In late May, the Treasury Department released its General Explanations to the Administration’s Fiscal Year 2022 Revenue Proposals (also known as the “Green Book”). The 114-page document contains detailed information about President Biden’s proposed tax law changes: the American Jobs Plan and the American Families Plan. The American Jobs plan is geared more towards business while the American Families Plan focuses on individuals. Both individuals and businesses could see tax rate increases under the proposed plan.
Clearly, these are just proposals at this point, and it’s too early to tell exactly which parts of the plan will eventually make it into law, or the extent to which they will be modified if they do. You’ve no doubt already started hearing from clients wanting to know what you know. To help with that, we’ve compiled a list of some of the highlights to help you gain an understanding of the major tax proposals and answer questions your clients may have.
Note that this is NOT an all-inclusive list of the Green Book provisions.
The American Jobs Plan
Increase the Tax Rate on C Corporations. The Tax Cuts and Jobs Act (TCJA) established a 21% tax rate for C corporations. Under President Biden’s proposal, that rate would increase to 28%. The higher rate would go into effect for tax years beginning after 2021. For fiscal year C corporations whose tax year starts after 1/1/21, the new rate would be prorated. According to the Green Book, these corporations would be taxed at a rate equal to 21% plus 7% times the portion of the year that falls in 2022. For example, if a C corporation with a June 30 year-end had $1,000,000 of taxable income for the year ended 6/30/2022, the tax would be computed by first determining how many days in the corporation’s tax year fell in each calendar year. In this case, 184 days are in 2021 and 181 in 2022. The corporation’s tax rate would be 21% + (7% x 181 / 365) = 24.471%, resulting in total tax for the fiscal year of $244,710. This mirrors the treatment required by IRC Sec. 15 and Notice 2018-38 and should be a familiar to fiscal year C corporations that dealt with this issue when the rate was reduced under the TCJA.
Impose a 15% Minimum Tax on Large Corporations. Corporations with book income of $2 billion or more would be subject to a 15% minimum tax on their worldwide book income. This proposal is expected to impact roughly 120 taxpayers and would go into effect for tax years beginning after 2021.
Observation: Clearly, the devil is in the details when computing worldwide book income.
Promote U.S. Job Creation. The proposal calls for the creation of a new general business credit of up to 10% of the eligible cost of onshoring a trade or business. Onshoring means reducing or eliminating a trade or business (or a line of business) currently conducted outside the U.S. and starting up, expanding, or otherwise moving the same trade or business to the U.S. and creating jobs in the process. Also, the proposal would disallow deductions for expenses related to offshoring a trade or business (that is, reducing or eliminating a trade or business currently conducted in the U.S. and starting up or moving the same trade or business overseas, causing the elimination U.S. jobs). The new credit for onshoring and deduction disallowance related to offshoring would apply to expenses paid or incurred after the date of enactment.
Eliminate Fossil Fuel Tax Preferences. The President’s plan is clearly steered in the direction of non-fossil fuel energy. To that end, the proposal would repeal many of the tax benefits currently available to encourage the production of fossil fuels. Among other things, the credits for enhanced oil recovery and marginal oil and gas well production would be repealed, was well as the ability to deduct intangible drilling costs and to claim percentage depletion on oil and gas wells. In general, these changes would go into effect for tax years beginning after 2021.
The American Families Plan
Increase Highest Marginal Rate for Individuals. The President’s plan calls for a return to the pre-TCJA top income tax rate of 39.6%. For 2022, that rate would affect married filing joint taxpayers with taxable income over $509,300 (over $452,700 for single taxpayers, over $481,000 for heads of households, and over $254,650 for married filing separate). These thresholds would be adjusted for inflation and be effective for tax years beginning after 2021.
Tax High-income Individuals’ Capital Gains and Qualified Dividends at Ordinary Rates. For taxpayers with Adjusted Gross Income (AGI) over $1 million ($500,000 if married filing separate), the maximum tax on long-term capital gains and qualified dividends is proposed to increase from 20% to the top rate on ordinary income (which is proposed to be 39.6%). When factoring in the 3.8% net investment income tax, this effectively would raise the tax rate on long-term capital gains and qualified dividends to 43.4%. The $1 million threshold would be indexed for inflation.
Taxpayers would be subject to the higher rate on their long-term capital gains and qualified dividends only to the extent their income exceeds the threshold. For example, a taxpayer filing a joint return with $900,000 of ordinary income and $200,000 of long-term capital gains would have $100,000 of the capital gain taxed at the current preferential rate and $100,000 of the long-term capital gain taxed at the ordinary income tax rate.
Caution: This change is proposed to apply to gains recognized after the date of the announcement. The Green Book does not define that date, but the American Families Plan was announced on April 28, 2021, presumably meaning that any gain recognized after that date would potentially be subject to the higher rate. Unfortunately, we won’t know when this provision will be effective (if at all) until things move a little further along. While not impossible, it is generally more difficult to impose a tax retroactively since a majority of lawmakers will have to agree. However, this signals that the administration would like to prevent, as much possible, taxpayers from recognizing capital gains in anticipation of a rate increase.
Treat Transfers of Appreciated Property by Gift or at Death as Realization Events. Donors and deceased owners of an appreciated asset would realize a capital gain when the asset is transferred (either as a gift or at the taxpayer’s death). The appreciated asset would be treated as transferred at FMV on the date of the gift or the date of death. Taxpayers would have a $1 million (adjusted for inflation after 2022) per-person exemption available. The proposed change would be effective for property transferred by gift after 12/31/2021, and for property owned at death by decedents dying after that date.
