On October 27, 2021, Senate Finance Committee Chair Ron Wyden (D-Ore.) released draft legislation that would, if enacted, tax the roughly 700 wealthiest Americans on a modified mark-to-market basis by requiring them to pay tax at long-term capital gain rates on their tradable assets as if they sold those assets on the last day of each year and imposing a “deferral charge” in the nature of interest on transfers of nontradable assets. On the same day, the Senate Finance Committee released a brief description and a more detailed section-by-section summary of the proposal.

Wyden’s proposal has received significant attention recently as a potential revenue raiser in light of other Democrats’ opposition to increasing the corporate and top marginal individual income tax rates.

Here are the key aspects of the proposal:

• Applicable taxpayer. The proposal would apply only to “applicable taxpayers,” which include individuals who, during each of the three immediately preceding tax years, had either:
  • Adjusted gross income exceeding $100 million (or $50,000,000 for married individuals filing separately); or
  • Assets with an aggregate value exceeding $1 billion (or $500 million for married individuals filing separately). A tradable asset’s value is its fair market value, while a nontradable asset’s value is the greatest of its original cost basis, its adjusted basis, its value on the date of the most recent event establishing value, its value reflected in an applicable financial statement, and the value used to secure indebtedness.

If an individual was an applicable taxpayer in the year they died or in any of the three preceding years, then the individual’s estate also would be an applicable taxpayer. Certain non-grantor, non-charitable trusts also would be applicable taxpayers if they meet a $10 million income or $100 million asset test similar to the tests for individuals.

• Mark-to-market of tradable covered assets. The proposal would require applicable taxpayers to mark-to-market their “tradable covered assets” annually and recognize long-term capital gain or loss on any increase or decrease in their value, regardless of holding period.

U.S. individuals generally are taxed at a 20% rate on long-term capital gains. Draft legislation from the House Ways and Means Committee would raise the rate to 25%. Individuals ordinarily may deduct capital losses only up to their capital gains plus $3,000 annually, and may not carry them backward, but Wyden’s proposal would allow individuals to carry back mark-to-market losses up to three years and apply them against mark-to-market gains.

Tradable covered assets generally are any assets—other than certain savings and retirement plans, insurance and annuity contracts, and cash and cash equivalents—that are traded on an established securities market, are readily tradable on a secondary market, or are available on an online or electronic trading platform. Derivatives on tradable covered assets are, themselves, tradable covered assets.

• Deferral charge on nontradable covered assets. Under the proposal, when an applicable taxpayer sells a nontradable covered asset, they would pay their normal tax on any gain plus a “deferral charge.”

They would calculate the deferral charge by (1) allocating the gain pro rata across their holding period, (2) reallocating gain for any period before they became an applicable taxpayer to the year they became one, and (3) calculating the amount of tax they would have owed on each year’s allocated gain based on the highest long-term capital gain or income tax rate (as applicable) in effect for that year. The deferral charge is the total amount of interest they would owe on a late payment of each year’s deemed tax amount, using an underpayment rate of short-term AFR plus 1% (except that no interest accrues for periods before the proposal is enacted). The short-term AFR for November 2021 is 0.22%.

The deferral charge would be capped so that the total tax imposed on a sale does not exceed 49% (plus the 3.8% tax on net investment income).

Capital gain dividends by a nontradable REIT would be treated as gain from the sale of a nontradable covered asset held for the shorter of the taxpayer’s holding period in the REIT stock and the REIT’s holding period in the gain-generating asset (which the REIT would be required to report to the taxpayer). A C corporation’s dividends in excess of 125% of a three-year rolling average (or, if shorter, the taxpayer’s holding period in the corporation’s stock) also would be treated as gain from the sale of a nontradable covered asset.

• Look-through rule for pass-through entities. An applicable taxpayer must notify a partnership, S corporation, or other pass-through entity specified in regulations if the taxpayer is a “significant owner”—that is, the taxpayer (1) directly, indirectly, or constructively owns at least 5% of the entity’s capital or profits interests (in the case of a partnership or other pass-through entity) or stock by voting power or value (in the case of an S corporation), or (2) holds at least $50 million of nontradable interests in the entity (calculated as described above under “Applicable taxpayer”). The pass-through entity must notify other pass-through entities in which the taxpayer is a significant owner indirectly through it.

Each pass-through entity is required to report to the taxpayer, and the taxpayer is required to take into account for the year, its share of (1) mark-to-market gain or loss on tradable covered assets and (2) deferral charges on sales of nontradable covered assets (treating the taxpayer’s holding period as the shorter of the entity’s holding period in the asset and the taxpayer’s holding period in the entity). The proposal leaves to regulations the task of providing for corresponding adjustments to the taxpayer’s inside and outside basis.

• Deemed sale treatment. The proposal would require applicable taxpayers to recognize gain or loss on bequests, otherwise tax-free contributions to controlled corporations, and like-kind exchanges, and to recognize gain (but not loss) on gifts and transfers in trust. Loss disallowed on a gift or transfer in trust reduces gain that the transferee subsequently recognizes on the asset. The proposal’s recognition rule would not apply to transfers to a spouse, surviving spouse, or former spouse incident to divorce, or to charitable contributions.
• First-year elections. Three elections would be available to taxpayers for the first year they are applicable taxpayers.

First, they can elect to pay the tax on their mark-to-market gains for that year in five equal annual installments.

Second, they can elect to mark to market their nontradable assets at a value of their choosing (so long as it exceeds the assets’ adjusted basis) and pay tax on the resulting gain, thereby potentially reducing the deferral charge on a subsequent sale of those assets. However, the second election is available for pass-through entities only if the taxpayer is a significant owner (as described above under “Look-through rule for pass-through entities”).

Last, only in 2022, they can designate up to $1 billion of tradable C corporation stock as a nontradable covered asset (and thereby avoid ever marking it to market).