Trust Estate

Keeping Composed Amid Threatened Taxes On Unrealized Capital Gains, Other Moves

Tom Burroughes Group Editor July 1, 2024

Keeping Composed Amid Threatened Taxes On Unrealized Capital Gains, Other Moves

When there's an election on the way, and tax is a regular feature of debate, advisors and clients need to be ready for whatever unpleasant measures are being proposed. The idea of taxing unrealized capital gains, for example, is one of the more unpalatable (and arguably unworkable) ones. We talk to a wealth advisor about the terrain.

The US has the right to tax US shareholders on undistributed operating income of their foreign corporations, the US Supreme Court has ruled (June 21). And that could spell a whole new slew of demands on wealth advisors as clients worry about being caught in the crossfire.

HNW Americans, even if they are skeptical on how such taxes can be efficiently enforced, must take these changes into account in their overall tax and wealth planning, Armanino, a US advisory firm, argues.

Already, the current Biden administration proposes a 25 per cent tax on unrealized capital gains for HNW individuals as part of his 2025 fiscal year budget.

"While there’s a long journey between such proposals and actually becoming law, the risk of such measures is real enough to prompt advisors to set out ideas for clients, “John Karls, who leads the HNW tax practice at Armanino, told this publication recently.

“For the US, any of this sort of uncertainty brings additional opportunities for planning,” Karls said.

Karls said he’s not particularly concerned about taxes on unrealized capital gains because he thinks these are hard to collect and enforce, particularly on unlisted private stakes in companies and many forms of real estate. “They [the government] would have to create a separate tax system for non-listed assets and I don’t see how the IRS could police this, given the shortage of people it has,” Karls said.

For US taxpayers with $100 million or more in net worth, the implications of such a tax could cause an exodus out of the country, he said. 

FWR spoke to Karls before the latest ruling from the US Supreme Court. At issue in the Moore case was whether Congress has the constitutional power – on a one-time basis in 2017 as part of a reform to certain foreign tax rules – to make US shareholders in foreign corporations pay tax on their share of the foreign company’s accumulated and undistributed earnings without any actual dividend being declared or paid. Writing in Reason magazine, Steven Calabresi, the Clayton J & Henry R Barber professor of law at Northwestern Pritzker School of Law, described the case before the Court as the “biggest tax case of the last generation.”

Get prepared
That such measures are in play or being considered, whatever the likelihood of becoming law, demonstrates how attempts to tax wealthy citizens remains a big political issue as the federal and state governments try to fill public coffers. It is not a conversation confined to the US.

Already, as explained here by US lawyer Matthew Erskine, there are various tools and structures citizens can use to mitigate tax burdens. As the US election process continues, focus on this topic will likely intensify.

Among other, more likely changes that Karls thinks advisors must consider includes Biden’s plan to increase the tax rate on dividends and capital gains from 20 per cent to 39.6 per cent. This will take away a number of advantages around investing, Karls said. “We could see more money move into real estate, and oil and gas,” he said. “This is easier for politicians to police because there is taxable income.” 

A change to how carried interest is taxed – a big deal for the private equity sector – is also an important, and relatively likely, change, Karls said. 

What all these proposals mean is that “the tax advantages are not in the financial markets at the moment,” he said. That said, Karls said he does not envisage large asset allocation shifts by investors as a result of such measures.

One possible beneficiary of tax squeezes on certain activities is that it increases the relative attractions of Qualified Opportunity Zones, Karls concluded. (These zones, which carry certain tax reliefs, were set up by the 2017 Tax Cuts and Jobs Act.)

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