Biden Budget And Treasury Green Book Add Details To Expected Far-Reaching 2021 Tax Changes – Tax

The White House and Treasury today released the Fiscal Year 2022
Federal Budget and the Treasury Green Book, which include new details
regarding the Biden administration’s American Families Plan and
proposed 2021 tax changes – including a proposed retroactive
capital gains tax increase to 37 percent to the extent household
adjusted gross income exceeds $1 million. The tax changes expected
to be enacted this year could be substantial and far-reaching and
include corporate, individual and capital gains tax rate increases;
international tax changes; and estate and gift tax changes.

The Treasury Green Book proposes to raise $2.4 trillion in
revenue from the proposed tax changes. It also proposes
significantly increasing IRS resources and staffing and estimates
that over $700 billion of federal revenue would be generated from
increased information reporting and tougher and more comprehensive
tax enforcement.

Expected Timing of Biden Administration Tax Changes

Congressional committees in the House and Senate will soon begin
working on tax and budget proposals that will become part of the
next budget reconciliation bill. The House and then the Senate will
craft and approve a budget resolution to serve as the vehicle for
the reconciliation process. Many expect committee action to begin
in the coming weeks, with ultimate enactment of a comprehensive,
single package in the fall. Only 51 votes are needed to pass
budget reconciliation legislation in the Senate. The effective
dates of the newly enacted provisions generally are expected to be
Jan. 1, 2022, but certain provisions may have proposed effective
dates tied to announcement, committee action or the date of
enactment. For example, capital gains tax rate increases have been
proposed by the Biden administration to apply to “gains
required to be recognized after the date of announcement
[presumably late April 2021],” and may be proposed by
congressional committees to apply to sales occurring after the date
of announcement, congressional committee action or the date of
enactment of the legislation later in the fall. Historically,
proposed effective dates for capital gains increases often have
slipped to date of enactment of the legislation. We expect the same
to occur this year. The effective dates of certain provisions may
be phased in over time, and certain provisions may be enacted on a
temporary rather than permanent basis to help keep the scored cost
of the legislation within acceptable parameters.

Depending on a taxpayer’s specific circumstances,
significant tax savings may be achieved by those who anticipate the
expected changes and take steps now to take advantage of existing
tax provisions and rates. This alert addresses only a fraction of
the tax changes expected to be enacted this fall; additional
details will be released over time as congressional proposals take
the form of draft legislation.

Expected Corporate Tax Rate Increases and Related Changes

Corporate tax rates are proposed by the Biden administration to
increase from 21 percent to 28 percent. Most believe the corporate
rate will actually increase to no more than 25 percent. For
noncorporate taxpayers, it is unclear whether the Section 199A 20
percent pass-through deduction will become unavailable or be
changed or reduced. The Joint Committee on Taxation estimates the
calendar year 2020 tax savings from Section 199A to be nearly $50
billion. The Green Book is silent on Section 199A, but President
Biden campaigned on limiting the Section 199A pass-through tax
deduction for high-income taxpayers (households earning in excess
of $400,000). Senate Finance Committee Democrat staff are working
on a series of changes that would eliminate Section 199A benefits
for high-income taxpayers. Section 199A already is unavailable to
certain individuals in certain services businesses (including
lawyers and doctors and certain businesses with insignificant
numbers of employees and few assets) earning in excess of $164,900
($329,800 for joint filers). The Green Book also is silent
regarding net operating loss (NOL) carrybacks. 2021 tax reform
legislation nevertheless is expected to prohibit NOL carrybacks for
tax returns not filed by the date of enactment. The American
Families Plan states that it will “permanently extend the
current limitation in place that restricts large, excess business
losses.” Internal Revenue Code Section 162(l) generally
disallows use of noncorporate losses in excess of $250,000
($500,000 for joint filers). The CARES Act removed the Section
461(l) limitation for tax years 2018-2020. The American Rescue Plan Act of 2021 (ARPA) pushed
out the current expiration of Section 461(l) from 2026 to 2027. The
ARPA did not remove or change CARES Act provisions relating to
Section 461(l). The Green Book proposes to permanently extend
Section 162(l), effective for taxable years beginning after Dec.
31, 2026.

