Modifications of business interest expense limitation for partnerships and S corporations
The Build Back Better bill (BBB) would drastically change the application of the section 163(j) business interest expense deduction limitation for partnerships and S corporations. Under current law, the limitation is applied at the entity level. For partnerships, excess business interest expense is passed through to the partners and is deductible in subsequent years only when the partner is allocated excess taxable income or excess business interest income from the same partnership. For S corporations, in contrast, any limited interest is carried over and tracked at the S corporation level.
If enacted, the BBB will make the following changes to section 163(j):
Research and experimental expenditures under section 174
The BBB favorably extends expensing treatment of research and experimental (R&E) expenditures for four tax years, through 2025
Under current tax law, the ability to immediately deduct R&E expenses, including software development costs, is scheduled to expire for tax years beginning after Dec. 31, 2021. Thereafter, taxpayers will be required to capitalize and amortize R&E expenses over five years (for U.S. expenses) and 15 years (for foreign expenses). Under the BBB, R&E expenses will remain deductible for tax years beginning before Jan. 1, 2026.
Given the current efforts to spur economic growth, attract U.S. R&D investment and better compete with more generous foreign R&D incentives, this provision has bipartisan support in both the House and Senate.
In addition to the favorable tax considerations, enacting the provision would avoid taxpayers incurring potentially significant administrative and tax compliance costs to identify, analyze and report R&E costs.
Modification of the deduction limitation for remuneration in excess of $1 million
Two provisions are included relating to the $1 million deduction limitation for excessive employee remuneration paid by a publicly held corporation to covered employees under section 162(m). The BBB modifies the aggregation rules by adding section 162(m)(7) and clarifies the meaning of employee remuneration by amending section 162(m)(4)(A).
Section 162(m) would be amended by adding section 162(m)(7) to apply the section 414 aggregation (i.e., controlled group and affiliated service group) rules to companies resulting in all companies in the aggregated group being treated as a single employer (previously, the aggregation rules were limited to covered health insurance providers). As a result, compensation paid by different entities within the aggregated group would be combined for purposes of determining whether the deduction limitation on remuneration paid to a covered employee would be exceeded and by how much.
The BBB also authorizes the IRS to issue regulations implementing the aggregation rule to prevent the avoidance of the deduction limitation by classifying individuals as other than employees or providing compensation through a pass-through or other entity.
The bill also clarifies that applicable employee remuneration expressly includes: (1) performance-based compensation, commissions, post-termination compensation and beneficiary payments, and (2) remuneration that is not directly paid by the publicly held company.
Clarification of trade or business requirement and inclusion of certain entities for common control rules
IRC section 52(a) addresses corporations under common control, while section 52(b) provides similar rules for trades or businesses, whether or not incorporated. Existing law is unclear as to whether a common parent entity needs to be operating a trade or business for a parent/subsidiary group under common control to exist under section 52(b). The BBB would amend section 52(b) to clarify that a taxpayer engaged in any activity in connection with a trade or business or any for-profit activity is subject to the common control rules under section 52(b). As such, a common parent entity’s activity would merely need to be connected to a trade or business or investment activity in order for common control to exist (if the requisite ownership tests pursuant to corresponding regulations are met).
It is also unclear under current law if certain entities that are considered “excluded members” (namely, foreign and tax-exempt entities) under section 1563(b)(2), for purposes of determining whether the entity is a component member of a controlled group, can be excluded from the controlled group altogether. The BBB amends section 52(a) to clarify that an entity is includable in a controlled group regardless of its exempt member status, if the aforementioned requisite ownership tests are met.
These provisions would be effective prospectively, for taxable years beginning after Dec. 31, 2021.
