Democrats tweak tax bill for House vote

House Democrats last week released an updated reconciliation bill for potential House passage, but postponed a vote after several moderates refused to support the bill without a full revenue score. The House is now targeting a vote by the week of Nov. 15, and also sent to the president’s desk a related bipartisan infrastructure bill with several narrow tax provisions.

The new version of the reconciliation bill makes several notable changes to the tax title that was unveiled as part of President Joe Biden’s framework agreement on Oct. 28, including an increase and extension of the cap on state and local tax (SALT) deductions and the addition of proposals aimed at individual retirement accounts (IRAs). The Joint Committee on Taxation estimates that the bill’s tax increases would raise nearly $1.5 trillion while its tax cuts would cost more than $500 billion.

The current bill is by no means a finished product, and does not have the endorsement of Senate holdouts Sens. Joe Manchin, D-W.V., and Kyrsten Sinema, D-Ariz. House leadership is pushing ahead toward a vote early as next week anyway—a significant shift in strategy. House Speaker Nancy Pelosi, D-Calif., had pledged for months not to bring a reconciliation bill to the House floor unless she was confident the Senate would pass it. But after disappointing election results for Democrats in Virginia and New Jersey, House Democrats last week pushed for immediate votes on the reconciliation bill.

Six moderate House Democrats scuttled those plans by refusing to vote without a full score from the Congressional Budget Office (CBO). The moderates did commit to voting for the bill “in its current form other than technical changes” no later than the week of Nov. 15 as long as the CBO numbers are consistent with the White House’s top-line revenue estimates.

Democrats did manage to pass the bipartisan infrastructure bill last week by a 228-206 vote (including 13 Republican votes) after most progressives relented and offered their support. Until last week, progressives had vowed not to pass the infrastructure until the reconciliation bill was complete in order to preserve leverage over moderate holdouts on the reconciliation bill. Biden is now expected to sign the infrastructure bill this week. It raises $50 billion in net revenue from a handful of both favorable and unfavorable tax changes, which include:

• Expanding information reporting to cover digital assets like cryptocurrency
• Ending the employee retention credit on Sept. 30, 2021, except for recovery start-up businesses
• Extending the transportation excise taxes that fund highway spending
• Reinstating Superfund taxes
• Extending pension funding relief
• Carving out certain utility water and sewer property from the exclusion from contribution to capital treatment under Section 118
• Increasing the private activity bond cap for transportation projects and expanding private activity bond eligibility to include qualified broadband projects and carbon dioxide sequestration facilities
• Expanding required IRS administrative relief for disasters

The reconciliation bill carries the bulk of the president’s social and tax agenda, and its prospects remain fluid. Manchin and House moderates have both refused to endorse it the without a full CBO score. Surprises in scoring remain possible and could present hurdles to moving forward. The bill relies on as much as $400 billion in new revenue that Treasury expects from IRS funding increases, and it is unclear whether CBO will score IRS funding in the same way. Even if the bill passes the House, it appears unlikely to pass the Senate in its current form. The bill includes specific measures Manchin currently opposes, including paid family and medical leave without new taxes to fund it.

Manchin and other senators may demand significant revisions to the tax title and other areas before enactment is possible. Negotiations will be interesting. The House action will put the pressure on the Senate to act, but also robs leadership of some leverage over Manchin and Sinema. There are no concrete deadlines to drive reconciliation action, but lawmakers will still be pressing for quick action and will certainly want to finish any deal before adjourning for the end of the year.

The new version of the reconciliation tax title—as it stands now—adds several significant tax provisions, including:

• Extending the SALT deduction for six years, through 2031, and raising the cap from $10,000 to $80,000 through 2030 before lowering the cap to $10,000 for 2031
• Adding a number of restrictions to IRAs and other retirement accounts that were dropped from an earlier version
• Increasing the employer-provided childcare credit
• Allowing taxpayers to deduct expenses in contingency fee cases
• Doubling the refundable portion of the research credit for qualified small businesses
• Terminating the employer credit for paid family and medical leave in 2023 instead of 2025
• Providing increased low-income housing tax credit allocations with several modifications to the rules
• Creating a new local journalist compensation credit
• Creating a new neighborhood homes credit
• Creating a new credit for economic activity in U.S. possessions
• Providing above-the-line deductions for employee uniforms and union dues
• Adding a new nicotine tax aimed at vaping
• Adding qualified sound recording to Section 181 expensing
• Expanding Section 139 to exclude certain state-based catastrophic loss mitigation from income

