A mark-to-market tax system would tax capital gains annually as they accrue rather than waiting to tax capital gains upon realization.
How Would Mark-to-Market Taxation Differ from the Current Treatment?
Under the current tax system, investors are not required to pay taxes on capital gains until they sell their assets. The ability to defer taxes on capital gains reduces the effective tax rate on gains, which creates a “lock-in” effect as investors can minimize their tax liability by holding their assets for longer periods. Mark-to-market would remove investors’ choice about when to pay taxes on gains, instead subjecting gains to tax on an annual basis. Removing deferral would remove the lock-in effect, but would lead to new problems including administrative complexity, especially for illiquid assets, and reduced incentives to save.
Mark-to-market taxation might not be suitable for illiquid assets or assets that are not traded on the open market unlike stocks or other financial assets. Part of the difficulty is because in many cases, little knowledge or information exists to determine the basis of the asset being taxed. Examples of difficult-to-value assets include a company’s intellectual property, reputation, or “brand value.”
Additionally, paying annual taxes on capital gains could present compliance challenges if taxpayers do not have enough cash or other liquid assets on hand to pay an annual tax. Such taxpayers may have to sell some of their underlying assets to pay their mark-to-market capital gains tax liability.
One solution often presented in response to such challenges is the idea of a deferral charge, which would wait to assess capital gains tax plus a look-back charge until taxpayers realize gains on non-tradable assets. Deferral charges present their own set of administrative and compliance challenges.
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