Treasury release provides key tax insights

The administration outlined the details behind more than $3.6 trillion in tax increases in its Treasury “Green Book,” which includes new information on proposed effective dates and other key issues. The bulk of the tax provisions would be made effective beginning in 2022, but the capital gains rate change is proposed to be effective “after the date of announcement.”

The Green Book was released by Treasury as part of the administration’s official budget proposal. It offers detailed descriptions of President Joe Biden’s tax proposals along with a full revenue score. Treasury estimates that the tax platform would raise more than $2.3 trillion in net revenue over the next 10 years, but that figure actually comprises $3.6 trillion in total tax increases offset by $1.3 trillion in tax cuts. The tax cuts include $300 billion in energy tax incentives and $820 billion in enhancements to the earned income tax credit, the ACA premium credit, the child tax credit and the child and dependent care credit.

More than $780 billion of new revenue is projected to come from IRS enforcement initiatives that will likely be controversial. Revenue from additional IRS funding is estimated to raise $316 billion, but congressional scorekeepers typically do not offer revenue scores for IRS spending increases alone. A staggering $463 billion is estimated to come from a sweeping new information reporting proposal that will likely face opposition over the compliance burdens and privacy concerns.

There are technical, political and revenue challenges for Biden’s platform that leave it far from a finished project. The tax increases are meant to fund infrastructure and economic security initiatives, and Democrats will face difficult decisions as they confront razor-thin majorities and political realities. Democrats may need to fill revenue holes as provisions meet resistance or evolve. The Treasury score counts on revenue from positions like the corporate rate that Biden is already partially conceding. The Green Book retains the 28% rate, but recent comments from Biden indicate he is open to compromise and would accept a rate as low as 25%.

The revenue pressure could also force Democrats to trim their spending and tax cut provisions, or to fund parts of the package through deficit spending. They could also resurrect tax increase proposals that are not currently part of Biden’s plan, like limiting the Section 199A deduction.

The Biden administration grouped the tax proposals into two packages. Business tax increases are meant to fund physical infrastructure investments as part of the “American Jobs Plan,” while individual tax increases cover new spending on paid leave, child care, health care, and education under the “American Families Plan.” These initiatives could be combined by Democrats and passed using the reconciliation process.

Biden is also exploring a potential bipartisan agreement on physical infrastructure, though Republicans and Democrats still appear far apart on both spending levels and the funding mechanisms. Republicans have drawn a hard line on refusing any tax increases. Democrats could try a two-track approach, agreeing on a smaller bipartisan package with Republicans while moving tax increases and other partisan priorities separately on a reconciliation bill. But Democrats may have trouble keeping their caucus together on a separate partisan package that doesn’t carry the most popular physical infrastructure investments.

Biden is planning to decide in the coming weeks whether a bipartisan deal is possible, and will move forward through reconciliation if not. Democrats have set an aggressive timeline to pursue changes, but a difficult legislative process could prolong the action until well into the fall or even to year’s end.

Grant Thornton Insight: While the final shape of the legislation remains uncertain, Democrats have an undeniable opportunity to enact significant tax increases on nearly all types of investors and businesses. Taxpayers should begin considering the potential effects of the proposals on their tax and business planning, especially with regard to the timing of income and deductions. The proposed effective dates are largely prospective and give taxpayers significant runway for planning. The timing of a capital gains rate increase appears the most uncertain. The Green Book proposes to make it effective as of the “date of announcement,” but offers no further information on what is considered the date of announcement. Press reports indicate that Treasury scored the proposal assuming this date was April 28, but congressional tax writers may be unwilling to accept such a retroactive change.

Corporate rate

The Green Book proposes to raise $857 billion by increasing the corporate rate to 28% effective for tax years beginning after 2021. Fiscal year taxpayers would prorate their rate based on the proportion of their fiscal year occurring after Dec. 31, 2021.

