealth Tax is essentially bringing forward a full estate tax, with IRC Section 2801 tax also imposed.
To calculate Wealth Tax, taxpayers will need to determine the value of all their taxable assets. Valuation of assets could become the most important battleground, especially considering that the draft legislation would: (1) require the IRS to audit at least 30% of the taxpayers required to pay Wealth Tax; and (2) increase accuracy-related penalties, up to 50%, attributable to valuation understatements.
The draft Wealth Tax legislation leaves it up to the Treasury Secretary to issue regulations to establish valuation rules and methods. Individuals and trusts owning interests in family businesses and other difficult-to-value assets may need to conduct annual appraisals, unless the Treasury Secretary provides a simplified method for valuing those assets.
Substantial expansion of IRS scrutiny on "ultra-millionaires"
The draft legislation states that "[t]he Secretary shall annually audit not less than 30% of the taxpayers required to pay the [Wealth Tax]." This audit mandate is not explicitly limited to Wealth Tax compliance and, therefore, would increase IRS scrutiny of wealthy individuals and trusts generally.