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The Administration’s Income Tax Proposals for Fiscal Year 2022

Or, the Government’s Search for Green as Reflected in the Green Book

June 21, 2021

In May 2021, the Department of the Treasury released its General Explanations of the Biden administration’s fiscal year 2022 revenue proposals, commonly referred to as the “Green Book.” The General Explanations seek a dramatic increase in revenue through an increase in corporate and individual income tax rates and various other revisions to the Internal Revenue Code (the “Code”) referred to in the General Explanations as closing loopholes. This article will describe some of the more salient provisions relevant to raising income tax rates and closing loopholes, particularly as they relate to domestic taxpayers and activities. The General Explanations also include provisions related to taxation of foreign taxpayers and activities, credits and incentives for infrastructure, housing and clean energy, support of families and workers, and improving compliance and tax administration, all of which are outside the scope of this article.

1. Increase in the Corporate Income Tax Rate

The General Explanations propose an increase of the income tax rate on C corporations from a flat 21 percent to a flat 28 percent, for taxable years beginning after December 31, 2021, with a blended rate for tax years beginning in 2021.

2. Imposition of a Minimum Tax on Book Earnings of Certain Corporations

The General Explanations propose a 15 percent minimum tax on worldwide pre-tax book income (as opposed to taxable income) for corporations with book income in excess of $2 billion, effective for taxable years beginning after December 31, 2021. There exists no similar provision under current law, although there had been a corporate alternative minimum tax in the past that was repealed by previous legislation.

3. Increase in Certain Individual Income Tax Rates

Currently, the top marginal individual income tax rate is 37 percent for tax years ending before January 1, 2026, reverting to 39.6 percent thereafter. The General Explanations propose an increase in the top marginal individual income tax rate to 39.6 percent effective for taxable years beginning after December 31, 2021. In addition, the highest rate would kick in at lower thresholds under the proposal contained in the General Explanations. Under current law, for 2021, the highest 37 percent rate applies to taxable income over $628,300 for married individuals filing a joint return and surviving spouses, $523,600 for unmarried individuals (other than surviving spouses) and heads of household filers, and $314,150 for married individuals filing a separate return. Under the proposal, the 39.6 percent rate would apply to taxable income over $509,300 for married individuals filing a joint return and surviving spouses, $452,700 for unmarried individuals (other than surviving spouses), $481,000 for heads of household filers, and $254,650 for married individuals filing a separate return. After 2022, the thresholds would be indexed for inflation.

4. Reform, Including Increase in the Tax Rate, Regarding Certain Capital Gains and Qualified Dividends

Currently, long-term capital gains and qualified dividends are taxed at graduated rates up to 23.8 percent (to the extent the 3.8 percent net investment income tax is applicable); taxation is imposed on capital gains only upon a realization event, such as a sale or exchange; (income) taxation is not imposed upon a gift or transfer on death of appreciated property; there is a carryover basis in the case of a gift; and there is a stepped up basis (an increase to fair market value) in the case of a transfer on death.

The proposed changes to the current regime under the General Explanations include the following, subject to certain exclusions to be addressed below:

  • For taxpayers with adjusted gross income in excess of $1 million, and to the extent adjusted gross income exceeds $1 million, long-term capital gains and qualified dividends would be taxed at 43.4 percent (including the 3.8 percent net investment income tax to the extent applicable and assuming the maximum ordinary rates are increased to 39.6 percent as mentioned earlier). This would be indexed for inflation after 2022. THIS PARTICULAR ASPECT OF THE GENERAL EXPLANATIONS WOULD BE EFFECTIVE FOR GAINS RECOGNIZED AFTER THE DATE OF ANNOUNCEMENT (PRESUMABLY IN APRIL 2021).
  • In the case of a gift or transfer on death of appreciated property, the donor or the decedent, as the case may be, would be subject to a capital gains tax on the appreciation in the property transferred.
  • Gain on unrealized appreciation would also be recognized by non-corporate entities if property has not been subject to a recognition event within the prior 90 years, commencing January 1, 1940.
  • For purposes of these rules, a transferred partial interest would be valued based on its proportional share of the fair market value of the entire property.
  • Transfers of property into, and distributions in kind from, a trust, partnership, or other non-corporate entity (other than a grantor trust that is revocable and deemed to be wholly owned by the grantor), would also be recognition events. It is not specified whether this rule would apply broadly to all transfers to and distributions from partnerships (which would entail a massive and revolutionary change of partnership taxation) or only to partnership-related transfers in the estate and gift context (which would also entail a massive and revolutionary change of partnership taxation, albeit somewhat less massive or revolutionary).
  • Unrealized appreciation on assets of a revocable grantor trust would be realized on the deemed owners’ death, at any time the trust becomes irrevocable, or on dispositions of any of the assets of the trust other than to the grantor or the U.S. spouse of the grantor.

