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   Mark-to-market Gains at Year-end?
 

April 22, 2012


Late 
last 
year, 
I 
attended
 a 
hearing 
of 
the 
congressional 
Joint 
Committee 
of 
Taxation
 on 
the 
taxation 
of
 financial 
products.



One
 of
 the
 four 
speakers 
testifying
 that 
day 
was 
attorney
 David
 S. 
Miller, 
who 
put 
forth 
the 
idea 
that
 really 
rich 
people
 should 
mark 
their 
assets 
to 
market 
at 
year-end 
and
 pay
 tax 
on 
unrealized
 profits
 every 
year.
 A
 professor 
from
 Columbia 
University 
testifying 
at 
the 
hearing 
also 
thought 
that 
an
annual
 tax 
on 
unrealized 
profits 
wasn't 
a 
bad 
idea.



Tax 
lawyer 
Andrea 
Kramer 
was 
the 
lone
 voice 
of 
skepticism,
 having 
thought 
through
 the 
practical
 problems 
with 
such
 an 
idea.



On
 April 
1, 
the 
blog 
Tax Prof
 reported 
that 
Warren 
E. 
Buffett 
liked 
Mr. 
Miller's
 idea
 so 
much
 that 
he
 would
 start
 the 
ball 
rolling 
by 
paying 
 a 
15% 
tax 
on 
his 
unrealized 
appreciation 
in 
Berkshire 
Hathaway
 Inc. 
The 
blog 
reported
 that 
Mr. 
Buffett 
had
 sent 
a 
check
 for 
$1.2
 billion 
to 
the 
Internal 
Revenue 
Service
 voluntarily.



Thankfully,
 on
 later 
inspection, 
I 
found
 out
 that 
his
 largess 
was 
only 
an 
April 
Fools'
 Day
 hoax.
 But
 the
 drumbeat 
for 
mark-to-market
 taxation 
can
 still 
be
 heard.



In
 looking
 for 
literature 
on 
the 
subject, 
I 
found
 that 
every 
20 
or 
30 
years, 
Congress 
toys 
with 
the 
idea
 of
 changing 
the 
realization-based 
capital 
gains 
taxation
 model.



A 
few 
of 
these 
forays
 ended 
after 
pretty 
much 
everyone 
came 
to 
the 
conclusion 
that 
asking 
people 
to
 pay
 tax 
on 
phantom 
profits 
just 
isn't
 fair.



Others
 got 
past 
the 
fairness 
issue
 but
 got 
bogged 
down
 on
 the 
problems 
that 
taxpayers
 would 
face
 trying 
to 
find
 the 
money 
to 
pay
 the 
tax 
on 
the
 unrealized 
appreciation.
 I 
was 
aghast 
when 
I 
read 
one
 paper 
blithely 
suggesting 
that 
investors 
just 
take
 out 
margin 
loans
 to 
pay 
the 
tax 
as 
long 
as 
the 
tax 
rate
 isn't 
above 
Regulation 
T's 
50%
 borrowing 
limit.



If
 the 
analysis 
gets 
past 
these 
hurdles, 
the 
practical 
realities 
of 
administering 
the 
tax
 come
 into 
play.

 Are
 capital 
losses
 marked 
to 
market, 
too?
 Can 
taxpayers
 start 
deducting 
capital 
losses?


If
 not, 
can
 the 
losses
 at 
least 
be 
carried 
back?
 How
 much 
money 
does 
the 
Treasury
 lose 
by 
allowing
 the 
deductibility 
of 
losses?



The
 really 
big 
headache: 
How
 does 
one 
value
 a 
fine-art
 collection 
or 
real
estate?



Mr.
Miller's 
answer 
is 
to 
apply 
this
 concept 
only 
to 
those
 publicly 
traded 
securities 
that 
have 
easily
 ascertained 
year-end 
values.



Previous
 analyses 
have 
discussed
 creating 
asset 
classes
 of 
winners 
and 
losers, 
and
 concluded
 that
 doing 
so 
would 
cause 
massive 
economic 
distortions.
 To 
minimize 
taxes, 
people 
would 
move 
out
 of
 publicly 
traded 
securities, 
hurting 
the 
markets.



A
 behavioral 
change 
leading
 investors 
to
 favor 
insurance-wrapped
 products, 
over-the-counter

derivatives 
and
 private 
securities 
would
 be
 inevitable.



The
 reason 
that 
Congress 
contemplates 
the 
marking 
to 
market 
of 
assets
 every
 so 
often 
is
 the

perception 
that 
investors 
have 
too 
good 
a 
deal
 under
 the 
realization 
system.
 The 
ability 
to 
cherry-pick
 what
 gains 
or 
losses 
to 
realize 
and 
pay
 tax
 on 
is 
indeed 
an 
important 
tool 
in 
tax-efficient
 investing, 
but
 that
 isn't 
all
 that 
Congress
 fears.


Under
 our
 system,
 the
 IRS
 is 
your 
partner 
when
 you
 make 
money, 
but 
when 
you 
lose, 
you're 
on 
your
 own

unless 
you 
have 
been 
lucky 
enough
 to 
have 
taken 
some 
gains 
that 
year. 
The
 limitation 
on 
the
 deductibility 
of 
capital 
losses 
is 
the 
trade-off
 for
 being
 able 
to 
time
 the
 realization 
of 
gains.



The
 wash
 sale
 rule 
hinders 
a
 true
 ability
 to
 manipulate 
gains 
and
 losses. 
The
 straddle 
rules 
inhibit 
any
 possible 
problems
 with
 cherry-picking
 gains 
and 
losses.



The 
root 
of 
the 
problem
 is 
the 
favorable 
rate
 given 
to 
long-term
 capital 
gains.
 The
 tax
 code
 encourages

investors
 to 
alter 
their 
behavior 
and
 tilt 
toward
 long-term
 capital 
gains.



Once
 the 
government 
asks 
taxpayers
 to 
alter 
their 
behavior
 in 
a 
particular 
way,
 they
 will 
oblige.



In 
the 
case 
that 
publicly 
traded 
securities 
were 
singled
 out
 for
 harsh
 tax
 treatment,
 there 
would 
be
an
 evolution 
of 
new 
financial 
products. 
These 
investments 
wouldn't
 fit 
within 
the 
definition 
of
 marked-to- market 
securities, 
yet
 would 
mimic 
direct 
holdings
 as 
best 
they
 could.



Most 
studies 
and 
testimony 
on 
the
 subject 
of 
timing 
capital 
gains 
taxes 
conclude 
that 
realization-based
 taxation 
is 
the 
right 
way 
to 
go. 
In
 addition,
 even
 if 
it 
were 
preferred 
philosophically, 
the 
mark-to-market
 method
 couldn't 
be 
levied 
on 
all 
assets
 and 
thus
 wouldn't 
work. 
Like
 democracy, 
a
 realization-based

taxation 
system
 may 
not 
be 
perfect,
 but 
it 
is 
still 
the
 best 
method
 that 
exists. 

This article and other articles are provided for information purposes only. They are not intended to be an offer to engage in any securities transactions or to provide specific financial, legal or tax advice. Articles may have been rendered partly inaccurate by events that have occurred since publication.  Investors should consult their advisers before acting on any topics discussed herein. 

 

 



 



     

 

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