Treasury’s “Green Book” provides details on administration’s tax blueprint
The U.S. Treasury Department on 28 May 2021 released its general explanation of tax proposals included in the Biden administration's fiscal year 2022 budget submission to Congress. Commonly known as the "Green Book," the 114-page document provides more details regarding the administration’s tax proposals that had been previewed in the American Jobs Plan and the American Families Plan.
The general contours of the administration’s tax plan—higher tax rates for high-income individuals and large corporations—were established during the presidential campaign and set down in broad terms with the release of the American Jobs Plan and the American Families Plan. However, important details were missing, and the Green Book fills in some of the gaps in the administration’s priorities.
A detailed look at the administration’s tax measures follows.
Corporate and international taxes
The Internal Revenue Code imposes a tax on the taxable income of every C corporation at a flat rate of 21%. The Tax Cuts and Jobs Act of 2017 (TCJA) imposed this rate, beginning in 2018, to replace a series of graduated tax rates ranging from 15% to 35%. Corporations did not become subject to the maximum 35% tax rate until their taxable income exceeded USD 10 million.
The administration proposes to increase the current rate to 28%, effective for taxable years beginning after 31 December 2021. For C corporations with a fiscal year that includes parts of the calendar years 2021 and 2022, the tax rate for that taxable year would be a blended rate between 21% and 28%, depending on the number of days in each calendar year.
If enacted, this increase would automatically apply to a number of other taxpayers whose tax rates are linked to the corporate tax rate, including insurance companies, foreign corporations, real estate investment trusts, regulated investment companies (mutual funds), publicly traded partnerships taxed as C corporations and S corporations subject to certain corporate-level taxes.
Despite the proposal to reverse one-half of the corporate tax rate reduction of 2017, the administration does not propose to restore the graduated rates (or any version thereof) that were in effect before 2018.
The administration would also impose a 15% minimum tax on corporations with more than USD 2 billion in worldwide book income. This minimum tax would equal the excess of book tentative minimum tax over regular tax. This proposal would be effective for taxable years beginning after 31 December 2021.
The Green Book incorporates measures originally proposed in the American Jobs Plan and newly released details regarding proposed changes that, if enacted, would significantly modify key international tax legislation enacted in the TCJA, including the global intangible low-taxed income (GILTI), the base erosion and anti-abuse tax (BEAT) rules and the associated foreign tax credit (FTC) rules, while continuing to tighten the already onerous provisions associated with corporate inversion transactions. An overview of the proposed changes is outlined below.
The GILTI regime would be modified as follows:
- The exemption for foreign oil and gas extraction income (FOGEI) from a controlled foreign corporation’s (CFC’s) gross tested income would be repealed.
- The high-tax exemption for GILTI and subpart F would be repealed.
- The amount of GILTI income and the associated FTC would be determined on a country-by-country basis rather than on an aggregate basis, which is expected to cause significant incremental taxation from the GILTI provisions.
- The country-by-country FTC limitation is also expected to be extended to apply to the “branch” basket.
- In the context of a foreign-parented U.S. group, when that U.S. group itself has CFCs for which it will have an income inclusion, take into account any foreign taxes paid by the foreign parent, under an income inclusion rule (IIR) that is consistent with an OECD/Inclusive Framework Pillar Two agreement on global minimum taxation (if such consensus is reached), with respect to the CFC income that would otherwise be part of the domestic corporation’s global minimum tax inclusion. A country-by-country approach would also be applied.
- Section 904(b)(4) addressing the increase in the foreign tax credit limitation denominator for those expenses that are allocated and apportioned to exempt income under IRC section 245A for foreign tax credit purposes would be repealed.
- The application of section 265 would be expanded to disallow deductions allocable to a class of foreign gross income that is exempt from tax or taxed at a preferential rate through a deduction (e.g., a global minimum tax inclusion with respect to which a section 250 deduction is allowed or dividends eligible for a section 245A deduction). Rules would be provided for determining the amount of disallowed deductions when only a partial deduction is allowed under section 245A with respect to a dividend or a partial section 250 deduction with respect to a global minimum tax inclusion.
