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Posted by Nate Smith and George Cobleigh on Mar 30, 2022 5:08:29 PM

Budget2022

President Biden’s latest budget proposal calls again for higher corporate and individual tax rates, ordinary tax rates for carried interest, and proposes a new “Billionaire’s Minimum Tax” that would subject wealthy individuals to a minimum 20% tax rate on income that includes unrealized capital gains. These and other tax proposals were outlined in the Treasury Department’s annual Green Book on March 28. The Green Book represents the President’s “wish list” for tax policy, while Congress must draft and pass any associated legislation. Although the fate of the Build Back Better Act (BBBA) remains stalled in the Senate, the Green Book is intended to help shape ongoing and future negotiations in Congress.

The major points from this year’s Green Book and some observations follow. We begin with major business provisions, and continue with individual provisions most likely to be relevant to the Private Equity and Venture Capital (PE/VC) space.

Biden Tax Proposals: Domestic Business Provisions

Tax Carried Interests as Ordinary Income

Effective Date: Jan. 1, 2023

Additional Details: This proposal would increase the tax rate for fund managers and other taxpayers who provide services to investment partnerships and are allocated income from a carried interest or profits interest in the investment partnership (investment services partnership interest, ISPI). An investment partnership generally is one where substantially all of its assets consist of investment-type assets (e.g., certain securities, commodities, real estate, etc.). Such allocations to an ISPI, regardless of character, would be subject to ordinary tax rates at the partner level, as well as self-employment taxes, and would not be eligible for lower capital gains tax rates. Allocations to a capital interest are not subject to the recharacterization. The proposal also includes anti-abuse provisions and would impose ordinary tax rates on income earned from a “disqualified interest,” defined as convertible or contingent debt, an option, or any derivative instrument with respect to the entity. The proposed changes would apply to all taxpayers with taxable income from all sources of more than $400,000 per year by repealing Sec. 1061 for such taxpayers.

CBIZ Observations: This proposal also appeared in last year’s Green Book. The BBBA does not currently contain this proposal. The Green Book proposal re-affirms the President’s desire to further limit the tax rate benefits obtained by investment managers even with the extended holding period requirement under Sec. 1061.

Raise the Corporate Tax Rate to 28%, Up from the Current 21%

Effective Date: Jan. 1, 2023

Additional Details: For fiscal year C corporations, there would be a blended rate in the initial year with the tax being 21% plus an additional 7% tax applied to the portion of the taxable year that begins in 2023. This rate increase would apply to all C corporations regardless of size or whether they are publicly traded or privately held.

CBIZ Observations: This proposal also appeared in last year’s Green Book. The BBBA does not currently contain this proposal. PE/VC funds should consider the potential impact on after-tax returns from portfolio companies and in blocker structures.

Biden Tax Proposals: International Business Provisions

BEAT Repealed and Replaced with UTPR

Effective Date: Tax years beginning after Dec. 31, 2023

 Additional Details: The proposal would repeal the Base Erosion and Anti-Abuse Tax (BEAT) as modified by the BBBA and replace it with an Undertaxed Payments Rule (UTPR) that is consistent with the UTPR described in the OECD Pillar Two Model Rules, including a global annual revenue threshold ($850 million), de minimis exclusions and allocation among jurisdictions. Further, a U.S. domestic minimum top-up tax would be part of the rules to protect U.S. revenues from the imposition of UTPR by other countries. The proposal expressly notes, “Separately, the proposal would provide a mechanism to ensure U.S. taxpayers would continue to benefit from U.S. tax credits and other tax incentives that promote U.S. jobs and investment.” It is not clear, however, how those benefits would be preserved.

CBIZ Observations: As explained within the Green Book, this new UTPR would primarily apply to foreign-parented multinationals operating in low-tax jurisdictions and would not apply to income subject to the Pillar Two Income Inclusion Rule (IIR), including income subject to Global Intangible Low-Taxed Income (GILTI). Both domestic corporations that are part of a foreign-parented multinational group and domestic branches of foreign corporations would be disallowed U.S. tax deductions in an amount determined by reference to the low taxed income of foreign entities and foreign branches that are members of the same financial reporting group (including the common parent of the financial reporting group). PE/VC funds should consider the potential impact on after-tax returns from portfolio companies.