No major provisions were cut from the last version of the bill, although some were modified. The bulk of the revenue would still be raised from:

• Imposing a 15% minimum book tax on corporations with more than $1 billion in net financial statement income
• Creating a 1% excise tax on stock buybacks by publicly traded companies
• Raising the rate on global intangible low-taxed (GILTI) income to 15%, imposing it on a country-by-country basis, and reducing the exemption from a return on tangible property
• Reducing the deduction for foreign derived intangible income (FDII)
• Enhancing the base-erosion and anti-abuse tax (BEAT)
• Imposing a new interest limit based on share of a global group’s total interest
• Implementing significant additional international reform
• Imposing a 5% surtax on adjusted gross income exceeding $10 million, with an additional 3% tax on AGI exceeding $25 million
• Expanding the 3.8% tax on net investment income (NII)
• Making the active loss limitation under Section 461(I) permanent and adjusting the carryforward rules

The bill also retains more than $300 billion new, enhanced, and extended green incentives. It would also postpone for four years the five-year amortization of research and experimental (R&E) expenditures that is currently scheduled to become effective beginning in 2022. On the individual side, there are extensions and enhancements for the child tax credit, the earned income tax credit, and Affordable Care Act premium credits.

The following provides more information on key proposals included in the most recent version of the bill.

Corporate changes

Corporate minimum tax

The bill would impose a 15% minimum “book” tax on corporations that report three-year average annual adjusted financial statement income in excess of $1 billion (with a $100 million threshold for certain foreign-parented corporations if the international reporting group has $1 billion in income). It includes both public and private C corporations, but not S corporations or real estate investment trusts or regulated investment companies. Lawmakers claim only about 200 companies would meet this threshold.

The 15% rate would apply against “net income” from an applicable financial statement (defined under Section 451(b)(3)) with many significant adjustments, including several international items. General business credits would be subject to the same limit applying under the old corporate alternative minimum tax. Newly defined “financial statement” net operating losses could offset up to 80% of financial statement income. Any tax paid would be creditable against regular tax in future years.

The proposal would be effective for tax years beginning after Dec. 31, 2022. The JCT estimates the tax would raise roughly $318 billion from 2022-2031.

Excise tax on corporate stock buybacks

The bill would impose a 1% excise tax on publicly traded U.S. corporations for the value of any of stock that is repurchased by the corporation during the taxable year. This is down from the 2% tax originally proposed. The term “repurchase” would mean a redemption within the meaning of Section 317(b) with regard to the stock of such corporation, and any other economically similar transaction as determined by Treasury. The tax would not apply to:

• Tax-free reorganizations
• Stock contributed to an employee pension plan, ESOP or similar plan
• Stock repurchases of less than $1 million in a year
• Stock purchased by a dealer in securities in the ordinary course of business
• Repurchases treated as a dividend
• Repurchases by a regulated investment company or real estate investment trust.

The tax would apply to repurchases of stock after Dec. 31, 2021. The JCT estimates the tax would raise roughly $124 billion from 2022-2031.

Divisive reorganizations under Section 361

The proposal would amend Section 361 to provide that a distributing corporation recognizes gain in a divisive reorganization under Sections 368(a)(1)(D) or 355 to the extent of controlled corporation debt securities transferred to the creditors of the distributing corporation in excess of the basis in assets (reduced by amounts paid by the controlled corporation to the distributing corporation) transferred from the distributing corporation to the controlled corporation in the transaction. The change would apply to reorganizations occurring on or after the date of enactment.

Common control

The bill would expand the aggregation rules under Section 52(b) that treat groups of related entities as a single employer. The legislation would require the inclusion of any trade or business activity under Section 469(c)(5) or Section 469(c)(6). Section 469(c)(6) would incorporate the definition of “trade or business activities” under Section 212, which includes management, conservation, and maintenance of property held for the production of income. Section 469(c)(5) would include research and experimentation activities.

