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October 28, 2021
Mark-to-Market Taxation of Capital Gains
Capital gains are subject to tax only when realized upon
Capital gains are taxed only if the asset is sold and not as
sale of an asset. The tax does not apply to gain on assets
gains accrue. This treatment allows the tax to be deferred. If
passed on at death, due to tax rules that apply to capital
the asset is passed on to heirs at death, any capital gain
gains realized by heirs. This exclusion from the tax base
escapes tax because the basis to the heirs is the market
limits the taxes, in particular, that can be imposed on high-
value at the time of death, referred to as stepped-up basis. If
income taxpayers who hold most of the assets that yield
an heir were to immediately sell an appreciated asset, no tax
capital gains. Senator Wyden, chairman of the Finance
would be due.
Committee, has proposed to tax gains realized by high-
income taxpayers on an accrual basis (i.e., regardless of
Concentration of Gains in High Incomes
whether the asset is sold), a method called mark-to-market.
Capital gains are largely realized by high-income taxpayers.
Table 1 indicates that the top 10% of taxpayers by income
What Are Capital Gains?
were responsible for almost three-quarters of capital gains,
Capital gains are the increase in the value of an asset, such
and the share of capital gains was almost three times the
as corporate stock, land, a building, or the increase in the
share of income. The top 0.001% of taxpayers (representing
value of a business. The gain is the difference between the
fewer than 1,500 returns) with average income of $179
market value and the basis . For a corporate stock, the basis
million were responsible for about 15% of capital gains ,
is the price paid for the stock when acquired. For a physical
and the share of capital gains was more than six times the
asset such as a building, the gain is the cost of acquiring or
share of income.
constructing the building plus the cost of any subsequent
capital improvements minus depreciation taken on the
Table 1. Distribution of Capital Gains (Income
original building or any capital improvements.
Amounts in Millions of Dollars), 2017
The Capital Gains Tax
Share of
Assets yielding capital gains benefit from (1) deferral of tax
Adjusted
Share of
until gains are realized, (2) a lower rate if held for a year or
Income
Average
Gross
Capital
more, and (3) exclusion of gain at death. As with other
Percentile
Income
Income
Gains
elements of the tax code measuring capital income, gains
0.001
178.8
2.3
14.6
are not adjusted for inflation.
0.01
39.5
5.2
29.8
Short-term gains, on assets held for less than a year, are
0.1
8.0
10.5
48.6
taxed at ordinary rates of up to 37%. Long-term gains, on
assets held for at least a year, are taxed at up to 20%. The
1.0
1.6
21.0
68.2
lower rates are tied to the permanent tax brackets (ordinary
tax rates are temporarily lower through 2025). For 2021, no
10.0
0.4
26.4
74.4
tax is due for returns with taxable income below $80,800
Source: Internal Revenue Service, Statistics of Income, Individual
for married couples ($40,400 for singles). For married
Statistical Tables by Tax Rate and Income Percentile, Table 3,
couples with income below $501,000 ($445,580 for
https://www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-
singles), the long-term capital gains tax rate is 15%. For
by-tax-rate-and-income-percentile.
taxpayers with higher incomes, the tax is 20%. For married
taxpayers with income above $250,000 ($200,000 for
The importance of capital gains is reflected in the share of
singles), capital gains, along with other types of passive
total income attributable to capital gains. For the top
capital income, are subject to an additional 3.8% net
0.001% of taxpayers by income, capital gains accounted for
investment income tax. (This rate equals the Medicare A
56.4% of income and wages less than 8.7%. For the top
tax imposed on earnings.)
10%, capital gains accounted for 16.8% of income and
wages accounted for 55.4%.
Certain types of capital gains have special rules. Gain that
results from depreciation of assets is subject to tax at
No data exist on the distribution of unrealized annual gain,
ordinary rates to the extent of the gain, although gain
but overall unrealized gain is estimated to be approximately
arising from depreciation of real property is subject to a
equal to realized gain, or about 50% of total accrued gain.
25% ceiling. Gain on collectibles is taxed at 28%. Gain on
Unrealized gain may be an even higher share for wealthy
the sale of a home is eligible for a $500,000 exclusion for a
families that are the founders of successful corporations and
married couple and a $250,000 exclusion for a single
retain shares to maintain control.
person.
https://crsreports.congress.gov
Mark-to-Market Taxation of Capital Gains
Mark-to-Market Proposals
the allowance of nominal interest deductions for borrowing
A mark-to-market proposal would measure gain each year
to finance assets that yield capital gains. Deducting interest
based on market value and thus would include not only
based on rates that reflect inflation and taxing only the real
realized gains but also unrealized gains. The recognized
part of gains would lead to tax arbitrage.
gain would be added to the basis for measuring future gain.
