Silicon Valley’s elite rattled by prospect of tax on unrealised gains

Under the Democrats' proposal, billionaires such as Elon Musk, Warren Buffett and Jeff Bezos (pictured), whose wealth is mostly derived from the stock they own, would likely face large tax bills. Photo / Getty Images

A novel proposal to tax the unrealised gains of wealthy Americans has incited fury from Silicon Valley’s richest investors.

US Vice-President Kamala Harris, the Democratic nominee for the 2024 presidential election, rolled out a tax plan last week aimed at raising nearly US$5 trillion ($7.98t) over a decade. It included support for the controversial tax proposal, which was also part of President Joe Biden’s federal budget plan for 2025.

Under the plan, people with more than US$100 million in wealth would pay taxes of at least 25% on a combination of their income and their unrealised capital gains — the value of the appreciation in the assets they own, which include stocks, bonds, real estate and other assets such as investments in start-up companies.

It is a political long shot, but if enacted would mark a fundamental change in how America’s richest individuals were taxed by sweeping in investment gains before an asset was sold or the person died. Billionaires such as Elon Musk, Warren Buffett and Jeff Bezos, whose wealth is mostly derived from the stock they own, as well as the founders and backers of successful start-up companies, would likely face large tax bills.

“It captures a small number of people, but for the people it impacts, it impacts them very meaningfully,” said Michael Bolotin, a tax partner at law firm Debevoise & Plimpton.

Some technology investors have rallied against the proposals, claiming the tax would stifle innovation as the founders and backers of high-performing start-ups would be penalised for large increases in their valuations. Marc Andreessen, the co-founder of US$35 billion venture capital firm Andreessen Horowitz, said during a podcast in July that if the tax was enacted, start-up companies would become “completely implausible”.

“Venture capital just ends. Firms like ours don’t exist,” Andreessen said. “Why on earth is anybody going to go do this versus going to Google and getting paid a lot of money every year in cash?”

The tax plan has also caused tensions with wealthy donors who are supporting Harris. Donors to her campaign have pushed back on the proposals in private meetings with Harris, and encouraged her to drop them from her election manifesto, according to a New York Times report. Harris has raised at least US$540m since launching her campaign, with contributions from a string of Silicon Valley groups such as VCs for Harris, which includes LinkedIn founder Reid Hoffman.

The idea of a so-called billionaire tax was initially floated by Ron Wyden, a Democratic senator from Oregon, and would have applied to individuals with US$1b or more in assets and who earned US$100m in three consecutive years — affecting only about 700 people. The latest version lowers the threshold to capture “centi-millionaires” — people whose wealth is more than US$100m — although it is not clear how many additional people it would affect.

The proposals are designed to address inequality in the US tax system that means the super-rich pay a lower overall rate of tax than most working families by favouring income from wealth over income from labour. The wealthiest 400 billionaire families in the US paid an average federal individual tax rate of 8.2% compared with 13% by the average American taxpayer, according to a 2021 White House study.

For example, Amazon founder and chief executive Bezos reported income of US$4.2b between 2014 and 2018, according to the Institute on Taxation and Economic Policy. His wealth during that period increased by US$99b, the think-tank said, mostly due to the appreciation of his approximately 10% stake in Amazon. As most of this asset appreciation was not realised — since the shares were not sold — it was not part of Bezos’s taxable income.

If Bezos gives his Amazon stock to his heirs when he dies, the inheritor is only required to pay capital gain tax on the appreciation of the stock’s value between when they inherited it and when it is sold. This means the unrealised gains accrued during Bezos’s ownership of the stock are never taxed as income.

The proposals have not been fully fleshed out in legislation, and there are high hurdles to becoming law. Even if the Democrats won a majority in Congress in November, they would face significant political opposition. There would almost certainly be legal challenges as to whether the US has the constitutional authority to impose such a tax.

Valuing unrealised gains would also present difficulties. In public markets, the sale of a large block of shares could command either a premium or a discount to the market price. Meanwhile, privately held investments prices can be extremely volatile, raising the possibility of a large tax bill one year and then zero or a reimbursement the next. The taxpayer would have to have enough liquidity to settle their tax bill, which could force them to borrow money from banks or credit firms, or sell their shares.

“When we talk about taxing unrealised gains, what we are doing is creating a fictional transaction and then looking at the amount of gains that would have been realised,” said Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Institute. “We don’t truly have a sale so there’s an issue of picking the right number.”

However, he said a threat to entrepreneurship was “rubbish” as the benefits of having achieved such wealth outweighed the adverse effects of the increased tax burden.

The founders and top executives of successful companies typically opt to receive most of their income in the form of stock, which allows them to decide how much income to realise each year, leaving most of it untaxed. Often they can avoid selling and instead borrow against their assets to finance their lifestyles.

For example, Tesla chief executive Musk has said he receives basically no cash salary from the electric vehicle maker or his other companies. When Musk bought Twitter, now X, for US$44b in 2022, he funded US$13b of the transaction with bank loans, partly secured against Tesla stock.

Musk criticised the tax proposals when they were first floated by the Democrats in 2021. He replied to a post on Twitter that protested the tax, saying: “Exactly. Eventually, they run out of other people’s money and then they come for you.”

Musk and Andreessen are among a handful of wealthy technology executives who have voiced their support for Trump to win the 2024 election in recent weeks.

Elsewhere in the tech industry, founders of successful start-ups and their investors would be taxed on large increases in the value of their equity in the company through private share transactions, even when they have not bought or sold shares.

Stripe, a Dublin- and San Francisco-based payments start-up, surged in value from US$36b to US$95b between 2020 and 2021 during a series of fundraising rounds. Hypothetically, if an individual investor owned 10% of Stripe’s preferred stock during that period, they would owe as much as US$1.5b in taxes for the year under the Harris proposal. Stripe’s founders, Patrick and John Collison, own about 10% of the common stock, which trades at a discount to the headline preferred price. Its value has also fluctuated. A rise in value could lead to a hefty tax bill.

Complicating matters, Stripe’s valuation has dropped to US$70b. In such a scenario, owners of its stock could potentially claim a tax refund on the loss in value, as the proposals allow the tax to be paid over nine annual instalments.

“There’s definitely a visceral reaction to the idea that you could be a founder of a start-up and have stock in a company that is illiquid, and be successful enough that you have a huge gain in the stock on paper, and as a result be left with dry income you have to pay tax on without any realistic way of getting liquidity,” said Scott Blumenkranz, a partner in the Silicon Valley office of Freshfields.

Paradoxically, the tax could even disincentivise founders from taking their company public if it is valued lower as a private company than it would be on the stock market.

Start-up investors at venture capital firms would be captured by the tax proposal if their individual carried interest — the main component of remuneration in investment firms — is greater than US$100m. Carried interest is a performance fee that pays partners with a percentage of the fund’s profits, usually about 20%.

Peter Hébert, a co-founder of Lux Capital, said the number of venture capital partners in Silicon Valley who would be affected is “not zero”.

“There will be [general partners of VC firms] that earn over US$100m in carried interest,” he said, but added that the tax proposals were an “illogical policy that has a very low likelihood of being enacted”.

Written by: Tabby Kinder

© Financial Times