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

A novel proposal to tax wealthy Americans’ unrealized gains has angered some of Silicon Valley’s wealthiest investors.

US Vice President Kamala Harris, a Democratic candidate for the 2024 presidential election, unveiled a tax reform plan last week that would raise taxes by about $5 trillion over 10 years, including support for a controversial tax reform plan that was also part of President Joe Biden’s 2025 federal budget proposal.

Under the plan, anyone with a net worth of more than $100 million would pay at least a 25% tax on any combination of income and unrealized capital gains (appreciation in the value of assets you own, such as stocks, bonds, real estate, and investments in startups).

While politically unlikely, if it were to pass, it would represent a fundamental change to how America’s richest people are taxed by taxing their investment gains in a lump sum before they sell their assets or die. Billionaires like Elon Musk, Warren Buffett, and Jeff Bezos, who derive most of their wealth from stock holdings, as well as founders and backers of successful startups, would likely face large tax bills.

“It’s a small number of people affected, but for those who are affected, it’s huge,” said Michael Bolotin, a tax partner at law firm DeBevoise & Plimpton.

Some tech investors have opposed the proposal, arguing that the tax would stifle innovation by penalizing founders and backers of high-performing startups with wildly inflated valuations. Marc Andreessen, co-founder of the $35 billion venture capital firm Andreessen Horowitz, said in a July podcast that the tax would make startups “totally unthinkable” if it were enacted.

“Venture capital is dead. Companies like us don’t exist,” Andreessen said. “Why on earth would anyone do something like this instead of going to Google and getting a load of cash every year?”

The tax reform proposal has also caused tension with wealthy donors who support Harris. The New York Times reported that donors to her campaign spoke out against the proposal in private meetings with her and urged her to remove it from her campaign platform. Harris has raised at least $540 million since launching her campaign, including from a series of Silicon Valley groups such as VCs for Harris, which includes LinkedIn founder Reid Hoffman.

The so-called millionaires’ tax idea, originally proposed by Sen. Ron Wyden, D-Oregon, would have applied to individuals with assets of more than $1 billion who made $100 million three consecutive years, affecting only around 700 people. The latest version lowers the threshold to include “centimillionaires” — those with assets over $100 million — but it’s unclear how many more people would be affected.

The proposal aims to address inequities in the U.S. tax system, where the ultra-rich pay lower overall tax rates than most working families, by favoring asset income over labor income. According to a 2021 White House study, the richest 400 billionaire families in the U.S. pay an average federal personal tax rate of 8.2%, compared to 13% for the average U.S. taxpayer.

For example, Amazon founder and CEO Jeff Bezos reported $4.2 billion in income between 2014 and 2018, according to the Institute for Taxation and Economic Policy. During that period, Bezos’ wealth increased by $99 billion, which the think tank said was mainly due to a roughly 10% increase in the value of Amazon shares. Most of that increase was never realized and the shares were never sold, so it isn’t included in Bezos’ taxable income.

If Bezos were to transfer his Amazon shares to his heirs upon his death, they would only have to pay capital gains tax on the increase in value between the time they inherited the shares and the time they sold them — meaning any unrealized gains that Bezos made while he owned the stock would not be taxed as income.

The proposal has not been fully fleshed out in legislation and faces significant hurdles before becoming law. Even if Democrats win majorities in Congress in November, they would face significant political opposition. Legal challenges would almost certainly be mounted over whether the U.S. has the constitutional authority to impose such a tax.

Valuing unrealized gains can also be difficult. In the public market, the sale of large amounts of shares can be over or undervalued relative to market value. Private investment prices, on the other hand, can be highly volatile, resulting in a large tax liability one year and zero or a refund the next. Taxpayers need to have sufficient liquidity to pay their taxes, which may force them to borrow money from banks or credit companies or sell shares.

“When we talk about taxing unrealized gains, what we’re doing is inventing fictitious transactions and looking at the amount of gain that would have been realized,” says Steve Rosenthal, a senior fellow at the Urban-Brookings Institute for Tax Policy Studies. “There’s no real buying or selling going on, so there’s the problem of picking the right numbers.”

But he said the threat to entrepreneurship was “nonsense” as the benefits of gaining such wealth outweigh the negative impact of an increased tax burden.

Founders and CEOs of successful companies typically choose to receive most of their income in the form of stock, which allows them to determine how much income they receive each year, much of it tax-free. They often avoid selling stock and can instead borrow against their assets to cover living expenses.

For example, Tesla CEO Elon Musk has said he receives essentially no cash salary from the company or any of the other companies it owns. When Musk bought Twitter (now X) for $44 billion in 2022, he funded $13 billion of the deal with a bank loan, some of which was secured by Tesla shares.

Musk criticized the tax plan when it was first proposed by Democrats in 2021. He responded to a post criticizing the tax on Twitter, saying, “You’re right. In the end, they’ll run out of other people’s money and then they’ll come after you.”

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

Elsewhere in the technology industry, founders of successful startups and their investors would be taxed on big increases in the value of their companies’ shares through private equity transactions, even if they never bought or sold any stock.

Dublin- and San Francisco-based payments startup Stripe saw its valuation soar from $36 billion to $95 billion between 2020 and 2021 in a series of funding rounds. If an individual investor held 10% of Stripe’s preferred stock during that period, Harris’ proposal would result in a tax liability of up to $1.5 billion that year. Stripe founders Patrick and John Collison own about 10% of the company’s common stock, which trades at a discount to the preferred’s headline price. Its value has also fluctuated, and if it rises in value it could lead to a large tax bill.

Complicating matters, Stripe’s valuation has fallen to $70 billion, a scenario in which holders of the company’s stock could seek a tax refund on the decline in value because the proposal allows for the tax to be paid in nine installments.

“There’s definitely a visceral reaction to the idea of ​​being a startup founder and holding shares in an illiquid company, and then being successful and making big gains on the books with the shares, only to end up with no real way to get liquidity and just income on which you have to pay tax,” said Scott Blumenkranz, a partner in Freshfields’ Silicon Valley office.

Paradoxically, the tax could even discourage founders from taking their companies public if their private valuation is lower than their stock market valuation.

Emerging venture capital firms would be subject to the proposed tax if they earn more than $100 million in performance fees, a major component of an investment firm’s compensation — fees paid to partners as a percentage of the fund’s profits, usually about 20%.

Lux Capital co-founder Peter Ebert said the number of Silicon Valley venture capital partners affected was “not zero.”

“there will be [general partners of VC firms] “I wouldn’t tax companies that make more than $100 million in carried interest,” he said, but added that the tax proposal was “an illogical policy that is highly unlikely to be enacted.”