These provisions would be effective for tax years beginning after 31 December 2021.
The administration’s proposal would repeal the current BEAT provisions and replace them with a new regime referred to as Stopping Harmful Inversions and Ending Low-Taxed Developments (SHIELD). Under the proposed SHIELD rules, a deduction (whether related- or unrelated-party deductions) would be disallowed to a domestic corporation or branch, in whole or in part, by reference to all gross payments that are made (or deemed made) to “low-taxed members,” defined as members of a financial reporting group whose income is subject to an effective tax rate that is below a designated minimum tax rate. The designated minimum tax rate would be determined by reference to Pillar Two of the OECD/G20 Inclusive Framework on BEPS. However, if an agreement has not been reached on minimum taxation under that framework by the time of the enactment of SHIELD, the designated minimum tax rate would be 21%.
In a related development, the Group of Seven finance ministers on 5 June issued a statement in support of a 15% global minimum tax imposed on a country-by-country basis, and expressed a commitment to reaching “an equitable solution” on the allocation of taxing rights among jurisdictions.
The amount disallowed would be determined in a two-step process. First, those payments that are made directly to low-tax members would be disallowed. Second, amounts paid directly to members that are not low-taxed members would be disallowed to the extent of the ratio of low-tax income of all members to the total income of all members.
Many details on the application of these rules remain unknown. Moreover, unlike the BEAT rules, which applied solely to deductions and not to reductions of gross income (e.g., amounts included in cost of goods sold), the SHIELD rules also would apply to amounts paid for items included in cost of goods sold by the U.S. corporation of U.S. trade or business.
FTC implications for sales of hybrid entities and check-the-box (CTB) elections
The proposal would apply the principles of IRC section 338(h)(16) to determine the source and character of income recognised in connection with a disposition of an interest in a specified hybrid entity and to CTB elections. For foreign tax credit purposes, the source and character of any item resulting from the disposition of the interest in the specified hybrid entity, or a change in U.S. entity classification as a result of a CTB election, would be determined based on the source and character of an item of gain or loss the seller would have taken into account upon the sale or exchange of stock (determined without regard to IRC section 1248).
The impact of these provisions is to recharacterize low-taxed tested income for GILTI purposes that could be combined with higher-taxed income for GILTI purposes with the effect of minimizing the amount of GILTI tax on a disposition as income (GILTI or otherwise) in the passive basket that likely would give rise to Subpart F (foreign personal holding company income) taxed at the full federal corporate income tax rate and not the GILTI effective rate in addition to having a different character for purposes of determining any foreign tax credit offset.
This proposal would be effective for transactions that occur after the date of enactment.
IRC section 7874 applies to inversion transactions whereby a U.S. corporation is acquired by a foreign corporation in a transaction where (1) substantially all the assets held directly or indirectly by the domestic corporation are acquired directly or indirectly by the foreign acquiring corporation; (2) the former shareholders of the domestic corporation hold at least a 60-percent ownership interest in the foreign acquiring corporation by reason of the acquisition; and (3) the foreign acquiring corporation, together with its expanded affiliated group, does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organised.
The administration’s proposals would remove the 60% inversion threshold altogether and expand the definition of an inversion transaction by incorporating a “greater than 50% test.” Moreover, it would expand the scope of the term “inversion,” regardless of shareholder continuity, by providing that an inversion occurs if:
- Immediately prior to the acquisition, the fair market value of the domestic entity is greater than the fair market value of the foreign acquiring corporation;
- After the acquisition the expanded affiliated group is primarily managed and controlled in the U.S.; and
- The expanded affiliated group does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organised.
The scope of an acquisition for purposes of section 7874 would be expanded to include a direct or indirect acquisition of substantially all of the assets constituting a trade or business of a domestic corporation, substantially all of the assets of a domestic partnership, or substantially all of the U.S. trade or business assets of a foreign partnership.
