If you’e been reading along at home, you may be aware that there is an extensive tax proposal from the Biden Administration on the table. The President previewed his tax proposal in the 2024 State of the Nation and documented it in the form of .the President’s 2025 budget and concomitant tax plan. It’s hard to know with certainty as of this writing, but it appears that Vice President Harris supports the President’s tax plan at least according to sources like Morningstar and may have adopted it in her campaign. I guess we’ll find out eventually.

Among other things, part of the proposal is to institute a new wealth tax by means of a new tax on something called “unrealized capital gains.” This means you pay tax on a paper gain from an asset like your home, artwork, or shares of stock regardless of whether you sold the taxed asset and had (or “realized”) gains from the sale. Those taxed assets may include the sale of a song or sound recording catalog.

Of course, if unrealized capital gains are taxed by the federal government, we have to imagine that the 41 states which tax capital gains at the state level will join in, starting with California and New York. Federal and state capital gains tax will be very complex. Commentators believe this idea is likely to have a host of unintended consequences.

Liquidity and Valuation Problems

The two biggest problems with this concept of taxing unrealized gains are liquidity of the taxpayer to actually pay the tax and how to determine the value to be attributed to the taxable asset in order to calculate that tax in the first place. If the proposal becomes law, we can see that there will be cottage industries in tax loans and valuation experts.

If you’re not familiar with the vernacular, “realized gains” means you made money on the sale of an asset and thus have the money to pay the tax at the time the taxed asset is sold (or gains are “realized”). You may also be able to take that cost into account when determine a selling price. Alternatively, “unrealized gains” means you have to pay the tax without selling the asset. That tax payment must come from somewhere; likely other liquid cash (or you may in the end have to sell the taxed asset in order to pay the tax on unrealized gains that were levied before you sold–and would have to pay tax on the sale and so on and so on). This is the liquidity problem with the idea of taxing unrealized gains.

So if you have a song catalog and the new tax covers intangible assets like songs (or patents for that matter), you have to pay taxes as you go if you are a taxpayer subject to the unrealized capital gains tax. It’s unclear whether it is Constitutional to tax an unrealized gain. (For “realized” interpretation see Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) which holds that income is realized whenever there are “instances of [1] undeniable accessions to wealth, [2] clearly realized, and [3] over which the taxpayers have complete dominion.”).

Remember, the sale of song catalogs is generally given capital gains treatment under Section 1221(b)(3) of the Internal Revenue Code. This provision permits songwriters to treat revenue from the sale of their self-created musical works as capital gains rather than ordinary income. This means that the profits from catalog sales are taxed at the lower capital gains tax rate, instead of the much higher ordinary income tax rates. If the unrealized gains proposal is applied to song catalogs, it goes even further than taxing at ordinary income rates on the realized gains from a sale–there doesn’t even need to be a sale.

Origins of the Billionaires Minimum Income Tax

I flagged a version of this new tax that was floated by Artist Enemy Number 1 Senator Ron Wyden back in 2019, but his “Billionaire’s Income Tax” bill has now been refined into an explicit budget proposal by the Biden Administration. Like most unpopular tax proposals (one study showed 3-1 opposition), Senator Wyden’s proposal was originally to apply to “millionaires and billionaires”, or in the immortal words of Senator Russell B. Long, don’t tax you, don’t tax me, tax that fellow behind the tree. Of course, if you count home values into net worth as one does, there’s way more than a handful of taxpayers with a net worth over $1 million. When Senator Wyden says “millionaires and billionaires” he doesn’t really mean just any millionaire because that would mean a lot of homeowners–eight million homes in the US are valued over $1 million. He probably means “rich people” especially rich people who inherited wealth. Like Ron Wyden.

But there’s rich and then there’s rich. Washington being what it is, when they’ve spent and leveraged new taxes from “millionaires and billionaires” what starts out being a tax that only effects a relatively small percentage of the universe of taxpayers, somehow has a way of seeking lower levels–you know, trickle down. That’s already happened–what started out with Senator Wyden going after “millionaires and billionaires” or what in March 2024 the Treasury Department called a “Billionaires Tax” has now settled into people with $100 million net worth (assets minus liabilities). That’s about 14,000 taxpayers in the US. And stay with me here–even though the threshold is $100 million the tax is called the Billionaires Minimum Income Tax, or “BMIT.” That acronym makes you focus on the billionaires (boo!) and ignore that billionaires are only about half the people who will be subject to the tax. And when Washington comes up with an acronym that hides an important detail like who is taxed, you know they’re serious. The plan may be shovel ready, but it’s definitely trickle down–and it’s only August.

$100 million is not a billion. $100 million could include Bruce Springsteen, Bob Dylan, Stevie Nicks, Neil Young and probably Paul Simon, estate of David Bowie and Bon Jovi, maybe all or substantially all major songwriters who sold their catalogs in the last few years. If they weren’t in the category before they sold their catalogs, they probably were after the sale which was likely taxed at the lower capital gains rate and not at the higher ordinary income rates. If you were, say, Taylor Swift or Beyoncé who have yet to sell their catalogs, your net worth is over $100 million and unrealized gains in that song catalog might be a juicy target for the IRS and their unrealized capital gains tax.

The Valuation Problem

So who decides how much unrealized gain is taxable? That question lays bare the valuation problem with this proposal. Remember, unrealized capital gain refers to the increase in value of an investment or an asset that you hold but have not yet sold. Remember, these gains are “unrealized” because they exist only on paper. Gains (or losses) only become “realized” once the asset is sold. The amount of unrealized gain or loss is the difference between the initial purchase price and the current market price. And therein lies the rub.

