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The Biden administration (the “Administration”) last
week released the “General Explanations of the
Administration’s Fiscal Year 2022 Revenue Proposals,”
commonly called the Treasury Department’s “Green
Book.” The Green Book provides more details regarding
the Administration’s tax proposals. This Client
Advisory describes some of these proposals.
Individual Tax Provisions
Increase in the Top Marginal Income Tax Rate for High
Earners
The Administration has proposed increasing the top marginal
individual income tax rate from 37% to 39.6%. In 2022, this
top marginal tax rate would apply to taxable income over $509,300
for married individuals filing a joint return, and $452,700 for
unmarried individuals (other than surviving spouses). These
thresholds would be indexed for inflation.
This proposal would be effective for taxable years beginning
after December 31, 2021.
Application of Ordinary Income Tax Rates to Capital Gains and
Qualified Dividends of High-Income Earners
Long-term capital gains and qualified dividends derived by
taxpayers with adjusted gross income of more than $1 million would
be taxed at ordinary income rates, but only to the extent that the
taxpayer’s income exceeds $1 million ($500,000 for married
filing separately), indexed for inflation after 2022. To the
extent that the $1 million threshold is exceeded, long-term capital
gains would be subject to a 43.4% (i.e., 39.6% + 3.8%)
federal tax rate, as opposed to the current 23.8% federal tax
rate.
Thus, for example, a taxpayer with $900,000 in compensation
income and $200,000 in capital gains income would have $100,000 of
capital gains income taxed at the current preferential tax rate and
$100,000 taxed at ordinary income tax rates.
The Administration has proposed that this tax increase would be
effective for gains recognized after the date “of
announcement,” presumably April 2021.
Observation:
Although retroactive tax increases are permissible, we would be
surprised if the Administration’s proposed retroactive
effective date is ultimately adopted. We believe that the
more likely effective date would be (i) January 1, 2022, (ii) the
date the tax legislation is ultimately enacted, (iii) the date of
Congressional Committee action, or (iv) the date that the House or
Senate pass a tax bill incorporating the capital gains tax
increase.
Treatment of Transfers of Appreciated Property by Gift or on
Death as a Tax Realization Event
Subject to the exceptions described below, the donor or deceased
owner of an appreciated asset would generally realize a capital
gain at the time of transfer, in an amount equal to the excess of:
(i) the fair market value of the property over (ii) the
decedent’s or donor’s tax basis in the property.
Transfers by a decedent to a U.S. spouse or a charity would not
trigger tax. Transfers of tangible personal property such as
household furnishings and personal effects (excluding collectibles)
would also not be taxable. The transfer of a principal
residence would similarly not be taxable, subject to a cap of
$250,000 of gain per person and $500,000 of gain per couple.
In addition to the exceptions described above, the proposal
would also allow a $1 million per person exclusion, and $2 million
exclusion per married couple, indexed for inflation after 2022.
Payments of tax with respect to “certain family-owned and
-operated businesses” would not be required prior to the date
the interest in the business is sold or the business ceases to be
“family-owned and operated.” No details are
provided regarding the type of business that would qualify for tax
deferral. Furthermore, except with respect to liquid assets,
such as publicly-traded financial assets, a taxpayer may elect to
pay the tax under a 15-year fixed rate payment plan, in which case,
the IRS would be authorized to require security in any form which
it deems acceptable.
This proposal would be effective for gains on property
transferred by gift, and on property owned at death by decedents
dying, after December 31, 2021.
If property is held by a trust, partnership or other
non-corporate entity and the property has not been subject to a tax
recognition event within the prior 90 years, the unrealized
appreciation with respect to such property must be
recognized. The first possible recognition date under this
provision would be December 31, 2030.
Changes in Self-Employment Taxes
Under current law, wages and self-employment earnings are
subject to employment taxes under either the Federal Insurance
Contributions Act (“FICA”) or the Self-Employment
Contributions Act (“SECA”), respectively. SECA
and FICA taxes apply at a rate of 12.4% for Social Security tax on
employment earnings, subject to a cap of $142,800 in 2021, and at
rate of 2.9% for Medicare tax on all employment earnings, not
subject to a cap. An additional 0.9% Medicare tax is imposed
on self-employment earnings and wages of high-income taxpayers.
Under current law, limited partners are not subject to SECA tax
with respect to their distributive shares of partnership
income. See Internal Revenue Code (“Code”)
Section 1402(a)(13). Furthermore, S corporation shareholders
are not subject to SECA tax with respect to their shares of S
corporation income, although the tax law requires that
owner-employees pay themselves “reasonable
compensation” for services provided, with respect to which
they are obligated to pay FICA tax.
The Administration has proposed that limited partners and LLC
members who provide services and “materially
participate” in their partnerships or LLCs would be subject
to SECA tax on their distributive shares of partnership or LLC
income to the extent that the income exceeds specified threshold
amounts.