The Biden administration also is proposing:

• For the global intangible low-taxed income (GILTI) regime:
  

  • Eliminating the exemption from GILTI for the 10 percent return
    on foreign tangible property (referred to as qualified business
    asset income or QBAI).

  
  

  • Doubling the GILTI tax rate from 10.5 percent to 21
    percent.

  
  

  • Imposing a country-by-country method for calculating GILTI
    (thus eliminating the ability to blend high-taxed GILTI against
    low-taxed GILTI).

  
  

  • Repealing the high-tax exemption to subpart F income and the
    cross-referencing to it in the GILTI rules.




• Limiting the ability of a domestic corporation to expatriate by
  lowering the threshold for continuing former shareholder ownership
  to at least 50 percent (rather than at least 80 percent) under the
  inversion rules of Section 7874. And regardless of shareholder
  ownership, proposing to find an inversion transaction where (1) the
  domestic entity has a greater fair market value than the foreign
  acquirer, (2) the group is primarily managed and controlled from
  within the United States and (3) the group does not conduct
  substantial business activities in the country in which the foreign
  acquirer is organized.




• Repealing the foreign-derived intangible income (FDII) regime
  that provides a deduction to domestic corporations regarding their
  intangible income earned from serving foreign markets, and
  replacing it with additional research and development credits.




• Replacing the base-erosion and anti-abuse tax (BEAT) with a
  so-called stopping harmful inversions and ending low-tax
  developments (SHIELD) proposal. SHIELD generally would deny tax
  deductions for certain related-party payments where the recipient
  is in a low-tax jurisdiction (i.e., a jurisdiction with a tax rate
  below 15 percent).
  

  • In tandem with this proposal, the United States is petitioning
    the OECD and G20 for an agreement on a global minimum corporate tax
    rate of 15 percent.




• Modifying the interest expense limitation rules under Section
  163(j) by limiting the available deduction of a U.S. corporate
  group member to its proportionate share of the financial reporting
  group’s net interest expense.




• Adding a 15 percent so-called minimum tax on corporations with
  more than $2 billion of “book income.”




• Creating a new business credit equal to 10 percent of certain
  eligible expenses associated with onshoring jobs and investments
  into the United States.




• Imposing an “offshoring penalty” surtax on U.S.
  company offshore production profits for sales back into the United
  States (10 percent surtax leading to a 30.8 percent effective tax
  rate; it would also apply, for example, to offshore services or
  call centers serving the United States).




• Providing or expanding tax credits and incentives for
  manufacturing, renewable energy, alternative fuels, carbon capture
  and small businesses.




• Repealing fossil fuel tax preferences.




• Eliminating deductions for consumer drug advertising.




• Repealing bonus depreciation, including repealing the increase
  in bonus depreciation from 50 percent to 100 percent.

Details of these proposals are still being refined, and certain
of these proposals may be difficult to draft or administer. Others
may be enacted only in part. All the proposals are relevant in the
sense that they provide insight into what the Biden administration
is hoping to achieve.

Changes in Social Security taxes, the minimum wage, and many
other Biden administration or congressional proposals do not
qualify for consideration as part of budget reconciliation
legislation. Somewhat surprisingly, Treasury’s 2021 Green Book
contained almost none of the corporate tax changes proposed in the
Obama administration’s fiscal 2017 budget, released on Feb. 9,
2016. That Obama administration budget included more than 140 tax
proposals, including a repeal of the last-in, first-out (LIFO)
method of accounting for inventories. A copy of that 2016 Democrat
Treasury Green Book is available
here. We expect Congress to propose to enact certain revenue
raisers from the 2016 Green Book.