If the asset has not been sold, then in order to be taxed in must be valued. Coming up with a value is pretty easy if the asset is a publicly traded stock. But–if that particular asset class does not have a liquid market, then someone has to “mark to market” being an estimate of the fair market value of the asset on the day the asset is valued, or “marked.” In other words, “they” guess. The taxpayer hopes they guess low, and the IRS hopes they guess high. The problem is, the IRS’s guess is the only one that counts.

If that seems unconstitutional, have a peek at a recent U.S. Supreme Court case, Moore v. United States. Writing for a 7-2 majority, Justice Kavanaugh said that a similar (but not identical in my view) set of facts allowed Congress to tax U.S. residents on “realized but undistributed” income from a closely held foreign corporation. Justice Kavanaugh for the majority held that tax “does not exceed Congress’s constitutional authority” that “applies when Congress treats the entity [receiving the money] as a pass-through.” Importantly, Justices Thomas and Gorsuch dissented asserting that because the taxpayers “never actually received any of their investment gains, those unrealized gains could not be taxed as ‘income.” It also should be noted that the majority took great pains to make clear that the Moore case presented a “precise and narrow question” which should be construed narrowly. Dissents have a way of becoming the opinion of the Court, so I wouldn’t make too much of the Moore case in the context of taxing unrealized capital gains for your house although many commenters think it’s a step toward finding that the “billionaire’s tax” is Constitutional. I think Moore can be distinguished.

The Invitation to Shenanigans

Compare mark to market to historical cost accounting, which maintains an asset’s value at the original purchase cost. This can get hinky in volatile markets. If you remember the end of The Big Short, Dr. Michael Burry was trying to get the smart people on Wall Street to mark his credit default swaps which would have required them to take an even bigger bath than the smug bankers actually took.

This was an invitation to shenanigans. Goldman came up with excuses for why they hadn’t marked the swaps (“Goldman had a systems failure…” an excuse Dr. Burry receives skeptically. That’s mark to market. Somebody like Goldman Sachs or the IRS who is conflicted invents a value today that benefits them without regard to what you paid or what would be paid. You know, like when the willing buyer and the willing seller are the same person.

Crucially, the liquidity and valuation problems with taxing unrealized gains are a practical ones–you’ll be taxing people on paper profits when they have not realized the cash to pay the tax. That means the tax payment has to come from somewhere else unless the holder is forced to sell the taxable asset in order to pay the tax. And is able to sell.

In the case of illiquid assets, like say song catalogs, that may not be so easy to do. One of the reasons that the U.S. has never taxed unrealized capital gains is that the practical problems can become political problems.

Will Song Catalogs Be Subject to the New Wealth Tax?

But, yes, I did say song catalogs. Hold that thought for a moment and let’s look at what assets will be included in this new tax category. And think about this thought experiment: Songwriter A manages to get to the point that they can sell their catalog for a price that puts their net worth over $100 million but does not sell futures. Those as yet unwritten songs will accumulate in a new catalog. The songwriter then continues to write valuable songs and creates a new publishing catalog and holds off selling that catalog for a while–under the proposal that new catalog would potentially be subject to the unrealized capital gains wealth tax. Here are the asset classes we know about:

1. Publicly Traded Securities

Publicly traded securities, such as stocks, bonds and mutual fund shares, are a big target. If there is a liquid market for these assets, valuation is relatively easy based on their market price. Remember, if you hold shares in a publicly traded company and the value of those shares increases before you sell the shares, that unrealized gain would be subject to the proposed tax, even if you don’t sell your shares. I haven’t seen a discussion about unrealized losses. Gee, I wonder why.

2. Private Equity and Venture Capital Investments

If you hold shares in a private company or a startup, i.e., not publicly traded, unrealized gain in those shares is also taxed. This will surely raise valuation issues.

3. Real Estate Holdings

Residential or commercial real estate gains are also taxed. For example, if a paying taxpayer owns a home that has appreciated in value, the unrealized gain could be subject to the proposed tax.

4. Collectibles and Art

Collectibles and art are also included in the proposed tax base including fine art, rare coins, vintage cars, and other valuable collectibles These assets can appreciate over time, and the proposed laws aim to capture the unrealized gains on such items. Again, there’s a valuation issue.

5. Cryptocurrencies

Cryptocurrencies like Bitcoin or Ethereum would need to report and pay taxes on the unrealized gains of these digital assets. Given the volatility of many cryptocurrencies, valuation is going to be a challenge, particularly if Bitcoin was valued at 10x in year 1 but fell to -10x in year 2.

6. Other Securities

Securities like derivatives and options, are also included. These instruments can have complex valuations, but the proposed laws require taxpayers to report unrealized gains on these assets.

Will Valuation Experts be Worth More than Songwriters?

There are many consequences of establishing a new tax regime like taxing unrealized gains. It may seem far off if the only people affected (for now) are $100 millionaires. But having crossed that red line, both more asset classes and more taxpayers could be drawn in. If the government dropped the limit to taxpayers with a net worth of $50 million, they now have 97,000 taxpayers to hit with an unrealized gains tax bill. At a $25 million net worth, there are over 250,000. Is $25 million still rich? Not in Silicon Valley, maybe, but anywhere else…. So how long do you think it will take for “them” to get down to that level or even lower with their billionaires tax on millionaires? Get thee behind me, Satan.

Obviously, the business to be in if this regime becomes law is the valuation business.