On March 28, 2022, the Biden administration released its 2023 budget proposal. Concurrently, the U.S. Department of the Treasury also issued the General Explanation of Provisions (the Greenbook), which includes various tax proposals for the government’s fiscal year 2023.
If you were following the different tax proposals throughout 2021, you likely felt like you were on a roller coaster. Ultimately, the most significant tax bill proposed in 2021, the Build Back Better plan, did not pass and was largely abandoned in early 2022. The tax proposals in the Greenbook released by the administration in May 2021 for the FY 2022 budget were significantly different, overall, than the tax legislation drafted for the Build Back Better plan. Therefore, while the tax proposals in the administration’s Greenbook for the FY 2023 budget may represent the president’s initial wish list, the proposals could change significantly like they did in 2021 by the time any legislation is ultimately considered by Congress.
Nevertheless, it is important to monitor the proposed tax legislation so taxpayers can start planning now should these proposals ultimately be passed. The remainder of this article highlights some of the notable proposals in the Greenbook. You can view the Greenbook for further details on these items as well as other proposals that may impact you or your business.
- Raise the Corporate Income Tax Rate to 28 Percent – The proposal would increase the tax rate for C corporations from 21 percent to 28 percent. The 28 percent corporate income tax rate will consequently increase the global intangible low-tax income (GILTI) rate in tandem to 20 percent. The White House was very transparent in discussing the reason for the change:
- “Raising the corporate income tax rate is an administratively simple way to raise revenue to pay for the Administration’s infrastructure proposals and other longstanding fiscal priorities. A corporate tax rate increase can expand the progressivity of the tax system and help reduce income inequality.”
This proposal would be effective for taxable years beginning after December 31, 2022. For taxable years beginning before January 1, 2023, and ending after December 31, 2022, there would be a phase-in of the 7 percentage point increase.
- Provide Tax Incentives for Locating Jobs and Business Activity in the U.S. and Remove Tax Deductions for Shipping Jobs Overseas – Effective for expenses paid on or after the date of enactment, the proposal would create a new general business credit equal to 10 percent of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business. For this purpose, onshoring a U.S. trade or business means reducing or eliminating a trade or business or line of business currently conducted outside the U.S. and starting up, expanding, or otherwise moving the same trade or business within the U.S., to the extent that this action results in an increase in U.S. jobs.
In addition, to reduce tax benefits associated with U.S. companies moving jobs outside of the U.S., the proposal would disallow deductions for expenses paid or incurred in connection with offshoring a U.S. trade or business. For this purpose, offshoring a U.S. trade or business means reducing or eliminating a trade or business or line of business currently conducted inside the U.S. and starting up, expanding, or otherwise moving the same trade or business outside the U.S., to the extent that this action results in a loss of U.S. jobs. In addition, no deduction would be allowed against a U.S. shareholder’s GILTI or Subpart F income inclusions for any expenses paid or incurred in connection with moving a U.S. trade or business outside the United States.
For purposes of the proposal, expenses paid or incurred in connection with onshoring or offshoring a U.S. trade or business are limited solely to expenses associated with the relocation of the trade or business and do not include capital expenditures or costs for severance pay and other assistance to displaced workers.
- Prevent Basis Shifting by Related Parties Through the Use of Partnerships – In certain situations, a partnership can elect to adjust the basis of partnership property through an election under Internal Revenue Code (IRC) Section 754. In its explanation of the reason for this change, the White House focuses on a narrow situation involving distribution of property to a partner who would take a basis less than what the property had to the partnership. If held until death, a step-up could occur at death. The proposal provides that in the case of a distribution of partnership property that results in a step-up of the basis of the partnership’s nondistributed property, the proposal would apply a matching rule that would prohibit any partner in the distributing partnership who is related to the distributee-partner from benefiting from the partnership’s basis step-up until the distributee-partner disposes of the distributed property in a fully taxable transaction. The effective date would be years beginning after December 31, 2022.
- Marginal Tax Rates – The proposal would increase the top individual marginal tax rate to 39.6 percent (currently 37 percent). The top marginal tax rate would apply to taxable income of more than $450,000 for married individuals filing a joint return, $400,000 for unmarried individuals (other than surviving spouses), $425,000 for head of household filers, and $225,000 for married individuals filing a separate return. After 2023, the thresholds would be indexed for inflation. This proposal would be effective for tax years beginning after December 31, 2022.
- Long-Term Capital Gains Tax Rates – Long-term capital gains and qualified dividends would be taxed at ordinary rates, with 37 percent generally being the highest rate (40.8 percent including the net investment income tax). The proposal would only apply to the extent the taxpayer’s taxable income exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2023. This proposal would be effective for gain required to be recognized and for dividends received on or after the date of enactment.
- Minimum Income Tax on the Wealthiest Taxpayers – This proposal would impose a minimum tax of 20 percent on the sum of taxable income and unrealized gains of the taxpayer. This would apply to taxpayers whose wealth (value of assets less liabilities) is greater than $100 million. The Greenbook provides further information for the treatment of these taxes as prepayments in the future when unrealized gains are ultimately recognized for tax purposes, as well as proposals for the valuation of assets and treatment of appreciation on illiquid assets. This proposal would be effective for tax years beginning after December 31, 2022.