Expected Changes to Existing Timeline for Certain Tax Cuts and
Jobs Act Provisions

Many of the provisions of the 2017 Tax Cuts and Jobs Act (TCJA)
that currently are scheduled to change or expire in the coming
years will be addressed in the budget reconciliation package this
fall and, as a result, may change or expire earlier than previously
provided. The larger standard deduction, the Section 199A deduction
and many other provisions of the TCJA currently are scheduled to
expire at the end of 2025.

Expected Capital Gains and Dividend Tax Rate Increases for
Higher-Income Individuals

Capital gains and dividend tax rates are proposed to increase
for certain higher-income taxpayers from their current level of
23.8 percent (a 20 percent tax rate plus the 3.8 percent tax on net
investment income) to 40.8 percent (a 37 percent capital gains rate
plus the 3.8 percent tax on net investment income). The higher
rates are proposed to apply “to the extent that the
taxpayer’s income exceeds $1 million ($500,000 for married
filing separately).” The Biden administration proposal would
tax higher-income individual taxpayers on their long-term capital
gains and qualified dividends at 37 percent, and on short-term
capital gains and ordinary dividends at an ordinary rate of 39.6
percent. It appears that a number of senators may be uncomfortable
with capital gains rates in excess of 28 percent (31.8 percent once
you add the 3.8 percent tax on net investment income); for now,
taxpayers should anticipate at least a nominal increase of 8
percentage points (8/20=40 percent; 8/23.8=33.6 percent), or
effectively a 33.6 percent increase in capital gains rates. The
Biden administration has proposed that the capital gains tax
increase apply to “gains required to be recognized after the
date of announcement [presumably late April 2021].” Most
expect congressional committees will propose that increased capital
gains rates apply at some date in 2021 tied to announcement,
congressional committee action or date of enactment. Most also
believe, based on history, that those effective dates may slip and
ultimately may apply to sales occurring on or after the date of
enactment of the legislation. We anticipate a single, substantial
tax reform package to be enacted sometime in the last calendar
quarter of 2021. We also expect capital gains tax increases will
apply to gains recognized after the date of enactment.

As discussed further below, the Biden administration also has
proposed that capital gains would be recognized upon the occurrence
of certain events, including gifts, deaths and other transfers.

End of S Corporation/’Active Income’ Medicare Tax
Loophole

The Green Book explains that high-income (generally those
earning more than $250,000 for joint filers) workers and investors
generally pay a 3.8 percent tax on net investment income, and a 3.8
percent Medicare tax (2.9 percent plus an additional 0.9 percent on
wages over $250,000 for joint filers) on employment earnings.
Application of these taxes is inconsistent across taxpayers, which
the Biden administration states is “unfair … and provides
opportunities … for those with high incomes to avoid paying their
fair share of taxes.” The Biden administration proposes that
all such taxes apply consistently to those making over $400,000.
Specifically, the definition of net investment income would include
gross income and gain “from any trades or businesses that is
not otherwise subject to employment taxes,” and certain
partnership income and S corporation income would be subject to
employment taxes (and therefore to the Medicare tax).

Expected Carried Interest and Like-Kind Exchange Changes

Profits from carried interest are further targeted for taxation
at ordinary income tax rates by a Biden administration proposal to
eliminate the application of Section 1061 for taxpayers with
taxable income in excess of $400,000 and to taxing as ordinary
income those partners’ share of income from an “investment
services partnership interest” in an investment partnership to
which they provide services. Such income also would be subject to
self-employment taxes.

The like-kind exchange rules are proposed to be repealed for
gains during a taxable year greater than $500,000 ($1 million for
joint filers). The Green Book proposed effective date of like-kind
exchange repeal is for “exchanges completed in taxable years
beginning after December 31, 2021.” We expect taxpayers to
lobby for helpful transition rules for sales under binding
contracts or sales completed before the date of enactment where
title to qualified replacement property is obtained after date of
enactment.

