It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

M is for Mark-To-Market.

One of the big buzz phrases from 2019 was “mark-to-market” taxation. That implies that it’s a novel way to look at tax – but it’s actually not. At least not in theory. The concept of mark-to-market already exists in some areas of tax such as international taxation and as it applies to traders. However, the idea of mark-to-market taxation for everyday taxpayers is somewhat different.

But before we dive into mark-to-mark taxation, it’s important to understand how our current tax system treats appreciated assets. 

When you buy assets for investment – like stocks – you hope that they will continue to gain value. But the reality is that stocks go up and down. And every time the market dips, that doesn’t equal a realized loss, and when the market goes back up, that doesn’t equal a realized gain. To realize a gain or a loss for tax and accounting purposes, you have to do something with the stock. Typically, that means that you sell it or otherwise dispose of it. So, gains and losses aren’t determined moment to moment, but instead on how much your cost basis has gone up or down from the time you acquired the asset to the disposition of the asset.

Basis is, at its most simple, the cost that you pay for assets. The actual cost is sometimes referred to as “cost basis” because you can make adjustments to basis over time. When it comes to stocks, your basis is generally equal to the original cost of the shares; if you participate in a DRIP or other reinvestment plan, your basis is your cost plus the cost of each subsequent purchase/reinvestment subject, of course, to other adjustments for splits and the like. When you dispose of the asset at sale or transfer, sometimes called a taxable event, the value of the stock or asset at that moment is what matters. Nothing else matters. It doesn’t matter if the stock went up and down a hundred times in the middle. Your realized gain or loss is figured by calculating the difference from purchase (plus adjustments) to sale. All that stuff in the middle is, for tax and accounting purposes, just a bunch of squiggly lines.

At tax time, you currently report your realized gains and losses on a Schedule D, and then transfer the results to the reconciliation page on your Form 1040. You don’t file a Schedule D if you don’t have any realized gains or losses: even if the value of your shares went up and down significantly. If there’s no sale or disposition, there’s nothing to report.

But mark-to-market taxation is the idea that you should be able to capture the value of appreciation each year. In other words, you would track (and pay tax) on the value of gains in the year they accrue, and not simply when you dispose of/transfer/sell/give away the assets. In theory, you’d achieve the same basic result as you would now – but you’d eliminate the deferral.

 Here’s an example.

  • Let’s say that I bought a share of stock in 2015 worth $100. And let’s assume it was worth as follows over the next few years: $110 in 2016, $120 in 2017, $150 in 2018, $200 in 2019, and $300 in 2020.
  • Under our current system, if I sold the stock in 2020, I’d have a capital gain of $200 ($300 less $100 basis). But I wouldn’t pay tax in 2016, 2017, 2018, or 2019 on the gain.
  • But if we taxed the appreciation each year, I’d still have a total taxable gain of $200, but it would be broken down into pieces: $10 in 2016, $10 in 2017, $30 in 2018, $50 in 2019, and $100 in 2020. And $10 + $10 + $30 + $50 + $100 = $200. That’s the same as before, just paid out over time instead of at the end.

That’s pretty simple to track if assets keep going up… But what happens if they go down? That’s the tricky part. Depending on the structure of the system, you could perhaps use the losses to offset other income, or allow taxpayers to carry those losses forward or back, as we do now for certain investment income.

So what’s the appeal of mark-to-market taxation? The idea is that you wouldn’t have unrealized or deferred gains for lengthy periods, which would create a reliable stream of revenue for the tax authorities. Some policymakers also believe it could close the tax gap by eliminating potential opportunities for tax evasion or fraud. But adding to the tax burden as you go isn’t popular for all taxpayers: that’s why most proposals have tended to focus on high-income taxpayers (largely by way of creating an exemption).

Mark-to-market taxation can be controversial, and you can sort out on your own whether you’re a fan. But, at least now, you know the basics.

You can find the rest of the series here:

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1 Comment

  1. The problem with mtm taxation is that you may have spent your last $100 to buy that stock. Where does the money come from to pay the taxes?

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