    These rules would be subject to the following exclusions:

    1. Gain would not be recognized, and there would be a carryover basis, upon transfer of an asset by a decedent to a U.S. spouse or to a charity. I would imagine the same rule applies in the event of a lifetime transfer to a U.S. spouse or charity, but the General Explanations are silent on this point.
    2. Gain would not be recognized on tangible personal property other than collectibles.
    3. The $250,000-per-person exclusion for capital gain on a principal residence would continue to apply and would be portable to the decedent’s spouse.
    4. The exclusion of gain on certain small business stock under Code Section 1202 would continue to apply.
    5. In addition to the other exclusions, the proposal would permit a $1 million-per-person exclusion on property transferred at death or by gift, portable to decedent’s surviving spouse. Basis would generally carry over to the extent gain is not recognized and would be stepped up to fair market value to the extent gain is recognized.
    6. Payment of the tax on the appreciation of certain family owned and operated businesses would not be due until the interest in the business is sold or the business ceases to be family owned and operated.
    7. The proposal would also permit a 15-year fixed payment plan on appreciated assets transferred at death other than for liquid assets such as publicly traded financial assets.

Other than as noted above, this proposal would be effective for gains on property transferred by gift and property owned on death by decedents dying after December 31, 2021, and for property owned by non-corporate entities on January 1, 2022.

5. Further Limit Opportunities to Avoid the Net Investment Income and SECA (Self-Employment Contribution Act) Taxes

Under current law, while most wages, self-employment income, partnership income, and investment income of high-income taxpayers is subject to an uncapped 3.8 percent tax (as either net investment income subject to the tax on net investment income, self-employment income subject to the SECA tax, or wages subject to Medicare tax ), the tax can be avoided altogether in the case of S corporation income of a shareholder actively engaged in most trades or businesses of the S corporation (Code Sections 1411( c ) (1 ) and (2)) and the distributive share of limited partners in a partnership, or analogous LLC members, other than for guaranteed payment for services ( Code Section 1402( a) ( 13)).

The proposal would ensure that all pass-through income of high-income taxpayers is subject to either the SECA tax or the net investment income tax. In particular, limited partners and LLC members that provide services and materially participate would be subject to SECA tax on their distributive shares to the extent certain thresholds are exceeded, and S corporation owners who materially participate in a trade or business of the S corporation would be subject to SECA taxes on their distributive shares of the business’s income to the extent that income exceeds certain thresholds. The thresholds are generally the excess of this type of income and FICA wages over $400,000.

This proposal would be effective for tax years beginning after December 31, 2021.

6. Tax Profits from Carried Interests as Ordinary Income

Under current law, individual partners who receive an interest in future profits of the partnership (“profits interests”) for services, are, like other partners, generally taxed on gain from the sale of their interests, or pass-through income from sale by the partnership of underlying assets, at preferential capital gains rates (subject to a 12-month holding period being met), with such gain not subject to SECA tax. Recently enacted Code Section 1061 extended the 12-month holding period to three years in the case of certain capital gains recognized by certain partners having received a profits interests for services.

The proposal would generally tax as ordinary income, and subject to SECA tax, a partner’s share of income of an investment services partnership interest (“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. Gain from the sale of a ISPI would also be subject to ordinary income rates. An ISPI is a profits interest in an investment partnership held by a person who provides services to the partnership.

There would be an exception for income attributable to invested capital (rather than services) that constitutes a qualified capital interest.

There is also a proposal for a person who performs services for certain entities (other than partnerships, S corporations, and certain C corporations) and holds a “disqualified interest” in the entity being subject to ordinary income rates on income or gain with respect to the interest if the person’s income from all sources exceeds $400,000. A “disqualified interest” is defined as convertible or contingent debt, an option, or any derivative instrument with respect to the entity.

These proposals would repeal Code Section 1061, mentioned above, for taxpayers with taxable income in excess of $400,000 and would be effective for tax years beginning after December 31, 2021.

7. Repeal of Deferral of Gain from Certain Like Kind Exchanges

Under current law, owners of appreciated real property used in a trade or business or held for investment can defer gain on exchange of the property for other real property of a like kind under Code Section 1031.

The proposal would eliminate this treatment for gains from like kind exchanges in excess of $500,000 ($1 million for married taxpayers filing jointly) during a taxable year, effective for exchanges after December 31, 2021.

8. Make Permanent the Excess Business Loss Limitations of Noncorporate Taxpayers

Currently, under Code Section 461(l), losses from pass-through businesses cannot offset other income. Rather “excess business losses” are carried forward to subsequent years as net operating losses. “Excess business losses” are defined as losses from business activities over gains from such activities and a threshold amount of $524,000 for married couples filing jointly and $262,000 for all other taxpayers, to be indexed for inflation. The intent of the provision is to bring excess losses from active pass-through businesses closer in line with excess losses of C corporations and passive losses from businesses.

The proposal would make the provision, which is currently set to expire on December 31, 2026, permanent.

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