- Student Debt Relief – The American Rescue Plan Act of 2021 (ARP) provides an exception to the treatment of discharged loan amounts as gross income for certain qualifying student debt that is discharged after December 31, 2020, and before January 1, 2026. The proposal would make permanent the ARP exclusion of certain discharged student loan amounts from gross income. The proposal would be effective on the date of enactment.
Estate & Gift Tax Proposals
- Tax Appreciated Property by Gift or on Death – Under the proposals, the donor or deceased owner of appreciated assets would realize a capital gain at the time of transfer. The proposals include provisions relating to the valuation of property; taxation on transfers to certain trusts and noncorporate entities; deferral elections for certain illiquid investments and family-owned businesses; exclusions for transfers to U.S. spouses and charities; and a lifetime exclusion of $5 million of unrealized gain. The proposal would be effective for gains on property transferred by gift, and on property owned at death by decedents dying, after December 31, 2022, and on certain property owned by trusts, partnerships, and other noncorporate entities on January 1, 2023.
- Treatment of Certain Grantor Trusts – The following proposals would be effective on or after the date of enactment.
- GRATs – The proposal would require that the remaining interest in a grantor retained annuity trust (GRAT) at the time the interest is created have a minimum value for gift tax purposes equal to the greater of 25 percent of the value of the assets transferred to the GRAT or $500,000 (but not more than the value of the assets transferred). The proposal would require that a GRAT have a minimum term of 10 years and a maximum term of the life expectancy of the annuitant plus 10 years.
- Transfers to Certain Trusts – For trusts that are not fully revocable by the deemed owner, the proposal would treat certain transfers of an asset for consideration between a grantor trust and its deemed owner or any other person as one that is regarded for income tax purposes, which would result in the seller recognizing gain on any appreciation in the transferred asset and the basis of the transferred asset in the hands of the buyer being the value of the asset at the time of the transfer.
- Treatment of Tax Paid by Grantor – The proposal also would provide that the payment of the income tax on the income of a grantor trust is a gift. That gift occurs on December 31 of the year in which the income tax is paid (or, if earlier, immediately before the owner’s death, or on the owner’s renunciation of any reimbursement right for that year) unless the deemed owner is reimbursed by the trust during that same year. The amount of the gift is the unreimbursed amount of the income tax paid.
- Generation-Skipping Tax (GST) Exemption – The proposed changes include limitations for whom the GST exemption may apply to and limits the duration of the exemption.
Closing Perceived Loopholes
- Tax Carried (Profits) Interests as Ordinary Income – Back for yet another cameo appearance, this frequent flyer in the proposals needs no real explanation. While existing IRC §1061 provides some hurdles, the perception is most carried interests are still being taxed at the favorable capital gains rates. While using a new term called an investment services partnership interest (ISPI), this is similar in definition to the existing applicable partnership interest contained in §1061. The proposal would generally tax as ordinary income a partner’s share of income on an ISPI in an investment partnership, regardless of the character of the income at the partnership level, if the partner’s taxable income (from all sources) exceeds $400,000. Accordingly, such income would not be eligible for the reduced rates that apply to long-term capital gains. The proposal also provides that partners recognizing income from an ISPI would be subject to self-employment tax on such income. In leaving an opening for the continuation of this perceived loophole, the Greenbook makes allowance for those partnerships that have “goodwill or other assets unrelated to the services of the ISPI holder” so that such income is not subject to the recharacterization. This proposal would repeal existing §1061 and be effective for tax years beginning after December 31, 2022.
- Repeal Deferral of Gain from Like-Kind Exchanges – This provision also has frequently been included in various wish lists (last year’s Greenbook) and has been a target of the Biden administration for some time. This proposal is similar to others; it would allow IRC §1031 gain deferral of up to $500,000 ($1 million in the case of married individuals filing a joint return) each year for real property exchanges. The provision would be effective for tax years beginning after December 31, 2022.
- Require 100 Percent Recapture of Depreciation Deductions as Ordinary Income for Certain Depreciable Real Property – For depreciation taken on §1250 property after the date of enactment, such depreciation would be subject to ordinary income recapture similar to the existing §1245 recapture rules upon the sale of the property. Depreciation taken on §1250 property prior to the date of enactment would be subject to the currently existing rules. In the case of a partnership, the recapture would be determined at the partner level. This proposal would not apply to noncorporate taxpayers with adjusted gross income (AGI) of less than $400,000, half that amount for married individuals filing separate returns. The effective date would be for tax years beginning after December 31, 2022.
As previously mentioned, the Greenbook only includes proposed tax changes and ultimately may not be signed into law. We will continue to monitor future legislation. In the meantime, reach out to your advisor or submit the Contact Us form below to discuss how the proposed changes could affect you or your business.