Incentive to Bring Jobs Home

Effective Date: Effective as of the “date of enactment”

Additional Details: A new general business credit would equal 10% of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business that is linked to reducing or eliminating a trade or business or line of business currently conducted outside the U.S. or 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. Deductions would be disallowed for expenses paid or incurred in connection with offshoring a U.S. trade or business, including denying deductions 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.

CBIZ Observations: Although the President's FY22 Budget proposed to repeal the deduction for foreign-derived intangible income (FDII) on the grounds that it encourages offshoring of U.S. businesses and jobs, that proposal is not included in the FY23 Budget.

Biden Tax Proposals: Individual Provisions

Increase the Top Tax Rate for Individuals to 39.6%, Up from 37%

Effective Date: Jan. 1, 2023

Additional Details: The proposal would increase the top marginal individual income tax rate to 39.6%. This rate would be applied to taxable income in excess of $450,000 for married individuals filing a joint (MFJ) return, $400,000 for single individuals, and $425,000 for head of household filers.

CBIZ Observations: This proposal also appeared in last year’s Green Book. The BBBA does not currently contain this proposal. The proposed tax bracket thresholds are substantially lower than those that appeared in last year’s Green Book proposals, where the proposals now align with those developed by the House Ways and Means Committee last September.

Tax Capital Gains for High Income Taxpayers at Ordinary Income Rates

Effective Date: Effective as of the “date of enactment”

Additional Details: This proposal would tax long-term capital gains and qualified dividends at ordinary income tax rates for taxpayers with adjusted gross income that exceeds $1 million ($500,000 for married taxpayers who file separately).

CBIZ Observations: This proposal also appeared in last year’s Green Book. The BBBA does not currently contain this proposal. The threshold applies equally to both single filers and married individuals filing a joint return. The Green Book also clarifies that all sources of income (including capital gains) are used to measure the $1 million threshold, and that only income in excess of the threshold is subject to the higher ordinary income tax rates. The Green Book is somewhat inconsistent in that it notes the highest proposed applicable tax rate on capital gains to be 37%, rather than 39.6% as proposed in the previous section, exclusive of the Net Investment Income Tax (NIIT).

Establish a 20% “Billionaire’s Minimum Tax” on Income and Unrealized Gains

Effective Date: Jan. 1, 2023

Additional Details: The new minimum tax would begin to apply to taxpayers with “wealth” (measured by assets net of liabilities) greater than $100 million, and would fully apply when wealth is greater than $200 million. The new minimum tax would apply to all sources of income, and for purposes of the minimum tax, income would now include unrealized capital gains. The value of non-tradeable assets would be eligible for determination by reference to the greater of the original or adjusted cost basis, the last valuation event from investment, borrowing, or financial statements, or other IRS-approved methods. The 20% gross minimum tax would be offset by any regular tax liability and any un-refunded, uncredited tax prepayments, to yield the net minimum tax liability. Minimum tax payments would be creditable against future taxes on realized capital gains in order to avoid double taxation. Taxpayers who are “illiquid” can elect to include only the unrealized gain on “tradeable assets” in the calculation of the minimum tax liability, with a deferral charge then applicable with respect to non-tradeable assets.

CBIZ Observations: This is a new proposal in this year’s Green Book. The BBBA does not currently contain this proposal. Although a taxpayer’s wealth determines whether the taxpayer is subject to the minimum tax, the minimum tax is based on income, which includes unrealized capital gains. This apparently means that the annual increase in unrealized capital gains is what gets included in income, whereas the total unrealized capital gains is what gets included in the determination of wealth. Senator Joe Manchin (D-WV) indicated to reporters on March 28 that he does not support the new minimum tax because he does not believe taxpayers should be taxed “on things you don’t have.”

Expand Access to Retroactive Qualified Electing Fund (QEF) Elections

Effective Date: Effective as of the “date of enactment”

Additional Details: The proposal would amend Sec. 1295(b)(2) to permit the IRS to enact regulations allowing taxpayers in certain situations to make retroactive QEF elections without having to request IRS consent. The current consent procedures are available only to taxpayers fitting a limited set of fact patterns and the White House further believes that the costly user fees preclude some taxpayers from requesting consent even if they are otherwise eligible.