Compensation deduction under Section 162(m)

The bill would modify the definition of “applicable renumeration” to include all pay whether or not paid directly by the public corporation. In addition, aggregation rules under Section 414 would apply.

Other business provisions:

The bill would also:

• Exclude from qualifying REIT income any rent from correctional, detention, or penal facilities, for tax years beginning after 2021
• Restrict the orphan drug credit to first use or indication for rare disease.

International tax changes

GILTI

The bill would significantly reform the GILTI system. The Section 250 deduction related to GILTI would be reduced from 50% to 28.5% for tax years beginning after 2022, creating a GILTI tax rate of 15%. In addition, GILTI would generally be determined on a country-by-country basis with the ability for controlled foreign corporations (CFCs) with tested losses in a particular country to carry forward such losses to reduce future years’ test income.

The bill would preserve the exemption for the deemed rate of return on qualified business asset investment (QBAI), but would cut the deemed rate of return in half from 10% to 5%. The deemed paid credit for foreign taxes attributable to GILTI would increase from 80% to 95%, and deductions for interest expenses, stewardship expenses and research and experimental expenses would not affect the taxpayer’s foreign tax credit limitation with respect to GILTI.

FDII

The FDII deduction would be reduced from 37.5% to 24.8% for years beginning after 2022, resulting in an effective 15.8% FDII rate. In addition, the Section 250 deduction (both GILTI and FDII portions) would no longer be limited to taxable income, and would be allowed as a deduction resulting in an increase in the net operating loss (NOL) for the taxable year.

The JCT estimates the proposed changes to GILTI, FDII, and the Section 250 deduction would raise roughly $200 billion from 2022-2031.

BEAT

The bill would expand the scope of BEAT and alter the calculation beginning in 2023 by adding costs of goods sold and other making other significant change. The BEAT rate would increase to 12.5% for tax years beginning in 2023, 15% in 2024 and 18% in 2025. The JCT estimates the proposed changes to BEAT would raise roughly $67 billion from 2022-2031.

New interest deduction limit

The bill would create a new Section 163(n) limit on the interest deduction under for domestic corporations that are members of a multinational group that prepares consolidated financial statements and has average annual business interest expenses of more than $12 million over the past three years. The domestic corporation could only deduct up to its allowable percentage of 110% of the total net interest expense. The allowable percentage is based on the member’s allocable share of the groups interest expense, and the allocable share is the ratio of the domestic corporation’s financial statement earnings before interest expense, taxes, depreciation, depletion and amortization (EBITDA) and the group’s EBITDA.

The disallowed interest expense under Section 163(j)(1) and new Section 163(n)(1) could be carried forward indefinitely, a favorable change from an earlier version that only would have allowed a five-year carryforward. The bill also modifies Section 163(j) for S corporations and partnerships so that the limitation is no longer computed at the entity level, but rather is computed at the investor level only. The latest version also adds a provision providing that interest from a business with less than $25 million in annual gross receipts under Section 448(c).

The proposal would be effective for tax years beginning after 2022—unlike the Ways and Means Committee proposal, which proposed an effective date beginning after 2021.

Portfolio interest exemption

The bill would narrow the portfolio interest exemption currently available for interest received by any corporate shareholder owning less than 10% of the combined voting power of all classes of such corporation. The definition of a 10% shareholder of a corporation would be expanded to include 10% ownership of total stock value or combined voting power. This proposal would apply to obligations issued after the date of enactment of the bill.

Other international changes

There are several other significant international tax provisions that would:

• Modify a number of foreign tax credit rules
• Limit the 100% deduction for dividends received to dividends from a CFC (currently available to CFCs and also foreign corporations that are owned from 10% up to 50% by domestic corporations)
• Repeal the election for a one-month deferral in the determination of taxable year of specified foreign corporations
• Limit foreign base company sales and services income to situations in which the relevant arrangement includes a related person that is a taxable unit that is a U.S. tax resident (i.e., U.S. residents, passthrough entities and branches in the U.S.)