Grant Thornton Insight: While the Green Book is still proposing a 28% rate, this appears to be one of the items most likely to change through negotiation. In recent comments, Biden said he is “open to compromising” on the rate and even specifically referenced a rate “between 25% and 28%.” Moderates like Joe Manchin, D-W.V., prefer a 25% rate, and such a change could lower the revenue projection by $300 billion or more.

Minimum tax on book income

The Green Book offers new details on the proposed 15% minimum tax on financial statement income for corporations with book income of more than $2 billion. Income would be calculated by subtracting net operating losses (NOLs) from worldwide book income. Both general business credits and foreign tax credits would be allowed in full. Any liability could be carried forward and used against regular tax as a credit in future years.

Grant Thornton Insight: The administration claims that only around 120 companies would surpass the income threshold, and that fewer than 50 would likely be required to pay. Given how narrow the proposal is, the $148 billion revenue estimate is somewhat surprising, especially considering that NOLs and tax credits are allowed in full. Limits on these items were often the primary reason many corporations paid tax under the now repealed corporate alternative minimum tax. In fact, NOLs would get a better result under this minimum tax regime than under regular tax, where they are generally limited to 80% of taxable income after 2021. There are still major administrability issues and technical questions that may hamper efforts to get this proposal enacted. It is unclear how the $2 billion threshold will operate, or whether congressional lawmakers will be willing to outsource the definition of taxable income for this provision to the accounting industry.

International changes

The Green Book significantly expands the scope of the international tax proposals, which aggressively target inversions and would reverse or reform many aspects the Tax Cuts and Jobs Act.

Global intangible low-taxed income (GILTI)

As expected, the administration is proposing to repeal the GILTI exemption for qualified business asset investment (QBAI). In addition, the 50% GILTI deduction would be reduced to 25% to create an effective GILTI rate of 21%. The Green Book expands the Administrations country-by country approach to require tax to be calculated on a “jurisdiction-by-jurisdiction” basis even at the branch level. The changes would be effective for tax years beginning after 2021.

Grant Thornton Insight: The administration may come under pressure to lower the effective GILTI rate below 21%, particularly if the corporate rate only rises to 25%. International pressure will also be a major factor. Biden is pushing the Organisation for Economic Co-operation and Development (OECD) to agree on a global minimum tax rate of 15% under its “Pillar Two” effort to address tax challenges of digitalization. Several countries would like an even lower rate. Congressional Democrats could also push for other changes to the GILTI proposals. Senate Finance Committee Chair Ron Wyden, D-Ore., has suggested using high-tax and low-tax buckets in place of a jurisdiction-by-jurisdiction regime.

Foreign-derived intangible income (FDII)

The Green Book proposes to repeal the FDII deduction for tax years beginning after 2021. However, the $124 billion that would be raised with repeal is reserved for unspecified incentives to support for research and development expenditures.

Grant Thornton Insight: No further information was offered on new potential research incentives, but Biden appears to be more focused on where research occurs rather than where intellectual property resides.

Base-erosion anti-abuse tax (BEAT)

The Green Book proposes to replace the base-erosion anti-abuse tax (BEAT) in 2023 with a “stopping harmful inversions and ending low-tax developments (SHIELD)” regime. SHIELD would apply much more broadly than BEAT, covering any “financial reporting group” with more than $500 million of global annual revenues (compared to BEAT’s $500 million in domestic income threshold). A financial reporting group would be defined as any group or business entities that prepares a consolidated financial statement and includes a domestic entity. SHIELD would deny deductions for any payment made from a domestic entity or branch to a member of the group whose effective tax rate is below the global minimum tax rate designated under a Pillar Two agreement.

Grant Thornton Insight: This provision appears incredibly broad, and targets not only direct payments, but also other types indirect payments and costs such as costs of goods sold.

