The ‘‘Ultra-Millionaire Tax Act of 2021’’ (the “Act”) was proposed by Democratic Senators Elizabeth Warren and Bernie Sanders on March 1, 2021. Like all other tax proposals I have seen in my over 35+ years of tax practice, once the bee is in the bonnet, legislation will inevitably, inexorably, eventually blossom and flourish. The Act seeks to narrow the US “wealth gap” and address wealth inequality which has grown wider during the COVID-19 pandemic.
The Act calls for an annual “wealth tax” to be assessed on an “applicable taxpayer’s” net worth (more later on who qualifies as an “applicable taxpayer”). The rate is 2% on the net worth ranging from US$50 million to $1 billion and 3% on wealth exceeding $1 billion. Net worth means assets/property/cash (in short, everything you own anywhere in the world) reduced by debts.
Who is Subject to the Wealth Tax?
Short answer: Potentially, everyone in the world and all trusts (with exception for tax-exempt trusts) if the net wealth threshold is satisfied.
Really? Even foreigners can be subject to the proposed wealth tax?
Here’s the scoop: The Act applies to any individual, wherever they may live in the world. If the individual is not a US citizen and is also a “nonresident” of the US, the Act applies only to the property of such individual which is situated in the United States (determined under rules similar to the rules under subchapter B of chapter 11). For the tax law geeks, Subchapter B Chapter 11 of the Internal Revenue Code deals with Estates of Nonresidents Not Citizens (IRC §§ 2101 – 2108). So, wealthy foreign persons should think twice about investing in the US at all (or if investing, make sure that the taxable asset base in the US remains under the thresholds). It is noteworthy that the term “nonresident” is not defined. This raises some questions, such as: Is a green card holder living and working overseas treated as a “nonresident”? Must the individual be “domiciled” in a foreign country to be treated as “nonresident” for purposes of the wealth tax?
As for the American abroad (assuming the threshold is met), he or she will be subject to the wealth tax imposed by the Act on worldwide net wealth, even if he or she is already paying a similar wealth tax in a foreign country or countries. For the tax geeks, the foreign wealth tax paid by the American overseas would not be eligible for the foreign tax credit. See e.g., Rev. Rul. 76-536, 1976-2 CB 224 concerning Ireland’s wealth tax where the IRS made clear that foreign wealth taxes are not creditable since they are taxes that are not based on one’s income. The Act itself does not appear to take into account any credits for foreign wealth taxes.
Special Treatment for Certain Taxpayers including “Covered Expatriates”
Married Taxpayers are treated as “one applicable taxpayer”. Now this is an interesting concept. If one is married to a nonresident/non-US citizen are all of the assets owned by the nonresident/non-US citizen counted in the calculation, or only his US assets? What if the property regime in the couple’s country of domicile entails a community property regime? The community property laws could deem ownership of half of the nonresident/non-US citizen’s property to the US spouse. Presumably, this community property could then become part of the wealth tax base. Accordingly, putting love aside, a wealthy nonresident/non-US citizen should definitely not marry an American!
Covered Expatriates are in for a very nasty surprise! As my readers already know, being a “covered expatriate” is not a good thing. You can learn all the gory details about the “expatriation” tax hits at my blog post here. The US tax laws eat up not only the covered expatriate, but any US person in his inner circle who may receive a gift or inheritance from the covered expatriate at any time in the future.
Now, the Act adds insult to injury. In addition to the existing Exit Tax imposed under Internal Revenue Code 877A, the covered expatriate will be required to pay an additional 40 percent tax on net wealth as if the calendar year ended on the day before the expatriation. I wonder if the Exit Tax can reduce one’s net wealth for purposes of the Act? Arguably perhaps the answer is yes. Under Section 877A the expatriate is treated as selling all of his worldwide assets on the day before the expatriation. At that time, the Exit Tax arguably becomes a fixed liability and should (hopefully) reduce net wealth for purposes of the wealth tax.
I provide a realistic example of how hard the wealth tax can hit a covered expatriate in my blog post here. Don’t forget green card holders can also end up being “covered expatriates”!
Trusts are carefully addressed in the Act to make sure taxpayers do not attempt to avoid the wealth tax through the use of numerous trusts or property transfers between trusts. All trusts with “substantially the same beneficiaries” shall be treated as a single applicable taxpayer and trusts involved in transfers of property to another trust (for example, a decantation) shall be treated as a single applicable taxpayer.
Gifting or Dying? Can These Help?
In a word, no. The wealth tax imposed by the Act “for the year of the decedent’s death shall be considered to have been imposed before such death”. In other words, the tax is calculated before the individual dies. After he or she dies, the decedent’s estate must pay the estate tax. These are two separate taxes.
What about gifting? The Act makes sure that many gifts will be included in the wealth tax base as if the taxpayer still owned the property. However, one wonders if the Gift Tax will still apply to the transfer? Again, these are two separate taxes.
Here is the relevant language from the Act:
(3) INCLUSION OF CERTAIN GIFTS.—Any property transferred by the taxpayer after the date of the enactment of this chapter, to an individual who is a member of the family of the taxpayer (as determined under section 267(c)(4)) and has not attained the age of 18 shall be treated as property of the taxpayer for any calendar year before the year in which such individual attains the age of 18.
There’s lots of authority given to the Internal Revenue Service (IRS) to make sure the provisions of the Act are carried out and enforced. Every year, the IRS must audit at least 30% of taxpayers subject to the Act. Foreign assets are targeted with very special provisions, including coordination efforts to leverage data gathered under FATCA and to enforce reporting of assets by financial institutions and others. Penalties are stiff for “wealth tax valuation understatements”.
Is the Act Constitutional?
Unlike many European countries, the US has never had a “wealth tax” before and many are already questioning the Act’s constitutionality. For the law geeks amongst us, the constitutional argument is based on Article I, Section 2, Clause 3, of the US Constitution, which forbids the federal government from laying “direct taxes” that aren’t apportioned equally among the states. A “direct tax” is a tax on a thing, such as a tax on tangible or real property, or a tax on income. In contrast, an “indirect” tax is a tax on a “transaction” rather than a tax on the thing involved in the transaction. For example, a sales tax or a gift tax are taxes on the “transactions” (i.e., the making of a sale of property or the transfer of property by way of a gift).
The US income tax is a direct tax on income yet it is constitutional because of the 16th Amendment, which specifically permits income taxes without equal apportionment among the states. With respect to property, however, the US government generally cannot tax such forms of wealth “directly”, but can do so if the form of wealth is taxed in connection with a “transaction” (e.g., a gift tax or estate tax are taxes on the “transaction” of transferring property by way of a gift or upon death). My guess is that there will be some way to find a wealth tax as “constitutional”.
What’s a Taxpayer to do?
I was interviewed today by John Richardson about the proposed Wealth Tax. You can access the podcast here.
If you are wealthy and want to avoid the wealth tax you need to consider your options before it (or some version of it) is enacted. For many wealthy individuals the answer lies in expatriation and best to make sure you do it before becoming a “covered expatriate”! I can help you, email me for a consultation.
Posted March 11, 2021
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