A distribution of stock of a foreign corporation by a domestic corporation or a partnership that represents either substantially all of the assets or substantially all of the assets constituting a trade or business of the distributing corporation or partnership would be treated as a direct or indirect acquisition of substantially all of the assets or trade or business assets, respectively, of the distributing corporation or partnership.
These provisions would be effective for transactions occurring after the date of enactment.
Foreign-derived intangible income (FDII)
Effective for tax years beginning after 31 December 2021, the administration’s proposal would repeal the FDII provisions, but would incorporate a new business credit for onshoring. The onshoring tax incentives (effective for expenses paid or incurred after the date of enactment) would provide 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, as well as disallow deductions for expenses paid or incurred in connection with offshoring a U.S. trade or business. Onshoring a U.S. trade or business is defined as 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 to a location within the U.S., to the extent that this action results in an increase in U.S. jobs.
Individual, estate and gift taxes
Individual income tax rate
The top marginal individual income tax rate would increase from 37% to 39.6%. For taxable year 2022, the rate would apply to taxable income over USD 509,300 for married individuals filing jointly (USD 254,650 for married individuals filing separately), USD 481,000 for head of household filers, and USD 452,700 for single filers. The proposed increase would be effective for taxable years beginning after 31 December 2021.
Capital gain and qualified dividend income
Long-term capital gains and qualified dividend income of taxpayers with adjusted gross income of more than USD 1 million would be taxed at ordinary income tax rates to the extent that the taxpayer’s income exceeds USD 1 million (USD 500,000 for married individuals filing separately). If the proposal for raising the ordinary income tax rate to 39.6 % becomes law, then the maximum tax rate of capital gains would be 43.4% (39.6% plus net investment income tax rate of 3.8%). The proposed effective date would be for gains required to be recognised after the date of announcement, which is understood to be 28 April 2021, the date of President Biden’s first address to a joint session of Congress during which he introduced the American Families Plan.
Transfers of appreciated property
Taxpayers transferring appreciated property during certain events would realize a capital gain based on the property’s fair market value at the time of the transfer. The proposal generally would be effective 1 January 2022. Recognition events include:
- Transfers of in-kind property to trusts (other than wholly revocable trusts)
- Distributions of in-kind property from a trust (other than to the grantor owner of a revocable trust or to a spouse of the grantor, as long as the distribution is not in discharge of an obligation of the deemed grantor owner)
- Terminations of revocable grantor trusts – at death or during life
- Transfers of in-kind property to partnerships or other non-corporate entities
- Distributions of in-kind property from partnerships or other non-corporate entities
- Holdings of trusts, partnerships or other non-corporate entities, when the property has not had a recognition event within the prior 90 years, measured as of 1 January 1940. The first recognition event under this 90-year rule would occur 31 December 2030.
The “deemed” gain would be taxable income to the donor or to the decedent. The amount of gain would be measured by the amount that the fair market value of the appreciated property exceeds the basis on the date of the gift or upon the date of death, whichever is applicable. The use of capital losses and carryforwards from transfers at death would be permitted on the decedent’s final income tax return.
The proposal allows for some exclusions. Transfers by a decedent to a U.S. spouse would not be a taxable event, and the surviving spouse would receive the decedent’s carryover basis. The surviving spouse would recognize the gain upon disposition or death. Transfers to charity would not generate a taxable capital gain. Transfers to a split interest trust, such as a charitable remainder trust, would generate a gain with an exclusion allowed for the charity’s share of the gain. Transfers of tangible personal property, such as household furnishings and personal effects (excluding collectibles), are excluded. The exclusion for small business stock would still apply.
The proposal would allow a USD 1 million per person exclusion from recognition of gain on properties transferred by gift or held at death. Any unused exemption by a deceased spouse will port to the surviving spouse making the exclusion effectively USD 2 million per couple. Generally, the cost basis of the transferee will be the fair market value of the property transferred. A donee receiving property that qualified for the USD 1 million exclusion of the donor will have a carryover basis.