Inversions

The administration is heavily targeting inversions and earnings stripping. It would replace the current 80% and 60% ownership thresholds for triggering the anti-inversion rules under Section 7874 with a single 50% test. In addition, any transaction in which the fair market value of a domestic entity is greater than that of a foreign acquiring corporation would be deemed an inversion if the new group is managed and controlled in the United States and the group does not conduct substantial business activities in the country in which the foreign acquiring corporation is organized.

The Green Book also includes significant new provisions that would:

Expand Section 338(h)(10) to cover transactions with hybrid entities
Impose “thin capitalization rules” denying deductions for interest expense exceeding financial statement interest expense thresholds

Onshoring

The Green Book would create a 10% credit for expenses connected to “onshoring” a U.S. trade or business while denying deductions for any expenses connected to “offshoring.”

Grant Thornton Insight: The Green Book does not meaningfully define these terms in a way that yet appears administrable, and hurdles remain for this provision. The Green Book describes onshoring as reducing or eliminating a trade or business outside the United States while expanding or moving the same trade or business inside the United States. Major challenges remain in creating clear-cut rules to implement such a definition.

Infrastructure

The Green Book proposes a new separate allocation for low-income housing tax credits tied to specific geographic locations, and a permanent new markets tax credit with a $5 billion annual allocation indexed for inflation.

Infrastructure

The administration is calling for the repeal of nearly every tax benefit for “fossil fuels,” including:

Enhanced oil recovery credit
Marginal wells credit
Expensing for intangible drilling costs
Deduction for tertiary injectants
Exception to passive loss limitations provided to working interests in oil and natural gas properties
Percentage depletion for oil and gas wells and hard mineral fossil fuels
Two-year amortization of geological and geophysical expenditures (changed to seven years)
Exploration and development cost expensing
Capital gains treatment for royalties
Exception from corporate level taxes for oil and gas publicly traded partnerships
Accelerated amortization for air pollution control facilities
Exception from the Oil Spill Liability Trust fund for crude oil derived from bitumen and kerogen-rich rock

Energy tax provisions

The Green Book finally fleshes out Biden’s ambitious energy tax platform. It would extend and enhance many of existing credits, including:

Section 45 – The production tax credit would be extended at the full credit rate for qualified facilities where construction began by the end of 2026, phasing down thereafter. Taxpayers could also elect to claim the 30% investment tax credit instead.
Section 48 – The investment tax credit would be restored to the full 30% rate for construction beginning after 2021 and before 2027, phasing down thereafter. Certain transmission and energy storage property would qualify.
Section 45J – Nuclear power facilities could apply or “bid” for up to $1 billion in annual credit allocations.
Section 48C – The Green Book proposes to resurrect the Section 48C advanced energy manufacturing credit with a new $10 billion allocation.
Section 45Q – The carbon oxide sequestration credit would be extended to cover facilities in which construction began before 2031.

All these credits would be made fully refundable with a direct pay mechanism and the administration stated that it would seek to impose labor standards on projects.

Grant Thornton Insight: The Green Book aligns fairly closely with energy tax legislation introduced by Wyden and recently marked up in the Senate Finance Committee. Both proposals include extending the credits at generous rates, providing a direct pay mechanism and imposing labor standards. The Wyden version adds several other novel concepts, including using a technology neutral approach, repealing normalization requirements for public utilities, and making solar property eligible for the production tax credit. Both versions are fairly expensive and may face obstacles as the package comes under revenue pressure.
The Green Book includes several additional energy provisions, including:

Extending the Section 25C tax credit for nonbusiness energy property for five years and increasing the cap from $500 to $1,200
Extending the Section 45L energy efficient home credit for five years and increasing it from $2,000 to $2,500
Increasing the Section 179D deduction from $1.80 per square foot to $3
Creating a production tax credit for low-carbon hydrogen and a new credit for sustainable aviation fuel
Extending for five years and increasing the cap on Section 30C alternative fuel refueling property credit from $30,000 per location to $200,000 per electronic charging device
Creating credits ranging from $25,000 to $120,000 for zero emission heavy duty vehicles

Grant Thornton Insight: The Green Book does not include any extension of the current $7,500 credit for consumer electric vehicles, which generally phases out once a manufacturer reaches 200,000 vehicles sold

Individual rate increases

The Green Book proposes to return the top marginal rate on ordinary income to 39.6% beginning in 2022. This bracket would kick in at $452,700 for single filers and $509,300 for joint filers. Under current law, the 37% bracket begins at $523,600 of taxable income for single filers and $628,301 for joint filers in 2021.