In addition to the $1 million exemption, certain other exclusions would apply. Capital gain would not be realized on transfers to a spouse. But, the surviving spouse would take on the decedent’s basis and any gain would be recognized when the surviving spouse disposes of the asset or dies. No tax would be due on a transfer to charity. Additionally, the proposal would exclude from recognition any gain on tangible personal property such as household furnishings and personal effects, other than collectibles. The $250,000 per-person exclusion under current law for capital gains on a principal residence would apply to all residences and would be portable to a decedent’s surviving spouse. Finally, the current-law exclusion for gain on certain small business stock would also apply.
The tax on the appreciation of certain family-owned and operated businesses would be deferred until the business is sold or ceases to be family-owned and operated. Additionally, tax on appreciated nonliquid assets could be spread over a 15-year period with a fixed rate payment plan. This deferral would not apply to the tax on any appreciated liquid assets, such as publicly traded securities.
Tax Appreciation on Certain Assets Held in a Trust, Partnership, or Other Noncorporate Entity. An entity would be subject to tax if the assets it holds have not been subject to a recognition event within the prior 90 years. The 90-year period begins 1/1/1940, making 12/31/2030 the earliest date that a taxpayer might have to recognize gain in this situation.
Subject Certain Income to Either Net Investment Income or Self-employment Tax. Currently, married taxpayers filing a joint return with AGI over $250,000 ($200,000 for single and head of household, $125,000 for married filing separately) are subject to a 3.8% tax on their Net Investment Income (NII), which generally includes capital gains, interest, dividends, royalties, and income from passive activities. Self-employment (SE) income is not subject to the NII Tax (NIIT). The proposed changes are aimed at nonpassive S corporation shareholders and limited partners/LLC members whose share of pass-through ordinary income currently isn’t subject to SE tax or the NIIT. All income not subject to SE tax would be subject to NIIT for taxpayers with AGI over $400,000. Also, ordinary income passed through to S corporation shareholders and limited partners/LLC members who materially participate in the trade or business would be subject to SE tax to the extent it exceeds certain thresholds, effectively making this pass-through income subject to either NIIT or self employment tax. This change would be effective for tax years beginning after 2021.
Make Certain Tax Credit Changes Permanent. The American Rescue Plan Act of 2021 (ARPA) expanded and modified several credits available to individuals. However, the changes made by ARPA were generally for 2021 only. The President’s proposal would make the following ARPA changes permanent.
•Premium Tax Credit. This refundable credit is available to taxpayers who get health insurance through a Marketplace established under the Affordable are Act of 2010 (ACA). ARPA modified the income threshold for eligibility and decreased the contribution percentages for taxpayers.
•Earned Income Tax Credit. This refundable credit is available to taxpayers with low to moderate income levels. ARPA expanded eligibility to taxpayers as young as age 19 (age 18 for a qualified former foster youth or a qualified homeless youth), provided the taxpayer can’t be claimed as a dependent on their parent’s return and expanded the credit for workers without children.
•Child and Dependent Care Tax Credit. This credit is available to taxpayers who must pay for childcare to allow them to work. ARPA made the credit fully refundable for eligible taxpayers and increased allowable expenses (to $8,000 for taxpayers with one qualifying child and to $16,000 for those with two or more children).
Extend Child Tax Credit Changes. This credit is available to taxpayers with qualifying children. ARPA made this credit fully refundable for eligible taxpayers in 2021 and increased the credit amount to $3,000 (for children ages 6 through 17) and $3,600 (for children under 6). The Biden proposal would extend these ARPA changes to tax years beginning before 2026.
Limit Like-kind Exchange Deferrals. The TCJA limited the ability to defer gains using a like-kind exchange to exchanges of real property. The proposed law changes seeks to further restrict a taxpayer’s ability to delay paying tax when a property is exchanged. The proposed law caps the amount of gain that can be deferred in a Section 1031 like-kind exchange at $500,000 per taxpayer, per year ($1 million for MFJ). Gains from a like-kind exchange that exceed the cap will be subject to tax in the year the taxpayer transfers the real property subject to the exchange. This proposal would be effective for exchanges completed in tax years beginning after 2021.
Make Excess Business Loss Limit Permanent. The provision that limits a noncorporate taxpayer’s ability to claim excess business losses is set to expire at the end of 2026. The proposed law would make this a permanent provision.
Increase IRS Funding. According to the Treasury Department’s report, the IRS’s operating budget (in constant dollars) decreased roughly 20% between 2010 and 2020. Meanwhile, additional resources were needed by the Service to keep up with new areas of noncompliance, implement changes brought on by the TCJA and other recent law changes, and respond to the COVID-19 crisis. Long story short, the IRS wants more funding. Under the proposal, additional funding would be used to beef up enforcement and compliance efforts, enhance information technology functionality, and specifically allocate resources to enforcement activities for taxpayers with income of $400,000 and higher.
Improve Oversight of Tax Preparers.The IRS seeks to gain additional regulatory control over paid tax return preparers to reduce collection costs, increase revenue, and increase overall confidence in the voluntary compliance system. The proposed changes would establish minimum competency standards, effective on the date of enactment. It will also increase penalties on tax preparers who don’t sign the returns they prepare (“ghost preparers”). The proposal would increase the penalty to the greater of $500 per return or 100% of the fee received for preparing a ghost return and increase the time to assess the penalty from three to six years after a return was filed, effective for returns required to be filed after 2021.
Expand Crypto Asset Reporting for Brokers. Crypto currency is a huge hot button issue for the IRS. The service sees the crypto realm as ripe for tax evasion. The proposal would expand the scope of information reporting by brokers, including entities such as U.S crypto asset exchanges and hosted wallet providers, to require reporting related to gross proceeds, sales, and “substantial foreign owners” in passive entities. The plan would allow the U.S. to share this information with other global taxing jurisdictions. This change would be effective for returns required to be filed after 2022.