CBIZ Observations: This is a new proposal in this year’s Green Book. The BBBA does not currently contain this proposal. This proposal would make it easier for individual taxpayers to make a retroactive QEF election without having to go through a lengthy and expensive process of requesting IRS consent.

Treat Transfers of Appreciated Property by Gift or on Death as Realization Events

Effective Date: Jan. 1, 2023

Additional Details: Transfers of property by gift or on death would no longer be sheltered from taxation at the time of the transfer. Under the proposal, the excess of the property’s fair market value on the transfer date over the transferor’s basis in the property would be deemed realized as capital gains by the transferor. Additionally (effective Dec. 31, 2030), gains on property that have not been the subject of a recognition event in the past 90 years would be deemed realized when transferred to or from a trust (other than a grantor trust), partnership, or other non-corporate entity. There is an option to pay the tax over a 15-year period in certain instances.

Transfers to a U.S. spouse or to a charity would not be treated as a realization event, but would be subject to carryover basis rules. The gift tax in its present-law form continues to apply, but the exclusion would be reduced. Specifically, there would also be a $5 million per-person (indexed for inflation) exclusion for gifts and transfers during life, with the unused exclusion available at death. This exclusion would be per spouse and any unused portion is transferrable from one spouse to the other upon the death of a spouse.

Family owned and operated businesses can elect to not be subject to this deemed realization rule until the interest in the business is sold or the business is no longer family owned and operated. The $250,000 ($500,000 MFJ) exclusion from capital gains on a principal residence would be maintained. Gains from transfers of tangible personal property, such as household furniture and personal effects (excluding collectibles), would be exempt.

CBIZ Observations: This proposal also appeared in last year’s Green Book. The BBBA does not currently contain this proposal. When gains are triggered under the deemed realization rule, the recipient obtains a basis in inherited/gifted property equal to its fair market value on the transfer date. However, the deemed realization of gains on transfer would cause “phantom” income to the transferor, meaning transferors may not have cash to pay the resulting tax. Furthermore, it is not clear whether a threshold for de minimis gifts (currently $16,000) would continue to be excluded. Regarding the gain exclusion on a principal residence, it is unclear whether the exclusions will be applied only to actual sales or exchanges, or if they will be applied to a deemed transfer of the principal residence when the other deemed transfer rules are triggered.

Modify Tax Rules for Certain Grantor Trusts

Effective Date: Effective as of the “date of enactment”

Additional Details: Sales of property between a grantor and a grantor trust would be treated as taxable transactions, and the payment of income tax by a grantor on the income of a grantor trust would be treated as an additional gift. Additionally, the proposal would require that the remainder 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% of the GRAT assets or $500,000 (or the full amount of the transfer, if less). Additionally, the proposal would prohibit decreases in the annuity during the GRAT term and would prohibit the grantor from acquiring in an exchange an asset held in the trust without recognizing gain or loss for income tax purposes. Finally, the proposal would require that a GRAT have a minimum term of ten years and a maximum term equal to the life expectancy of the annuitant plus ten years.

CBIZ Observations: This is a new proposal in this year’s Green Book. The BBBA does not currently contain this proposal. The proposal to make sales of property to a grantor trust taxable now aligns with the proposal developed by the House Ways and Means Committee last September.

Concluding Thoughts

Again, the Green Book simply outlines the President’s agenda for tax policy, and it is Congress that will have to draft, and eventually pass, any tax legislation. The Senate is likely to be the chamber that creates the most difficulties for the President to be able to move forward with these tax proposals, many of which were already rejected by Senators Joe Manchin (D-WV) and Kyrsten Sinema (D-AZ) during negotiations over the BBBA. For additional information on the Administration’s tax plan, please contact us.

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Headshot_Nate Smith_2Nate Smith is a Director for CBIZ MHM’s National Tax Office. He can be reached at 727.572.1400 and nate.smith@cbiz.com

 

 

 

George-Cobleigh-Print ColorGeorge Cobleigh is a Managing Director and a member of the Private Equity and Venture Capital Practice in New England. He can be reached at 401.626.3283 and george.cobleigh@cbiz.com

 

 

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Tags: tax planning, Private equity, venture capital, Private Equity & Venture Capital, PE/VC, Biden, President Biden, Green Book, Biden Administration

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