Biden Administration Releases Treasury Inexperienced E book, Offering Detailed Rationalization Of Tax Proposals – Tax

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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.

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