Here’s how Janet Yellen's proposed tax on unrealised capital gains may work

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Here’s how Janet Yellen's proposed tax on unrealised capital gains may work
Janet YellenBusiness Insider
  • US Treasury Secretary Janet Yellen has proposed a tax on unrealised capital gains of billionaires.
  • The unsold wealth of the super rich are often transferred to the heirs and eventually, when they are sold, they yield very little tax.
  • Wealth managers believe this could spook investors in the US and that could move money towards emerging economies, which includes markets like India.
  • Check out the latest news and updates on Business Insider.
Janet Yellen, the Treasury Secretary in the Joe Biden administration, has proposed a tax on unrealised capital gains.

Capital gains tax is a tax on the profit that investors realise on the sale of their assets. If you sell shares that you own in a company and make a profit when you sell them, you pay a tax on the profit. The current rate in the US is up to 37%, based on the asset type, period of holding, and the income of the investor.

Yellen, the former Chair of the US Federal Reserve, wants investors to pay a tax on the increase in value of stock every year, even if it is not sold. So if a stock goes from $100 to $150 apiece in a year but you haven’t sold it, you may still have to pay a tax on that $50 a share, where you haven’t made a profit yet. That’s tax on unrealised capital gains.

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However, the Democrat administration in the US is targeting only the super rich with this tax

The unsold wealth of the super rich are often transferred to the heirs without a tax. “I wouldn't call that a wealth tax. But it would help get at capital gains, which are an extraordinarily large part of the incomes of the wealthiest individuals, and right now escape taxation, until they're realised, and often they're unrealised in the death benefit from a so- called step up of basis,” Yellen explained in an interview with the CNN.

Simply put, in the US, if a person sells an asset that s/he inherited, the cost of the asset (for the calculation of profit) is considered to be the price at the time of inheritance. That’s usually a lot higher than the actual cost of the asset and so, the taxable profit shrinks.

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The Biden administration is looking to raise its tax revenue to fund a $3.5 trillion spending plan over ten years. Yellen had first proposed the tax on unrealised capital gains in February 2021.

Since then, many wealth managers from Howard Marks to Peter Mallouk, as well as many others, have argued that this may lead to more investments in markets outside the US in a bid to escape the added tax.

“Creative Planning clients are holding 20% to 40% of their portfolios in foreign stocks, both emerging markets and developed markets, tilting toward the latter,” he said in a podcast with ThinkAdvisor.

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At a time when there are fears of a bubble in emerging markets like India, this move in the US could come as a big boost if spooked investors on Wall Street decide to move money to other destinations.

It may be good for India, but tax is just one factor that investors consider before putting money in any country. The inherent growth potential and ease of doing business are considered before the tax implications.

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