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Retirement Assets Could be Ensnared in New Social Security Proposal

Legislation

Under a new proposal put forward by an influential Democratic member of Congress, retirement assets could be factored into a new tax regime targeting higher-income taxpayers. 

Labeling it as a proposal to help pay for a Social Security overhaul, Sen. Ron Wyden (D-OR), the ranking member on the Senate Finance Committee, on Sept. 12 unveiled a 33-page proposal that he says would “fix the broken U.S. tax code and require millionaires and billionaires to pay their fair share by equalizing the tax treatment of wages and wealth.” 

According to the report, revenue generated from the proposal – an estimated $1.5 to $2 trillion over 10 years – would be used to protect benefits currently promised under the Social Security system. Wyden notes that without additional funding and based on current estimates Social Security would be able to pay only 80% of currently promised benefits after 2035.  

Harmonization, Anti-deferral and Lookback 

As part of the funding for the Social Security remedy, the proposal seeks to tax ordinary income and capital gains at the same rates (capital gains are currently taxed at a lower rate). The proposal also introduces a new marked-to-market anti-deferral accounting system to require so-called high-income taxpayers to recognize unrealized gains and losses from tradable assets annually (rather than waiting until the gains/losses are realized), as well as a lookback rule to tax gains from the sale of nontradable assets (such as business interests and real estate) upon realization.

In general, those so-called “anti-deferral” rules would apply to taxpayers who have met either the income threshold of $1 million or an asset threshold of $10 million of applicable assets for each of the preceding three tax years – and that’s where retirement assets come into play. Tax-preferred savings accounts with a combined value in excess of $3 million (indexed for inflation) would be included for purposes of determining the asset threshold and whether the taxpayer is an applicable taxpayer and, therefore, subject to the new taxation rules. 

However, the proposal doesn’t impose a tax on trading in those retirement accounts. Assets held in tax-preferred savings accounts would be taxed in the same manner as under current law, even if a taxpayer is an applicable taxpayer. Tax-preferred savings accounts would include tax-qualified retirement plans (like a pension or 401(k) plan), 403(b) plans, 457 plans, SIMPLE IRAs, SEPs, IRAs (traditional or Roth), HSAs, Archer MSAs, 529 plans or Coverdell accounts. 

According to an example, if an individual taxpayer has $4 million in tax-preferred savings accounts, only $1 million (the amount over the $3 million threshold) is counted toward the asset threshold for the purpose of determining whether a taxpayer is an applicable taxpayer, but no amount of the savings in such accounts is ever subject to anti-deferral accounting.

The proposal also explains that balances in flexible spending accounts (FSAs), health reimbursement accounts (HRAs) and the right to a benefit from a defined benefit (DB) plan would not be considered applicable assets. Additionally, the current tax rules that permit a business owner to defer recognition of gain from the sale of stock in the business to an ESOP would not change under the proposal. 

What is Counted?

For purposes of determining whether a taxpayer meets the asset threshold, applicable assets would include all capital property, such as stocks; partnership interests; bonds or other evidence of indebtedness; futures, options, and other derivatives; intangibles; real property; acquired patents and copyrights; collectibles; and other personal property. Cash would also be considered an applicable asset. Household goods would not generally be considered applicable assets, subject to limits to prevent abuse. 

Special rules would also apply for personal residences and family farms. Personal residences up to $2 million and family farms up to $5 million would not be counted when determining whether a taxpayer meets the asset threshold. Values above these thresholds will be counted toward the asset threshold. For example, if a taxpayer’s home is valued at $3 million, the first $2 million is exempt and $1 million is counted toward the asset threshold. 

Non-Tradeable Assets

Taxes on gains realized from non-tradeable property such as real estate, business interests or collectibles will be calculated at sale or transfer through a lookback charge, according to a summary. The lookback charge would tax accrued gain and minimize the benefit of deferring tax. Wyden notes that he is evaluating several possible methods of calculating a lookback charge, including an interest charge on deferred tax, a yield-based tax to eliminate the benefits of deferral or a surtax based on an asset’s holding period.

Warren's Social Security/Investment Income Tax Proposal

On the same day that Wyden unveiled his proposal, presidential candidate Sen. Elizabeth Warren (D-MA) released an ambitious proposal to expand Social Security benefits, paid for by increasing Social Security payroll taxes on higher-income taxpayers and implementing a net investment income tax. 

Warren would impose a 14.8% Social Security contribution requirement on individual wages above $250,000, split equally between employees and employers at 7.4% each (up from the 6.2% rate that employees and employers currently pay).

It also would establish a new 14.8% Social Security contribution requirement on net investment income for individuals earning more than $250,000 in annual income or families earning more than $400,000 in annual income.

Warren explains that this new contribution requirement is modeled on the Net Investment Income Tax (NIIT) from the Affordable Care Act. Under the NIIT, distributions from certain qualified plans (including those under sections 401(a), 403(a), 403(b), 408, 408A or 457(b)) are not counted as net investment income. Gains from the sale of stocks, bonds, mutual funds, investment real estate (including gain from the sale of a second home that is not a primary residence) and interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner) are examples of net investment income.

The proposals from Wyden and Warren are to the latest in a series of proposals targeted at higher-income individuals, including proposals to tax financial transactions. Various other presidential candidates and Democratic lawmakers have also floated proposals for a financial transaction tax (FTT), first offering them to limit purported speculative trading and later repurposing them to help pay for pet projects. Another iteration comes from Democratic presidential candidate Sen. Kamala Harris (D-CA), who has proposed an FTT to pay for a “Medicare-for-all” proposal. Similarly, Democratic presidential candidate Sen. Bernie Sanders (I-VT), along with several cosponsors, has proposed an FTT with different rates to help pay for a cancelation of all student loan debt. 

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