Most proposals would limit this treatment to high-income
Issues in a Mark-to-Market Regime
taxpayers, in part to avoid compliance and administration
One of the benefits of mark-to-market taxation is that it
problems for other taxpayers. The Wyden proposal would
would permit higher tax rates on capital gains, likely
apply this regime to taxpayers with either $1 billion of
without inducing behavioral responses. Some part of the
assets or $100 million of earnings over the past three years,
revenue gain from raising taxes on realized capital gains is
affecting approximately 700 taxpayers (so-called
lost because it increases the lock-in effect, as individuals
billionaires). Taxpayers would stay in this regime, until
reduce their realizations as a result of higher taxes. There is
they fell to half of both thresholds for three years.
a considerable range in the estimates of the magnitude of
this effect (see CRS Report R41364, Capital Gains Tax
One of the challenges of a mark-to-market proposal would
Options: Behavioral Responses and Revenues, by Jane G.
be in the treatment of assets that are not publicly traded,
Gravelle for a review). For taxpayers subject to accrual
such as real estate, land, and private businesses. The share
methods, rates could be raised without a loss of revenue
of gains in tradeable assets varies from year to year.
from the lock-in effect.
Internal Revenue Service data for the latest year available
(2012) indicate that financial assets account for 33% of
A mark-to-market regime would also increase the
gain. These ratios may be higher for the wealthiest
progressivity of the tax system by increasing the amount of
taxpayers whose wealth may be in the form of shares in
income subject to tax for high-income taxpayers. Some of
stocks of companies they or their families founded.
these taxpayers pay a small effective tax rate on their
economic income. A White House study, released on
Excluding non-traded assets would encourage investments
September 23, 2021, estimated that the Forbes 400 paid an
in forms not subject to tax. It is possible to apply a look-
effective tax rate of 8.2% for the period 2010-2018 on
back method or interest charge that would account for the
income including unrealized gain.
value of deferring the tax. To complete the equating of tax
on these assets, gains would be taxed at death or subject to
The revenue gain from a mark-to-market regime would
a carry-over of the original basis. (See CRS In Focus
depend on the income floor, the rates applied, and the
IF11812, Tax Treatment of Capital Gains at Death, by Jane
coverage of assets. A study by Batchelder and Kamin
G. Gravelle for a discussion of these approaches to
estimated an $80 billion revenue gain, if the top 0.1% of
addressing the step-up in basis that leads to the exclusion of
taxpayers were covered and the income taxed at ordinary
gains.) Senator Wyden’s proposal would incorporate these
rates.
elements, using an interest charge method and treating
transfers by gift, death, or trusts as a taxable event. Spouses
Two concerns about mark-to-market are (1) costs of
would be exempt but would retain the original basis of the
administration and compliance and (2) liquidity. These
asset.
issues are less important if mark-to-market is confined to
tradeable assets and high-income individuals, who have the
There are also issues about whether to grandfather existing
resources to comply with the new regime and access to
unrealized gains; if so, those gains would be recognized
other income or borrowing as well as selling shares to pay
only if and when assets are sold. Senator Wyden’s proposal
the tax.
would include existing gains over a five-year period.
Alternatives to Mark-to-Market
Another issue is how to treat accrued losses. Net capital
Several alternatives to a mark-to-market regime exist. One
losses are restricted to reducing ordinary income of $3,000
alternative to addressing the exclusion of unrealized gains
and unused losses are carried forward. Loss limits may be
from the tax base is to change the treatment of capital gains
considered appropriate in light of the tax rate differentials
at death. Two approaches could be considered. The most
on ordinary income and capital gains and the discretion
effective approach would be to treat death as a realization
individuals have over realizations. Accrual taxation
event, and directly tax those gains at death. A second
eliminates the latter concern. One option would be to allow
approach would be to impose carry-over basis so that heirs
losses in proportion in the tax rate differentials. For
would take as their basis the basis of the decedent rather
example, if the capital gains tax rate is 20% and the
than market value, so that these gains would be taxed if and
ordinary rate is 37%, each dollar of net loss could offset 54
when sold. Both approaches could be designed to apply
cents (0.20/0.37) of income. The Wyden proposal would
only to high-income taxpayers. See CRS In Focus IF11812,
allow a three-year carry-back of losses against gains taxed
Tax Treatment of Capital Gains at Death, by Jane G.
due to mark-to-market.
Gravelle for a discussion of these approaches. Another
alternative is to increase the corporate tax rate.
A final issue is whether to index gains for inflation, if the
ability to defer and possibly eliminate tax on unrealized
Jane G. Gravelle, Senior Specialist in Economic Policy
capital gains occurs under mark-to-market. A case against
this treatment could be made based on rate differentials and
IF11957
https://crsreports.congress.gov
Mark-to-Market Taxation of Capital Gains
Disclaimer
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https://crsreports.congress.gov | IF11957 · VERSION 1 · NEW