Capital gains rate increase

Biden is proposing to tax long-term capital gains and qualified dividends as ordinary income at a top rate of 39.6% to the extent adjusted gross income exceeds $1 million for single and joint filers. This proposal “would be effective for gains required to be recognized after the date of announcement.” The Green Book itself offers no indication of what is meant by “date of announcement,” and administration officials have been fairly quiet on the subject. Press reports indicate that Treasury scored the proposal assuming it will be effective retroactive to when Biden released his American Families Plan on April 28.

Grant Thornton Insight: Both the rate and effective date will be subject to fierce negotiation. Many Democrats believe a 39.6% rate is too high, and a final rate may end up closer to 28%. The effective date is also not settled. While Democrats have been quietly discussing whether to make a rate change effective on the date the proposal is introduced, congressional lawmakers may not consider an “introduction” to occur until a proposal is formerly introduced in Congress. The ultimate decision on effective dates could hinge on how the JCT scores the revenue impact based on how they model behavioral responses. A delayed effective date for a capital gains rain increase could prompt a sell-off and generate short-term revenue. If the JCT believes those sales would not otherwise happen within the 10-year budget window under an immediate effective date, then a delayed effective date could raise additional revenue. There could also be rules grandfathering rules for transactions subject to a binding written contract.

Carried interest

The Green Book would treat gain from a partner’s share of an investment services partnership interest (ISPI) as ordinary income to the extent taxable income exceeds $400,000. An ISPI would generally be defined as a profits interest held by a partner who provides services for a partnership if substantially all of its assets are investment assets. Although few details are available, the descriptive language in the Green Book appears similar to the Carried Interest Fairness Act of 2021 (H.R. 1068) introduced by House Democrats.

Grant Thornton Insight: This proposal only appears meaningful for taxpayers with income between the $400,000 threshold at which it applies and the $1 million threshold at which Biden proposes to tax all capital gain as ordinary income. The inclusion of this proposal may also be an indication that the Biden administration does not expect to actually achieve a 39.6% capital gains rate.

Like-kind exchanges

The Green Book proposes capping the gain deferred in a like-kind exchanges under Section 1031 to $500,000 per year for single filers and $1 million per year for joint filers. The change is proposed to be effective for exchanges completed in taxable years beginning after 2021. The TCJA limits like-kind exchanges to real property.

Basis step-up and gain recognition

The Green Book significantly expands the administration’s proposal to repeal the step-up in basis for inherited assets, and would treat transfers of property by death or gift as realization events. The proposal would also require recognition of any unrealized asset held in of a trust or partnership at least 90 years, beginning in 2030.

The proposal includes exclusion for transfers to charity or a spouse, and would exclude gain household furnishing, personal effects, and gain on a principal residence. In addition, a $1 million per person exclusion would be available. Taxpayers would generally have 15 years to pay the tax under an election available for non-liquid assets. Payment of 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.

Grant Thornton Insight: The basis step-up provision appears to be a necessary backstop to ensure a capital gains rate increase raises significant revenue. Without it, government scorekeepers may assume that taxpayers would hold onto more assets until death to avoid the higher capital gains rate. Still, the proposal could face resistance. Congressional Democrats have already discussed whether to repeal the basis step-up without making the transfer itself a realization event. Tax writers also may be more inclined to raise revenue through adjustments estate and gift tax exemptions and rates, or by pushing their proposals aimed at specific transfer tax planning techniques.