AGI surtax

The bill would impose a 5% surtax to the extent AGI exceeds $10 million ($200,000 for an estate or trust) and an additional 3% surtax to the extent AGI exceeds $25 million ($500,000 for an estate or trust). The threshold is identical for joint, single, and head of household filers, but is cut in half for those married filing separately. AGI would be reduced by the investment interest under Section 163(d) and business interest under Section 163(j). The separate portions of an electing small business trust would be treated as a single trust. The change would be effective for tax years beginning after 2021. The JCT estimates the AGI surtax would raise roughly $227 billion from 2022-2031.

Excess business losses under Section 461(l)

The bill would make permanent the limit on deducting excess business losses under Section 461(l). The provision was created by the TCJA, but was suspended from 2018 through 2020 and is scheduled to expire in 2026. The bill would also change the treatment of excess losses subject to the limit. Excess losses would no longer carry forward an NOL the following year, but would remain subject to the Section 461(l) limit in future years. Trusts that terminated with suspended losses would transfer the loss carryovers to beneficiaries. The JCT estimates the Section 461(I) changes would raise roughly $160 billion from 2022-2031.

Net investment income tax

The bill would expand the scope of the 3.8% Medicare tax on net investment income (NII) so that essentially all income not subject to employment or self-employment tax would be subject to NII tax. Most income that escapes both employment or self-employment tax on earned income is taxed as NII, but there can be exceptions, such as non-compensation income from an owner of an S corporation or a partner in a limited partnership who is not passive. This provision would close that gap by repealing the exception for income derived in the ordinary course of a trade or business for a nonpassive owner for taxpayers with income exceeding $400,000 (single) or $500,000 (joint). The JCT estimates the proposed NII changes would raise roughly $252 billion from 2022-2031.

SALT cap

The bill includes a long-awaited compromise on SALT cap relief. Under the new provision, the cap would be extended to 2031, and the cap would be increased from $10,000 to $80,000 beginning in 2021, before decreasing back to $10,000 in 2031. The current cap is scheduled to expire after 2025 with rest of the individual provisions enacted as part of the Tax Cuts and Jobs Act.

A previous version of the bill—from Nov. 3—proposed to increase the cap from $10,000 to $72,500 and extend the cap through 2031, however, these provisions were subsequently amended in a manager’s amendment filed late on Nov. 4. Because of these late-breaking amendments, the JCT estimate analyzed the Nov. 3 proposal with the outdated cap of $72,500. The JCT estimated that those superseded SALT cap changes would have cost roughly $222 billion from 2022-2026, but would have been completely offset by the reinstatement of the cap after 2027 and would raise a net $2 billion over 10 years.

Individual retirement accounts

The latest version of the bill resurrects proposals aimed at IRAs with several modifications to the prior versions. The most significant provisions would apply to taxpayers whose income exceeds 450,000 (joint) or $400,000 (single):

• Barring contributions to IRA once aggregate retirement accounts reached $10 million in value beginning in 2028 (instead of 2022 as originally proposed)
• Requiring additional minimum distributions for taxpayers with aggregate retirement accounts exceeding $10 million beginning in 2028 (instead of 2022 as originally proposed)
• Barring any rollovers from a traditional IRA to a Roth IRA beginning in 2032

In addition, the bill would bar all taxpayers from any Roth conversion after 2021 that includes any nondeductible contributions. The bill would also treat IRA owners as disqualified persons for purposed of the prohibited transaction rules.

New loss rules

The House bill would make several changes to loss rules, including:

• Generally making all losses from a worthless partnership interest capital in nature even if the partner does not share in the partnership’s liabilities
• Providing that a worthlessness loss from a security arises at the time of identifiable event establishing worthlessness rather than the end of the tax year
• Expanding the definition of “worthless securities” to include certain securities to bonds debentures, notes, certificates, or other debuts issued by a partnership with interest coupons or in registered form
• Providing a deferral of losses in complete liquidation under Section 331 when two corporations are members of the same controlled group

Other investor provisions

The bill would also:

• Expand the wash sale rules to include commodities, currencies and digital assets
• Expand the constructive sale rules to include digital assets
• Amend Section 871(m) to provide that payments for certain notional principal contracts tied to publicly traded partnerships are treated as dividend equivalents.
• Restrict the orphan drug credit to first use or indication for rare disease

Green energy package

Sections 45 and 48

The bill strikes a compromise between the House and Senate approaches on the Section 45 production tax credit (PTC) and Section 48 investment tax credit (ITC). In general, the bill extends both at enhanced rates through the end of 2026, and then transitions to a Senate approach in which they are replaced by similar credits that are “technology-neutral.”

