Paul L. Caron

Friday, April 9, 2021

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Measuring And Valuing Wealth For Federal Wealth Tax Reform

This week, Mirit Eyal-Cohen (Alabama; Google Scholar) reviews David Gamage (Indiana; Google Scholar), Ari Glogower (Ohio State; Google Scholar) and Kitty Richards (Independent), How to Measure and Value Wealth for a Federal Wealth Tax Reform, Roosevelt Inst. Issue Brief (2021):   

Mirit-Cohen (2018)

One of the most debated topic in the last decade is wealth inequality and the unequal distribution of assets among individuals in the U.S.. Wealth distribution becomes even more skewed when race and ethnicity are involved with (not surprisingly) a staggering racial wealth gap.

Recent proposals to reduce the wealth gap (such as those proposed by Senators Warren and Sanders) encountered the hurdle that fails to succeed any tax reform—overcoming valuation issues.  Our current income tax system is cash realization–based and thus mostly takes a deferral-based approach to valuation of wealth accumulation, which makes valuation of wealth rather challenging. If we truly want to make a progress on narrowing the income inequality gap and tax income and wealth of the highest income taxpayers in our society, we have to find efficient ways to overcome assessment difficulties, namely how to measure and value taxpayers’ wealth. This report—published under the auspices of the Roosevelt Institute, a think tank of experts on the American economy—is a practical attempt by Gamage, Glogower, and Richards to do just that.  

Overall, they propose to value assets at their fair market value (the arm’s length price a willing buyer will pay a willing seller) with necessary tradeoffs between conflicting goals (e.g. administrability, complexity, and fairness) when tackling some valuation difficulties. The report lays out their depiction of the best approaches for valuing central categories of taxpayers’ wealth.

While slightly half of the wealth holdings of individuals with more than $5 million of net worth is held in easy-to-value assets based on market trading prices (such publicly traded stock, bonds, mutual funds, retirement assets, mortgages and notes, life insurance, and cash) the extremely wealthy tend to hold more difficult or hard-to-value assets. Real estate properties, interests in private businesses, and interests in trusts are more difficult to assess because valuations often cannot easily be derived from current or recent arm’s length transactions or when such assets haven’t been sold or marketed recently. Existing U.S. estate and gift tax approaches use appraisals and other prospective valuation approaches or proxy-based formulas to derive valuation in such cases. Gamage, Glogower, and Richards recommend a hybrid approach that relies on a combination of formulaic valuation and appraisals. In some cases, they suggest adding retrospective “look-back” rules to lower the probability for aggressive undervaluation and to allow taxpayers to make adjustments to correct undervaluation based on the exact price when the asset is sold.  In addition to incorporating such approaches they suggest increasing IRS funding and enforcement tools to support administration of the new wealth tax compliance rules.

For example, Gamage, Glogower, and Richards suggest combining private and government tax appraisals of local property taxes in the case of real estate assets (which comprise a substantial portion of the wealth of very wealthy taxpayers) with a minimum value formula (such as cost basis plus improvements) to limit the extent to which undervaluation by local authorities can reduce federal wealth taxes. In addition, value adjustments can be made based on annual average growth rates for real estate valued by zip code or by other geographic designations. When the property is finally sold, the government can take the look-back approach and allow retrospective adjustments based on the accurate value of the assets.

In the case of interests in privately owned business entities (amounts to about 18 percent of the wealth of wealthy taxpayers) there is a serious valuation issue due to lack of information. Gamage, Glogower, and Richards suggest creating formulaic valuations based on book value with the additions of final sale adjustment and certified appraisal information where available and appropriate. These adjustments can be based on publicly available information IRS could publish comprising of various industry-based factors such as multiples of book profits for different types of businesses. To avoid overload of valuation litigation, Gamage, Glogower, and Richards suggest these formulaic valuations be structured as deemed valuation rules that are not challengeable by taxpayers or as rebuttable presumptions that can only be challenged through the taxpayer substantiating any lower value asserted with a heightened standard of proof. Moreover, to facilitate easier compliance, they suggest including mandatory reporting information of book value and book profits for business entities with at least one U.S. taxpayer owner.

As for valuation of interest in trusts (the utmost utilized tool to pass wealth from one generation to the other) Gamage, Glogower, and Richards suggest imposing a flat-rate wealth tax at all trusts (including foreign trusts with U.S. beneficiaries) at the trust level with no exemption. They are less worried about non-tax reasons for holding assets indirectly via a trust and simply suffice with the general impact this action will have on discouraging taxpayers from using trusts to shelter wealth. But some legitimate non-tax reasons are not lost on the Authors because they do offer an exception for trusts whose beneficiaries are minor children or adults with disabilities.

For other difficult to assess assets such as artwork, Gamage, Glogower, and Richards suggest sticking to certified appraisals and then vigorously monitoring those appraisals through IRS audits. All personal property and valuable assets should be included in the wealth tax base under a required annual reporting of valuation with de minimis exemption threshold of $50,000 in the aggregate and significant penalties for underreporting. Taxpayers should be able to deduct against their wealth tax base debts and liabilities they owe measured at their dollar cash value as of the end of the last day of the tax year, subject to anti-abuse rules to prevent overinflation or creation of artificial liabilities (e.g. related parties transactions).

To conclude, different valuation approaches have their advantages and disadvantages depending on the type of the valued asset. This proposal will clearly introduce more complexity and administrative and compliance cost. As the stakes will increase (corresponding taxation on substantial wealth of the wealthiest) so will opportunities of shrewd tax professionals offering tax avoidance opportunities for undervaluation. While Gamage, Glogower, and Richards’ proposal relies heavily on the integrity of appraisals, it is not clear whether the appraisals industry is currently equipped to handle the new demand (and pressure to undervalue). A corresponding professional reform, increased penalties, and oversight will be needed here as well. Involving appraisers as middlemen may be beneficial all the while increasing cost of monitoring and enforcement. Gamage, Glogower, and Richards are convinced such costs will be outweighed by the benefits of taxing the rich.

Here's the rest of this week's SSRN Tax Roundup:

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