Payment of the tax on the appreciation of certain family owned and operated businesses would not be due until the business was sold or ceases to be family owned and operated. The capital gains tax on appreciated property transferred at death will be eligible for a 15-year fixed rate payment plan. However, publicly traded financial assets will not be eligible for the payment plan. Family businesses electing the deferral will not be eligible for the payment plan.
Contributions of appreciated property to split-interest trusts, such as charitable remainder trusts, will no longer have the favorable treatment afforded under current law, likely making that deferral planning technique no longer viable. Transfers to S corporations and C corporations do not appear to generate gain, assuming those transfers qualify for the deferral provisions of section 351.
This proposal radically alters the rules for recognition of income when it comes to capital assets. Under current law, there generally must be a sale or exchange of property to generate a capital gain. Because the proposal would “deem” a sale when in fact there was no sale, the taxpayer will not necessarily have the cash to pay the capital gains tax. Thus, the utmost care would need to be exercised to avoid the liquidity issues created by a “deemed” sale.
Carried (profits) interest
A partner’s share of profits and gain from an investment services partnership would be taxed as ordinary income, if the partner’s taxable income from all sources exceeds USD 400,000. The income would no longer be eligible for capital gain rates, and self-employment taxes also would apply. Income attributable to invested capital would continue to be treated as capital gain. The proposal would be effective for taxable years beginning after 31 December 2021.
Gain from like-kind exchanges
Gains in excess of USD 500,000 (USD 1 million for married individuals filing jointly) from like-kind exchanges of real estate would be taxed in the year the property is transferred. Deferral of gain only up to USD 500,000 for each taxpayer (USD 1 million for married individuals filing jointly), each year, from like-kind exchanges of real estate would be allowed. The proposed effective date would be for exchanges completed in taxable years beginning after 31 December 2021.
Excess business loss limitation
The excess business loss limitation on noncorporate taxpayers would be made permanent. The proposal would be effective for taxable years beginning after 31 December 2026.
Prospects of tax legislation
Although the White House, House of Representatives and Senate are each in Democratic hands, the path to enacting tax legislation remains unclear. With a narrow majority in the House and a 50-50 margin in the Senate (with the Vice President breaking any tie), all Democratic members of Congress must agree to moving forward. The Senate, in particular, must be watched closely, as its current filibuster rules essentially allow any senator to block legislation, requiring 60 votes to invoke “cloture,” or to end the filibuster block. It is unlikely that 60 senators will agree to invoke cloture for any legislation.
In the face of certain filibuster, the only other option available to pass tax legislation in the Senate is the budget reconciliation process, which ultimately requires only a simple majority to pass budget-related legislation, which can include tax. The budget reconciliation process was utilised to pass the American Rescue Plan in March 2021.
Passing tax legislation through budget reconciliation does, however, have its drawbacks, such as policy changes that can be effective only during the budget window, which generally is 10 years. Most importantly, recent remarks from some moderate Senate Democrats suggest that they may resist further use of the budget reconciliation process this year, making the path to any tax legislation this year uncertain.
The administration’s Green Book provides important details on the anticipated changes to the U.S. international tax landscape. It remains to be seen whether these proposed changes will be enacted as outlined or if additional revisions will be made. However, multinational companies can start modeling the impact these changes may have on their operations and tentatively planning to mitigate any anticipated impact.
On the individual side, many of the current estate planning techniques will generate capital gain upon funding, such as transfers to grantor retained annuity trusts, transfers to “defective” grantor trusts and outright gifts to trusts for children and grandchildren. Under these proposals, there would be an income tax cost to estate planning transactions that would have to be considered.
The Green Book does not discuss eliminating the state and local taxes limitation, repealing or modifying the qualified business income deduction, reducing the lifetime estate tax exemption or increasing the estate tax rate. These items were proposed during President Biden’s election campaign, in the American Families Plan, or in other proposals; however, the mere absence of these items in the Green Book does not mean that they are not still in play. They may become important bargaining chips as the Green Book proposals are discussed in Congress.