Shareholders of an S corporation who “materially
participate” in the trade or business would similarly
be subject to SECA taxes on their distributive shares of the
S corporation’s income to the extent the income exceeds
specified threshold amounts.
A taxpayer would be considered to “materially
participate” in a business if he or she is involved in the
business in a “regular, continuous, and substantial
way.”
This proposal would be effective for taxable years beginning
after December 31, 2021.
Carried (Profits) Interests Taxed as Ordinary Income
The Administration would generally tax as ordinary income a
partner’s share of income with respect to an
“investment services partnership interest,” if the
partner’s taxable income from all sources during the year
were to exceed $400,000. In addition, the Administration
would require partners in such investment partnerships to pay
self-employment taxes with respect to such income.
An “investment services partnership interest” is a
profits interest in an “investment partnership” that is
held by a person who provides services to the partnership. A
partnership is an “investment partnership” if
substantially all of its assets are “investment-type
assets” (such as securities, real estate, commodities, cash
or equivalents or derivative contracts with respect to such
assets), but only if more than 50% of the partnership’s
contributed capital is from partners in whose hands the interests
constitute property not held in connection with a trade or
business.
This proposed change in law would be effective for taxable years
beginning after December 31, 2021.
Repeal of Deferral of Gain from Like-Kind Exchanges (Section
1031)
Section 1031 would be repealed, subject to the following limited
exception: taxable gain could be deferred up to an aggregate
amount of $500,000 for each taxpayer ($1 million in the case
of married individuals filing a joint return) each year.
This proposed change in law would be effective for exchanges
completed in taxable years beginning after December 31, 2021.
Business Tax Provisions
Corporate Tax Rate Increase
The Administration has proposed increasing the income tax rate
for C corporations from 21% to 28%. The proposed change in
law would be effective for taxable years beginning after December
31, 2021.
Observations
- If enacted, C corporations would be incentivized to accelerate
income into 2021 and defer deductions to post-2021 taxable
years. - The Administration previously suggested that it may be willing
to compromise and accept a lower 25% corporate tax rate.
Revision of the Global Minimum Tax Regime
Under the Global Intangible Low-Taxed Income
(“GILTI”) tax regime, a U.S. shareholder of a
controlled foreign corporation (a “CFC”) is taxed
annually in the United States. See Code Section 951A.
The U.S. shareholder’s minimum tax inclusion reflects a
reduction for a 10% return on specified tangible foreign property
held by the CFC, so-called “qualified business asset
income” or “QBAI.”
Pursuant to Code Section 250, a corporate U.S. shareholder of a
CFC is generally allowed a 50% deduction with respect to its GILTI
minimum tax inclusion, which results in a 10.5% effective U.S. tax
rate.
Certain foreign income taxes paid by a CFC can be credited
against a corporate U.S. shareholder’s GILTI tax
obligation. The amount of the credit is limited to 80% of the
foreign income taxes allocable to the CFC’s GILTI
inclusion. Under recently-promulgated tax regulations, if
gross income is subject to a foreign effective tax rate that
exceeds 90% of the U.S. corporate income tax rate, then the U.S.
shareholder of the CFC is generally allowed to exclude such gross
income from its GILTI.
Under current law, there is a single foreign tax credit
limitation that applies with respect to a corporate U.S.
shareholder’s GILTI inclusion. Thus, foreign income
taxes paid in a high-tax foreign jurisdiction could be used to
reduce the U.S. tax liability with respect to income derived in
low-tax jurisdictions.
The Administration has proposed making the following changes to
the GILTI tax regime:
- The QBAI exemption would be eliminated;
- The Section 250 deduction would be reduced from 50% to 25%,
thus generally increasing the U.S. effective tax rate to 21%
(reflecting the newly-proposed 28% corporate tax rate); - The “global averaging” method for calculating GILTI
would be replaced with a “jurisdiction by jurisdiction”
calculation, and as a result, a separate foreign tax credit
limitation would be required for each foreign jurisdiction;
and - The high-tax exception would be repealed.
This proposal would be effective for taxable years beginning after
December 31, 2021.
Limitations on the Ability of Domestic Corporations to
Expatriate
Under current law, Code Section 7874 applies to so-called
“inversion transactions,” in which a U.S. corporation
is acquired by a foreign corporation in a transaction in which (i)
substantially all of the assets of the domestic corporation are
acquired directly or indirectly by the foreign acquiring
corporation, (ii) the former shareholders of the domestic
corporation hold at least a 60% ownership interest in the foreign
acquiring corporation by reason of having held stock in the
domestic corporation, and (iii) the foreign acquiring corporation
does not conduct substantial business activities in the country in
which the foreign acquiring corporation is organized.