Net investment income tax

The Green Book proposes to expand the scope of the 3.8% Medicare tax on net investment income (NII) so that essentially all income not subject to 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 income from an owner of an S corporation or partner in a limited partnership who is not passive. This provision would close that gap, but would also expand the types on income subject to self-employment tax. Under the proposal, S corporation owners and LLC members who are not passive would be subject to self-employment tax on their distributive shares of income above certain thresholds.

Grant Thornton Insight: It is unclear why Treasury wants to expand the scope of self-employment tax as part of this proposal. Reducing the amount of income subject to self-employment tax only benefits taxpayers if that income is not otherwise be subject to NII tax. With the proposal already closing the gap between the two, there would seem to be no need to expand the application of self-employment tax. In fact, self-employment tax will provide a better result than NII tax because a self-employment tax deduction is allowed.

Loss limitation

The Green Book proposes to make permanent the limit on deducting business losses exceeding $250,000 ($500,000 for joint filers) under Section 461(l). This limit was created by the TCJA and was originally scheduled to be in effect from 2018 through 2026. It was suspended from 2018 through 2020, but is back in place for 2021 and scheduled to expire with the rest of TCJA’s individual provisions in 2027.

IRS enforcement

The Green Book pledges to raise $780 billion of new revenue from IRS enforcement initiatives, including $316 billion from IRS funding increases. The effort is centered around an unusually expansive new reporting proposal projected to raise $463 billion. Under the regime, financial institutions would be required to report gross inflows and outflows with breakdowns for physical cash, foreign account, and related account transfers and other for all business and personal accounts over a $600 de minimis threshold, including bank, loan, and investment accounts. Similar reporting would be required for payment settlement entities.

The Green Book also includes tax administration provisions that would:

Extend the statute of limitations for listed transactions to six years
Give the IRS the authority to regulate return preparers
Impose liability for unpaid corporate taxes on shareholders who dispose of a controlling interest

Grant Thornton Insight: The administration’s projection of $780 billion in new enforcement revenue is very aggressive, and it may be hard to convince the Joint Committee on Taxation to score mere IRS funding increases. This could create a revenue hole in the bill that would put pressure on lawmakers to cut costs or find additional revenue. The JCT may score the new reporting regime more favorably, but it is sure to raise opposition. The breadth of the proposed reporting is expansive, and could raise complaints about the potential burden and privacy. Much of the reporting would not necessarily correlate to specific items on the return, and the IRS could face challenges actually leveraging the information to improve audit selection.

Potential additions

There are a handful of provisions popular with Democrats omitted from the Green Book that could still potentially be added at future points in the legislative process.

Congressional Democrats in particular will be pushing for relief from the $10,000 cap on the SALT deduction, and many Democrats have already threatened to block any tax bill that does not repeal the cap. This issue will likely need to be addressed in order to overcome congressional opposition. Full repeal is very expensive, however, and Democrats may consider compromises such as temporary repeal or a sizeable increase in the cap.

Biden also declined to include his own campaign proposals to cap the value of itemized deduction at 28%, impose Social Security taxes on income over $400,000, and repeal the Section 199A deduction for pass-through business income over certain income thresholds. All of these could still certainly be considered, though the increase to Social Security taxes might be less likely outside of Social Security reform. The Section 199A deduction enjoys a private business constituency that Democrats generally find sympathetic, but Democrats have also complained that too much of the benefit goes to high earners. Phasing out Section 199A above certain income threshold could be resurrected by congressional Democrats as revenue pressure heats up.

Next steps

The ultimate outcome is far from certain, and many of these proposals will continue to evolve significantly. Still, Democrats appear poised over an opportunity to make transformational tax changes. Taxpayers should begin considering the potential effects of the proposals on their tax and business planning, especially with regard to the timing of income and deductions. The proposed effective dates are largely prospective and give taxpayers significant runway for planning.