Authored by Paul Dillon, Michelle Hobbs, Mike Schiavo and Pat Balthazor
The Treasury Department released detailed information about the Biden administration’s tax proposals for fiscal year 2022 for the American Families Plan and the American Jobs Plan (i.e., the infrastructure bill, see our previous tax alert). Traditionally, tax professionals have referred to this annual publication as the “Green Book.” The report contains new information about the effective dates of these proposed changes as well as additional details on the tax elements of each plan. It is critical to note these are only proposals and will be subject to extensive negotiations and debate.
Prospects for passage
Legislation needs 60 votes to pass in the Senate, unless the bills are run through the budget reconciliation process. Budget reconciliation generally is limited to one spending bill per federal fiscal year, and it was used already in the current fiscal year to pass the American Rescue Plan Act. At this point, it is uncertain whether reconciliation would be used again on either of these plans, or if the political climate will allow them to be combined into one package.
However, even achieving the 50 votes needed for passage via reconciliation in the Senate (with Vice President Harris casting the tie-breaking vote) may be difficult. In addition to apparent differences within the Democratic Party over how much spending is necessary, there is a desire among some senators to pass a bipartisan infrastructure bill. The need to secure 10 Republican votes in the Senate (assuming all Democratic senators vote in favor) may limit the size and scope of any legislation. As a result, we expect lengthy negotiation and debate before any of these proposals are brought up for a vote.
American Families Plan: key tax proposals
- Increase the top individual rate to 39.6% from the current 37%, effective for tax years beginning after Dec. 31, 2021 (this rate was at 39.6% prior to passage of the Tax Cuts and Jobs Act (TCJA) in 2017). For taxable year 2022, the top marginal rate would apply to taxable income over $509,300 for married individuals filing a joint return, $452,700 for unmarried individuals (other than surviving spouses), $481,000 for head-of-household filers, and $254,650 for married individuals filing a separate return.
- Tax long-term capital gains and qualified dividends of taxpayers with adjusted gross income over $1 million at ordinary rates, effective for gains required to be recognized after the date President Biden first announced the American Families Plan (April 28, 2021). Combined with the proposed increase in the top marginal rate and the 3.8% net investment income (NII) tax, capital gains would be subject to a maximum federal rate of 43.4%.
– This rate would apply to the extent that the taxpayer’s adjusted gross income exceeds $1 million. For example, a taxpayer with $900,000 in wages and $200,000 of long-term capital gain would have $100,000 of capital gain taxed at the current preferential tax rate and $100,000 taxed at the proposed ordinary income rates.
- End the step-up in basis of assets to fair market value as of the date of death. Specifically, a transfer of appreciated property by gift or upon death would be treated as a realization event – the donor or decedent would realize a capital gain at the time of transfer, which would be taxable income on the federal gift or estate tax return or on a separate capital gains return.
– This change generally would apply to gains in excess of $1 million for an individual and $2 million per couple, and would tax appreciation if property is not donated to charity.
– Gain on unrealized appreciation also would be recognized by a trust, partnership or other noncorporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years, with such testing period beginning on Jan. 1, 1940. The first possible recognition event for any taxpayer under this provision would thus be Dec. 31, 2030.
– Protections would be put in place to exempt family-owned businesses and farms from taxes when passed down to heirs who continue to run the business. For example, payment of tax on the appreciation of certain family-owned and -operated businesses would not be due until the interest in the business is sold or the business ceases to be family-owned and -operated. In addition, the proposal would allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made.
– This proposal would be effective for gains on property transferred by gift and on property owned at death by decedents dying, after Dec. 31, 2021, and on certain property owned by trusts, partnerships and other noncorporate entities on Jan. 1, 2022.
- Subject all trade or business income of high-income taxpayers to the 3.8% Medicare tax, either through the NII tax or the self-employment (SE) tax. For taxpayers with adjusted gross income in excess of $400,000, the definition of NII would be amended to include gross income and gain from any trades or businesses that is not otherwise subject to employment taxes. Effective for taxable years beginning after Dec. 31, 2021.
- “Rationalize” the SE tax treatment for income from flow-through entities. Limited partners and limited liability company (LLC) members who provide services and materially participate in their partnerships and LLCs would be subject to SE tax on their distributive shares to the extent their income exceeds certain threshold amounts. Additionally, S corporation owners who materially participate in the trade or business would be subject to SE taxes on their distributive shares to the extent their income exceeds certain threshold amounts. The various exemptions from SE tax provided under current law for certain types of flow-through entity income (e.g., rents, dividends, capital gains, certain retired partner income) would remain. Effective for taxable years beginning after Dec. 31, 2021.