The beginning construction deadline for the PTC would generally be extended through 2026 at a rate of 2.5 cents per kilowatt hour, and would add solar property. The full credit rate would generally be available only if the project met prevailing wage and apprenticeship requirements. An additional boost in the credit of 2% (10% if prevailing wage and apprenticeship requirements are met) would be available for projects that use domestic steel, iron, and manufactured products. The bill would also extend the ability to claim the ITC in lieu of the PTC.

The ITC would generally be extended through 2026 at the full 30% rate (solar property placed in service in 2021 would remain at the 26% rate). Like the Section 45 credit, the full credit would be available only if it meets prevailing wage and apprenticeship requirements, with a similar 10% additional credit for domestic suppliers. An additional 10% credit would also be available for “energy community” projects or from “low-income” community projects. The bill would also add energy storage technology, biogas property, microgrid controllers, linear generator assemblies, electrochromic glass, transmission property and zero emissions property.

The bill would also allow taxpayers to elect a direct payment in lieu of the PTC or ITC (see below for more information). Beginning in 2027, the credits would be replaced with technology neutral versions that would phase out in 2031 or when greenhouse gas emissions for electrical production are half of the 2021 amount, if earlier.

Direct payments

The bill would also allow taxpayers to elect a direct payment for several credits:

• Section 48 ITC
• Section 45 PTC
• Section 45Q credit for carbon capture and sequestration
• Section 30C alternative fuel vehicle refueling property credit
• Section 48C advanced energy project credit
• Section 48D investment credit for transmission property
• Section 45W zero-emission nuclear power production credit
• Section 45X clean hydrogen production credit
• Section 48E advanced manufacturing investment credit
• Section 45AA advanced manufacturing production credit
• Section 45BB clean electricity production credit
• Section 48F clean electricity investment credit
• Section 45CC clean fuel production credit

The direct payments would be available for tax-exempt entities and would be claimed by pass-throughs at the entity level.

Section 45Q carbon capture credit

The bill would increase the Section 45Q carbon capture tax credit for direct air capture facilities to $180 per metric ton for carbon oxide captured and sequestered, and to $130 per metric ton for carbon oxide captured and used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project or otherwise used in an approved manner. In addition, the bill would raise the Section 45Q credit for other qualified projects to $85 per metric ton of carbon oxide captured and sequestered and $60 per metric ton of carbon oxide captured and used as a tertiary injectant or otherwise used in an approved manner.

In order to qualify for the full credits, taxpayers would need to meet prevailing wage and apprenticeship requirements. The bill would also reduce the minimum capture requirements for carbon capture facilities to receive the credit and would extend the credit to facilities that begin construction before the end of 2031.

Publicly traded partnershipsThe bill would expand the qualifying activities of publicly traded partnerships (PTP) under Section 7704 to include a variety of alternative energy activities, including most ITC and PTC projects.

Clean hydrogen production

The bill would create a new credit for production of clean hydrogen under new Section 45X, which would be available for businesses producing clean hydrogen at a clean hydrogen facility. The amount of the credit would depend on the reduction in lifecycle greenhouse gas emissions compared to hydrogen produced by steam-methane reforming.

Alternative fuel refueling property

The bill would extend the 30% alternative fuel refueling property for depreciable property for 10 years through 2031, and would increase the $30,000 per location cap to $100,000. An additional uncapped 20% credit would be available for costs exceeding $100,000 for electricity and hydrogen fuel meeting specific requirements. The full credits would only be available for taxpayers meeting prevailing wage and apprenticeship requirements.

Section 48C advanced energy project credit

The bill would revive the Section 48C credit by providing an annual $5 billion credit allocation for 2022 and 2023 and a $1.875 billion allocation each year from 2024-2031. from 2022 through 2031. Taxpayers would be required to apply for the 30% investment tax credit for qualified property used to manufacture certain energy property. Treasury would prioritize projects based on net reduction in greenhouse gases and domestic job creation (including in underserved communities at risk of health issues due to greenhouse gases).

