Christmas Tree Lot Deception, Income Taxes, and the Supreme Court
Is it immoral to not buy a Christmas Tree from your church’s tree lot?
I’m asking for a friend.
Tons of organizations raise money by operating tree lots, and the quality of trees can vary greatly- particularly when you get passed December 15th. Churches, schools, Lions Club, you name it.
We all have our opinions on what’s fair or moral- and what’s not.
Here’s another one for you.
Should individuals be taxed on a transaction if they haven’t received the profits yet?
Seems like a reasonable question- and the Supreme Court may answer it soon. To understand what’s at stake, we need to define realized and unrealized gains.
Realized gains vs. unrealized gains
You need a buy and a sell to generate a realized gain.
If you buy an asset and sell it for more than you paid for it, you have a realized gain. If, for example, you buy 100 shares of IBM common stock for $10,000 and sell the shares for $15,000, your realized gain is $5,000.
An unrealized gain has a buy- but no sale. If you buy 100 shares of IBM common stock for $10,000, hold the stock, and the value increases to $17,000, you have an unrealized gain.
Generally speaking, unrealized gains are not taxable.
Here’s why.
The value of your investment could also decline. Sure, the IBM investor has a $7,000 unrealized gain right now, but what if the stock price declines to $8,000? It doesn’t make sense to tax someone on an unrealized gain, when it could eventually turn into a realized loss.
So, we agree that the investor does not have the dollars from the gain yet- right? No sale, no profit yet.
What about profits earned overseas?
Accumulating profits earned overseas
Here’s one component of the Supreme Court case, from the Wall Street Journal:
“The court will hear arguments in Moore v. U.S., which challenges a piece of the 2017 tax law that imposed a one-time levy on profits that companies had accumulated outside the U.S.
The case, brought by a Washington state couple seeking a $14,729 refund, raises a seemingly simple question: Must income be “realized,” or received, before it can be taxed?”
It’s the same issue.
The investors have not received the profits- so how can a gain be taxed on profits not received?
Now, there are some exceptions that are in the tax code.
“The government contends that plenty of tax-code provisions already don’t require Americans to see income hit their bank accounts. That includes rules governing the taxation of futures contracts and bonds with original-issue discounts.”
Original issue discount (OID) bonds are a good example. Say, for example, that you buy an OID bond at $830 and it matures at $1,000. Some of that $170 difference is income- and you’re taxed on the interest income over time.
OK, I can live with that.
Here’s another one:
“Partners are taxed on partnerships’ annual profits, even if they don’t get a check for their portion.”
Sure, I’ll buy it.
So, why is there such an uproar over this case?
A potential wealth tax
We’re running massive deficits, and politicians aren’t willing to raise income taxes or cut government spending.
So where do they raise more revenue?
By taxing unrealized gains on investments, that’s where. In this scenario, your investments are taxed each year, based on your unrealized gains.
Now, I assume that we all get a tax deduction when we have unrealized losses- which would reduce tax collections in years when the markets decline.
With both unrealized gains and losses, the wealth tax sounds like a bad idea, and tax compliance and enforcement would be insanely complex.
Here’s a final quote from a tax expert on the Supreme Court case:
“A holding that the realization rule is constitutionally required could well cause massive parts of the current tax system to become invalidated.”
Stay tuned.