Deferral of losses in controlled group liquidations
An additional statute, requiring deferral of losses in certain controlled group liquidations, is included in the BBB. The provision states no losses may be recognized in certain controlled group liquidations until all members of the controlled group which received property in the liquidation have transferred the property to one or more unrelated parties. The deferral applies when losses are realized on taxable liquidations of a subsidiary, a dissolution of a subsidiary whose stock or securities become worthless, or a subsidiary issues debt to a related party, resulting in any of the subsidiary’s stock becoming worthless. The changes are effective on or after the date of enactment.
Corporate stock repurchase excise tax
The BBB imposes a 1% excise tax on the value of any stock repurchased by a domestic corporation with stock traded on an established securities market, effective for transactions beginning on Jan. 1, 2022. The tax extends to subsidiaries of U.S. corporations as well as U.S. subsidiaries of foreign corporations performing buybacks on behalf of their parent organization.
Several exceptions are provided, including: (1) the corporation undergoes a tax-free reorganization; (2) repurchased stock is contributed to a pension plan or employee stock ownership plan; (3) total annual repurchases do not exceed $1 million; (4) the purchase is completed by a dealer in securities in ordinary course of business; (5) the repurchase is treated as a dividend; and (6) the repurchase is by a regulated investment company (RIC) or real estate investment trust (REIT). Additionally, repurchases subject to tax are netted with new public and employee stock issuances during the taxable year.
Changes to the exclusion for gain from small business stock
Section 1202 currently allows an exclusion for any gain realized on qualified small business stock, a type of stock that meets a certain set of criteria. When the owner sells the qualified stock, 50%, 75% or 100% of the gain from the sale may be excluded from taxable income, depending on the date the stock was originally issued. The exclusion for any taxable year cannot exceed the greater of $10 million or 10 times the adjusted basis of qualified small business stock issued by the corporation and disposed of during the taxable year. The BBB limits the exclusion percentage to 50% for qualifying sales or exchanges for high-income taxpayers, those with adjusted gross income of $400,000 or more, and for all estates and trusts. The change applies to sales and exchanges after Sept. 13, 2021, unless a written binding contract was in effect on Sept. 13, 2021.
Corporate alternative minimum tax
For tax years beginning after Dec. 31, 2022, the BBB imposes a 15% tentative minimum tax on the adjusted financial statement income (AFSI) of certain corporations. Affected corporations are those with an average AFSI in excess of $1 billion over the three preceding taxable years. The income of corporations under common control, including foreign corporations, is aggregated in determining whether the average AFSI exceeds the threshold. AFSI is defined as the net income or loss of the taxpayer on its applicable financial statement with certain modifications. Types of financial statements can include a Form 10-K filed with the Securities and Exchange Commission, an audited financial statement or other financial statement. The tax applies to all corporations except S corporations, RICs and REITs.
The alternative minimum tax equals the amount by which the tentative minimum tax exceeds the corporation's regular tax. Certain credits, such as general business and foreign tax credits, are allowed as offsets to the minimum tax. As with the pre-2018 corporate alternative minimum tax, corporations are eligible to claim a credit for the alternative minimum tax paid in prior years against the regular tax for the current year, to the extent that the regular tax exceeds the tentative minimum tax for the year.
Expansion of energy-efficient commercial buildings deduction
The maximum deduction under section 179D for the installment of energy-efficient commercial building property is temporarily increased on a sliding scale. Additionally, the energy consumption reduction percentage threshold the property must satisfy is reduced to 25% from 50%.
Further expanding the benefit of section 179D, taxpayers now must only reduce their deduction for qualifying property in a taxable year by the amount of deductions claimed for the same property in the three previous tax years, rather than all previous tax years.
An alternative deduction for energy-efficient lighting, HVAC and building envelope costs related to a qualified retrofit plan is also available. Qualified retrofit plans must reduce a buildings energy usage intensity by a minimum of 25%. To claim this deduction, projects must meet certain prevailing wage and apprenticeship requirements.
These provisions apply to taxable years beginning after Dec. 31, 2021, and before Jan. 1, 2032.
We encourage you to reach out to your Baker Tilly advisor regarding how any of the above may impact your situation.