Fuel credits

The bill would extend several excise tax credits related to alternative fuels, biodiesel and renewable diesel, and biodiesel mixtures through Dec. 31, 2026 (a small agri-biodiesel credit would go through 2031), to be replaced by a technology-neutral version through 2031.

In addition, the bill would add a sustainable aviation fuel credit under new Section 40B for sustainable fuel sold as part of a qualified fuel mixture. The sustainable aviation fuel credit would be determined on a sliding scale from $1.25 to $1.75 per gallon, depending on the reduction in lifecycle emissions of the fuel, and could be claimed as a credit against excise tax liability under Section 4041. The credit would apply to fuel sold or used after 2022 and before 2027.

Green incentives for individuals

The bill includes several provisions aimed at consumers, including:

• Extending and increasing the nonbusiness energy property credit under Section 25C
• Extending and residential energy efficient credit under Section 25D
• Reinstating and increasing the fringe benefit income exclusion for bicycle commuting

Energy efficient commercial buildings

The bill would increase the maximum Section 179D energy-efficient commercial building deduction starting in 2022 and would change the maximum to a three-year cap rather than a lifetime maximum. The changes to the provision would expire after Dec. 31, 2031.

Electric vehicles

The bill would replace the current elective vehicle credits, which generally phase out by manufacturer based on the number of vehicles sold, with new expansive and generous credits.

Plug-in electric vehicles would generally qualify for a credit of $4,000, plus an additional $3,500 if battery capacity is 40 kilowatt hours or more and the gas tank holds less than 2.5 gallons. The battery requirement would increase to 50 kilowatt hours in 2027. The credit would be unavailable for vehicles exceeding certain price thresholds and for taxpayers exceeding certain income thresholds.

Qualified commercial vehicle would be eligible for a 30% uncapped credit, and a new credit would be created for electric bicycles.

Other credits

The bill would create a number of other new credits, including credits for:

• Qualifying electric transmission property
• Existing nuclear plants for electricity sold to a third party
• Wildfire mitigation expenses
• Labor costs of installing mechanical insulation
• Superconductor manufacturing
• Manufacturing or solar and wind components
• Qualified environment justice programs at education institutions

The bill would also extend and enhance the new energy efficient home credit

Key omissions

The bill still omits many significant provisions that were proposed throughout the process, including:

• A corporate rate increase
• Individual ordinary and capital gains rate increases (apart from the AGI surtax)
• A cap on pass-through deduction under Section 199A
• A proposal to require “billionaires” to mark-to-market tradeable assets
• Carried interest changes
• Estate and gift tax changes and the repeal of step-up in basis of inherited assets
• IRS bank and financial account reporting
• A carbon tax
• Repeal of like-kind exchanges
• Repeal of oil and gas tax incentives

It is possible that some of these proposals could be resurrected, much like the IRA changes were dropped from the package and then added back. Estate and gift tax changes could be a target along with carried interest. If proposals like the minimum tax on book income run into opposition, or revenue needs arise, corporate and individual rate changes could also be considered if Sinema can be convinced to budge on her objections. The mark-to-market proposal appears too fraught with administrative problems to succeed and Manchin has been a hard “no” on the carbon tax and repealing oil and gas incentives. The IRS reporting expansion has also proven unpopular, though Treasury has pushed it hard. It appears unlikely Congress would target Section 199A if corporations aren’t facing a rate increase.

Next steps

House passage of the reconciliation bill would be a major step forward—and the new version may bring us closer to a potential agreement. Taxpayers should examine the provisions in detail to determine the potential effect. Pre-emptive planning may still be beneficial in some situations. Reverse tax planning could still offer rate arbitrage for some pass-throughs whose owners would pay the AGI surtax, CFCs for multinationals who will pay GILTI, and investors who may face the AGI surtax. C corporations not facing the minimum tax would generally not appear to benefit from income acceleration unless the corporate rate increase is resurrected. Taxpayers should also keep in mind that the bill is far from a finished product and its success is not assured. Taxpayers should continue to monitor the legislative process to see how the proposals evolve.

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