Expected Individual Income Tax Rate Increases and Changes

For individuals (including households of joint filers) earning
more than $452,700 in a calendar year ($509,300 for joint filers),
the Green Book proposes to increase the top marginal income tax
rate from its current level of 37 percent to the pre-2018 level of
39.6 percent. The Section 199A pass-through deduction, which allows
certain pass-through business owners to deduct up to 20 percent of
their qualified business income (leading to a current-law marginal
rate of 29.6 percent), is not proposed to be changed by the Green
Book, but is expected to be repealed or carved back by Congress for
taxpayers with adjusted gross income in excess of $400,000.

The $10,000 cap on state and local tax (SALT) deductions may be
repealed and replaced by Congress with limitations on itemized
deductions (i.e., phaseouts, a 28 percent cap on the value of
itemized deductions, etc.) for taxpayers earning in excess of
$400,000. The outright repeal of the SALT cap is expected to cost
the government in excess of $600 billion over 10 years. The Green
Book is silent on the SALT cap; views in Congress vary widely among
members.

Expected Estate and Gift Tax Increases and Changes

The estate tax and lifetime gift tax exemption (which was
temporarily doubled until 2025) is currently $11.7 million per
person ($23.4 million for married couples). In addition, there is a
$15,000 per donee gift tax exclusion ($30,000 if spouses agree).
The current estate tax rate on amounts in excess of the exemption
amounts is a flat 40 percent, and the tax basis in inherited assets
is “stepped up” to the fair market value upon the death
of the decedent. President Biden stated during the presidential
campaign that he would seek an increase in the estate tax rate to
45 percent and a reduction in the exemption amounts to their
pre-TCJA level ($5.3 million per person, $10.6 million for married
couples). The Green Book is silent regarding these expected changes
(which are still expected to be enacted this year) and focuses on
recognition of gains upon several defined events – a
substantial departure from current law. Specifically, the donor of
an appreciated asset generally would recognize capital gains at the
time of a gift in the amount of the excess of the fair market value
of the asset as of the date of the gift over the donor’s basis
in such asset. Likewise, the estate of a decedent generally would
recognize capital gains on appreciated assets at death. The
recipient’s basis in property received by reason of the
decedent’s death would be stepped up to the fair market value
as of the decedent’s date of death. Such gain would be taxable
income to the decedent on his or her federal gift or estate tax
return or on a separate capital gains return. Assets transferred by
a donor or a decedent to a U.S. spouse or a charitable organization
would retain a carryover basis, and a charity generally could
dispose of such property without being taxed on the gain. The use
of capital losses and carry-forwards from transfers at death would
be allowed against capital gains income and up to $3,000 of
ordinary income on the decedent’s final income tax return, and
the tax paid would be deductible on the estate tax return of the
decedent’s estate.

A $1,000,000 per-person ($2,000,000 per married couple)
exclusion from recognition of unrealized capital gains on property
transferred by gift or held at death, indexed for inflation after
2022, would be allowed and would be portable to a decedent’s
surviving spouse. The American Families Plan also provides that the
payment of tax on the appreciation of certain family-owned
businesses would not be due until the interest in the business is
sold or the business ceases to be family owned. The proposal would
allow a 15-year fixed-rate payment plan for the tax on appreciated
assets transferred at death, other than liquid assets.

Many Democrat members of the House and of the Senate are
expected to withhold their support for the imposition of capital
gains taxes at death. Democrats generally seem supportive of
imposing carryover basis at death.

In addition to recognition of gain upon gifts and death, the
Green Book describes other transfer events that would trigger a
capital gains tax. These events include transfers of an appreciated
asset to or from a trust, partnership or other noncorporate entity
(other than a grantor trust that is deemed to be wholly owned and
revocable by the donor). Similarly, transfers out of a revocable
grantor trust would be a recognition event to the extent such
transfer is to someone other than (i) the deemed owner, (ii) the
U.S. spouse of the deemed owner or (iii) a distribution made in
discharge of an obligation of the deemed owner. Current law deems
many of these transfers as nonrecognition events; thus, the
proposed new changes would cause more frequent taxation of asset
appreciation and make it much more difficult and expensive to
transfer assets to heirs.