- End like-kind exchange tax deferrals for real estate gains in excess of $500,000 ($1 million for married taxpayers filing a joint return); effective for exchanges completed in taxable years beginning after Dec.31, 2021.
- Tax carried interests as ordinary income, effective for taxable years beginning after Dec. 31, 2021. The proposal would generally tax a partner’s share of income on an “investment services partnership interest” (ISPI) in an investment partnership as ordinary income, regardless of the character of the income at the partnership level, if the partner’s taxable income (from all sources) exceeds $400,000. In addition, partners in such investment partnerships would be subject to SE taxes on such income.
- Make permanent the “excess business loss limitation,” which limits the amount of business losses that can offset a taxpayer’s income from other sources. This limitation expires in 2025 under current law and was temporarily suspended for 2018, 2019 and 2020 by the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
- Extend, increase or make permanent several credits; including the child tax credit, the child and dependent care credit, the earned income tax credit and Affordable Care Act premium tax credits.
American Jobs Plan: key tax proposals
- Increase the corporate income tax rate from 21% to 28%. The rate increase would apply to taxable years beginning after Dec. 31, 2021. For taxable years beginning after Jan. 1, 2021, and before Jan. 1, 2022, the 7% rate increase would be prorated based on the portion of the year occurring in 2022.
- Impose a 15% minimum tax on worldwide book income in excess of $2 billion. The book income tax equals the excess, if any, of tentative minimum tax over regular tax. Additionally, taxpayers would be allowed to claim certain credits, including a book tax credit (generated by a positive book tax liability) against regular tax in future years but this credit could not reduce tax liability below book tentative minimum tax in that year. The minimum tax is targeting large corporations that report substantial book income to shareholders, yet pay little or no federal income tax. Earlier proposals would have applied to corporations with incomes above $100 million. The effective date is taxable years beginning after Dec. 31, 2021.
- Change the global intangible low-taxed income (GILTI) regime, effective for tax years after Dec. 31, 2021.
– Eliminate the exemption from GILTI for the 10% return on foreign tangible property (known as qualified business asset income or QBAI). This makes the U.S. shareholder's entire net controlled foreign corporation (CFC) tested income subject to U.S. tax.
– Double the GILTI tax rate to 21% from 10.5%.
– Impose a country-by-country method for calculating GILTI. This would eliminate the ability to blend excess foreign tax credits from high-tax jurisdictions against GILTI inclusions from low-taxed jurisdictions.
– Repeal the high-tax exemption for GILTI and Subpart F.
- Modify the current inversion rules by lowering the continuing shareholder ownership threshold to 50% rather than 80%. These changes would be effective for transactions that are completed after the date of enactment.
- Repeal the deduction for foreign-derived intangible income (FDII). Under current law, a 37.5% deduction is allowed for FDII, which is calculated as a percentage of intangible income from exports. The proposal states that the resulting revenue will be used to encourage research and development, but no mention is made of any specific research and development enhancements. This would be effective for taxable years beginning after Dec. 31, 2021.
- Repeal the base erosion and anti-abuse tax (BEAT) and replace it with a “stopping harmful inversions and ending low-tax developments” (SHIELD) rule. SHIELD would deny tax deductions for certain related-party payments to a member in the same financial reporting group where the recipient member is in a low-tax jurisdiction. The repeal of BEAT and replacement with SHIELD would be effective for tax years beginning after Dec. 31, 2022.
- Modify the interest expense limitation under section 163(j) for members of certain multinational groups. The interest deduction would be limited to the member’s proportionate share of the financial reporting group’s net interest expense and would be effective for taxable years beginning after Dec. 31, 2021.
- Create a new general business credit equal to 10% of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business. 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. The proposal also includes a disallowance of deductions for expenses paid or incurred in offshoring a U.S. trade or business. This would be effective for expenses paid or incurred after the date of enactment.
- Repeal various tax credits and incentives for the oil and gas industry. In addition, numerous clean energy, renewable and alternative energy credits and incentives would be added or continued. These provisions clearly indicate the administration's preference toward clean energy and reduced greenhouse gas emissions, while moving away from fossil fuels.
We encourage you to connect with your Baker Tilly adviser regarding how any of the above may affect your tax situation.