If the former shareholders own at least 80% of the stock in the
foreign acquiring corporation (measured by vote or value) by reason
of having held stock in the domestic corporation, the foreign
acquiring corporation is treated as a domestic corporation for all
U.S. tax purposes (the “80% Test”). If the former
shareholders of the domestic corporation own at least 60% but less
than 80% (measured by vote or value) by reason of having held stock
in the domestic corporation, the foreign corporation is treated as
a foreign corporation, but U.S. tax must generally be paid with
respect to certain income and gain recognized by the expatriated
U.S. entity and its affiliates within the ten year period ending
after consummation of the inversion transaction (the “60%
Test”).
The Administration has proposed replacing the 80% Test with a
greater than 50% Test, thereby eliminating the 60% Test, and
thereby expanding the circumstances under which a foreign
corporation can be deemed to be a domestic corporation.
The Administration has also proposed that, regardless of the
shareholder continuity level, an inversion transaction would be
deemed to occur if (i) immediately prior to the acquisition, the
fair market value of the domestic entity is greater than the fair
market value of the foreign entity, (ii) after the acquisition, the
foreign entity’s “expanded affiliated group” is
managed and controlled in the United States, and (iii) the expanded
affiliated group does not conduct substantial business activity in
the country in which the foreign acquiring corporation is
organized.
This proposal would be effective for transactions completed
after the date of enactment.
Repeal of Deduction for Foreign Derived Intangible Income
(“FDII”)
Under current law, a domestic corporation is allowed to deduct
37.5% of its FDII for taxable years after December 31, 2017 and
21.875% for taxable years beginning after December 31, 2025.
A domestic corporation’s FDII is equal to the portion of its
intangible income derived from export transactions.
The Administration has proposed repealing the FDII deduction
effective for taxable years beginning after December 31,
2021.
Fifteen Percent (15%) Minimum Tax on Book Earnings of Large
Corporations
The Administration has proposed imposing a 15% minimum tax on
worldwide book income of corporations with book income in excess of
$2 billion. In calculating this tax liability, book net
operating loss deductions, general business credits, including
R&D, clean energy and housing, tax credits, and foreign tax
credits, would be allowable.
This proposal would be effective for taxable years beginning
after December 31, 2021.
Tax Incentives for Locating Jobs and Business Activity in the
United States and Disallowance of Deductions for “Offshoring
a U.S. Trade of Business”
The Administration has proposed creating a new tax credit equal
to 10% of eligible expenses paid in connection with
“onshoring a U.S. trade or business.” The
technical explanation states that “onshoring a U.S. trade or
business means reducing or eliminating a trade or business (or line
of business) currently conducted outside the United States and
starting up, expanding, or otherwise moving the same trade or
business to a location within the United States to the extent that
this action results in an increase in U.S. jobs.”
Deductions would be disallowed for expenses paid or incurred in
connection with “offshoring a U.S. trade or
business.” “Offshoring a U.S. trade or
business” is defined as “reducing or eliminating a
trade or business or line of business currently conducted in the
United States and starting up, expanding, or otherwise moving the
same trade or business to a business outside the United States to
the extent that this action results in a loss of U.S.
jobs.”
Expenses paid or incurred in connection with
“onshoring” or “offshoring” of a U.S. trade
or business are limited solely to expenses attributable to the
relocation of the trade or business and do not include capital
expenditures or costs for severance pay and other assistance to
displaced workers.
This proposal would be effective for expenses paid or incurred
after the date of enactment.
Limit on Deductions of Interest for Disproportionate Borrowing
in the United States
A U.S. corporation’s deduction for interest expense would
generally be limited if it has net interest expense for U.S. tax
purposes, and its net interest expense for financial reporting
purposes (computed on a separate company basis) exceeds its
“proportionate share” of the net interest expense
reported on the group’s consolidated financial
statements. A member’s “proportionate
share” of the group’s net interest expense would be
determined based on the member’s proportionate share of the
group’s earnings reflected in the group’s consolidated
financial statements.
This proposal would not apply to (i) financial services
entities, or (ii) groups that report less than $5 million of net
interest expense, in the aggregate, on one or more U.S. tax returns
for a taxable year.
Any disallowed interest expense could be carried forward
indefinitely. A taxpayer subject to this proposal would
continue to be subject to Code Section 163(j).
This proposal would be effective for taxable years beginning
after December 31, 2021.
Replacement of the “Base Erosion Anti-Abuse” Tax
(“BEAT”) with the “Stopping Harmful Inversions
and Ending Low-Tax Developments” Rule
The BEAT would be repealed and replaced with a new rule
disallowing deductions with respect to payments made to affiliates
in low-tax jurisdictions. Under the “Stopping Harmful
Inversions and Ending Low-Tax Developments”
(“SHIELD”) rule, a deduction would be disallowed to a
domestic corporation with respect to payments made to a
“low-tax member,” which is generally any affiliate
whose income is subject to an effective tax rate that is below a
designated minimum tax rate.
This rule would apply to financial reporting groups with greater
than $500 million in global annual revenues (based on the
group’s consolidated financial statement).
This proposal would be effective for taxable years beginning
after December 31, 2022.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.