The aforementioned proposals are proposed by the Green Book to
be effective for gains on property transferred and on property
owned at death by decedents dying after Dec. 31, 2021.

The portability of exemption amounts between spouses generally
is expected to continue, but many other planning techniques
(including valuation discounts obtained in related-party
transactions) presently utilized by taxpayers are proposed to be
curtailed. While it is worth noting that (i) the Tax Reform Act of
1976 would have imposed carryover basis on inherited assets, that
provision was repealed before it could ever take effect, and (ii)
the Economic Growth and Tax Relief Reconciliation Act of 2001
repealed the estate tax and curtailed step-up in basis, but only
for one year (2010), Treasury Secretary Janet Yellen has stated
that elimination of the step-up in asset basis at death is a
priority for the Biden administration.

Securing a Strong Retirement Act’s Proposed Changes to
Retirement Plans

On May 5, 2021, the House Ways and Means Committee voted
unanimously to send the Securing a Strong Retirement Act to the
full House for consideration. The proposed legislation aims to
increase retirement savings and simplify retirement plans with
changes that include:

• Requiring automatic enrollment for 401(k) and 403(b) plans.
  Initial automatic enrollment must be at least 3 percent of pay,
  with 1 percent increases each year up to at least 10 percent.
  Participants may opt out at any point. The proposed legislation
  exempts existing plans in some cases, SIMPLE 401(k) plans, small
  businesses with 10 or fewer employees, and new businesses.




• Increasing the mandatory-distribution age for retirement plans
  from 72 to 73 in 2022, to 74 in 2029 and to 75 in 2032.




• Increasing the catch-up contribution limit for individuals age
  62 to 64 from $6,500 to $10,000 for non-SIMPLE plans and from
  $3,000 to $5,000 for SIMPLE plans. Both limits would be indexed
  with the cost of living.




• Requiring qualified plans, as well as 403(b) and 457(b) plans,
  to designate catch-up contributions as Roth contributions.




• Allowing qualified plans, as well as 403(b) and 457(b) plans,
  to provide participants with the option of treating matching
  contributions as Roth contributions.




• Allowing plans to treat student-loan payments as elective
  deferrals for the purpose of making matching contributions under
  401(k), 403(b), SIMPLE IRA and 457(b) plans.




• Reducing the waiting time before plans are required to allow
  long-term, part-time workers into 401(k) plans from three
  consecutive years of service to two.

The bill also reduces required notices to unenrolled retirement
plan participants and makes other changes aimed at increasing
retirement savings and simplifying retirement plan
administration.

Two senators – one Republican and one Democrat –
have introduced a comparable bill in the Senate. The Senate bill
has not yet gone through committee, and it differs from the House
bill. A few key differences are that the Senate proposed
legislation would (i) not require automatic enrollment; (ii)
increase the mandatory-distribution age only once, to 75 in 2032;
and (iii) increase the catch-up limits at age 60 (rather than at
age 62).

This bipartisan legislation previously was introduced in 2019.
We expect this legislation to be included in the fall 2021 budget
reconciliation bill or otherwise enacted within the next year or
so.

Expected Additional Clarifications, Details and Changes

As the administration and congressional committees continue to
work on tax and budget proposals, clarifications and details
regarding the various proposals will emerge. Some of the initial
proposals may be abandoned and revised, and additional proposals
may emerge. As noted above, depending on a taxpayer’s specific
facts and circumstances, significant tax savings may be achieved by
taxpayers who anticipate expected tax changes and take steps
regarding their business plans, transaction pipelines,
restructurings, operational affairs and estate plans in a manner
that takes advantage of current tax provisions.

BakerHostetler will continue to keep our clients and friends
updated on these developments.

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.