House tax writers approved more than $2 trillion in tax increases on Sept. 15 to fund a massive reconciliation bill Democrats are racing to complete by Sept. 27. The tax hikes are offset by more than $1.2 trillion in proposed tax cuts.
The House action finally translates the Democratic tax agenda into concrete legislative language. Although the tax package survived several days of mark-up with no substantive changes, it still represents a starting point in the legislative process. The tax title will be added to other spending titles into a broader reconciliation bill. Many of the House tax provisions remain contentious and could change significantly to shore up Democratic support before it goes to the House floor. Negotiations with Senate Democratic moderates will also continue to shape the bill.
The House tax title aligns fairly closely to the tax platforms laid out by President Joe Biden’s tax proposals and Senate Democrats, but there are significant differences in some areas. Key revenue raisers include:
- Raising the top corporate rate 26.5%
- Raising the top individual rate to 39.6%, plus a 3% surtax
- Raising the top capital gains and qualified dividend rate to 25%, plus a 3% surtax
- Expanding the 3.8% tax on net investment income (NII)
- Capping the Section 199A deduction at $400,000 (single filers) and $500,000 (joint filers)
- Creating new limit on the interest deduction
- Repealing the 100% gain exclusion for qualified small business (QSB) stock
- Cutting the unified estate and gift tax exemption in half
- Significant reform of international tax rules, including to the tax on global intangible low-taxed income (GILTI), the foreign-derived intangible income (FDII) deduction, the base-erosion anti-abuse tax (BEAT), and foreign tax credits (FTCs)
The bill also includes substantial tax cuts, including:
- Delaying the effective date of five-year amortization of R&D costs from 2022 until 2026
- Increasing the work opportunity tax credit to 50% and providing a minimum wage cap of $10,000 in first-year wages and $10,000 in second-year wages all groups except summer youth employees
- Enhancing tax-favored bond provisions
- Allowing tax-free conversions from an S corporation into a partnership before the end of 2023
- Enhancing the rehabilitation credit
- Making permanent the new markets tax credit
- Enhancing the low-income house credit
- Providing more than $230 billion in clean energy extensions and enhancements
- Providing more than $830 billion in tax incentives and enhancements for health coverage, higher education, child and depending care tax credits, child tax credits, and earning income tax credits
Most of the changes are proposed to be effective beginning in 2022 or later, with some important exceptions. The proposed change in the capital gains and dividend rate is generally effective for transactions after Sept. 13, 2021, with transition relief for sales subject to a written binding contract.
There are several areas where Democrats made significant concessions, but many others where they appear very aggressive, perhaps as a starting point for further negotiations. The corporate rate proposal was reduced from 28% to 26.5%, but that still may be too high for moderates who have called for corporate rates no higher than 25%. The 25% capital gains rate is notable retreat from Biden’s proposed 39.6% rate, but the 3% surtax may raise objections.
There are also several notable omissions from the mark-up, including:
- Relief from the cap on state and local tax (SALT) deductions
- Repeal of the step-up in basis for inherited assets
- Minimum tax on financial statement income
- Repeal of like-kind exchanges
- Repeal of oil and gas tax incentives
SALT cap relief remains a sticking point. House Ways and Means Committee Chair Richard Neal, D-Calif., has pledged to include “meaningful SALT relief,” but negotiations continue. Several moderate Democrats have threatened to oppose any bill unless the cap is fully repealed, but this seems unlikely. Negotiators have discussed a temporary repeal or an increase in the cap.
Some of the other omitted revenue raisers could also surface again during the legislative process as lawmakers scramble for revenue. But controversial provisions like the minimum tax on book income and the repeal of basis step-up at death appear much less likely to gain traction now. Senate Finance Committee Chair Ron Wyden, D-Ore., has also released a handful of revenue-raising discussion drafts he hopes to eventually add to the bill, including:
- Significant and unfavorable changes to partnership rules
- 2% excise tax on stock buybacks
- Rules requiring mark-to-market of derivatives for some taxpayers
The bill itself still faces major hurdles. There are deep divisions between moderate and progressive Democrats and very slim margins for error. The reconciliation process allows Democrats to bypass filibusters in the Senate, but with only 50 Senate seats, they cannot lose a single vote. In the House, they can currently only lose only three votes to pass legislation without Republican support.
Senate Democratic moderates like Sens. Joe Manchin, D-W.V., and Kyrsten Sinema, D-Ariz., have said they cannot support a $3.5 trillion bill. The tax title raises over $2.1 trillion, and drug pricing provisions and economic growth are supposed to cover the rest of the package. Biden recently met with Manchin and Sinema to try and shore up support.
The fate of the reconciliation bill may be tied to the bipartisan infrastructure bill that has already passed the Senate. Democratic leaders have been holding the infrastructure bill hostage in the House to force moderates on board the reconciliation process. But House moderates refused to vote on the budget resolution without language providing for an infrastructure vote by Sept. 27. Although this deadline is nonbinding, leadership is losing leverage over moderates as it approaches. Lawmakers are therefore racing to complete a reconciliation bill in just weeks.
Although the ultimate outlook is not certain, some taxpayers may benefit from pre-emptive tax planning. Most of the proposals include prospective effective dates, meaning there is a potential window of opportunity to plan in front of changes.
The following provides more information on key proposals and their outlook for enactment.
The bill would replace the flat 21% corporate rate with three brackets of 18%, 21%, and 26.5%, with the 26.5% rate imposed on income exceeding $5 million. An additional 3% tax would be imposed on income exceeding $10 million until the benefit of the lower brackets is erased. The rate change would be effective for tax years beginning after 2021. Under Section 15, fiscal year taxpayers would prorate their rate based on the proportion of their fiscal year occurring after Dec. 31, 2021. The proposal would also increase the 50% dividends received deduction to 65% and the 65% deduction to 72.5%.
Grant Thornton Insight: The bill makes a significant concession by reducing the proposed rate from 28% to 26.5%, but it may not go far enough. Moderates like Manchin have indicated they cannot support legislation with a corporate rate exceeding 25%.
The bill would significantly reform the GILTI system. The Section 250 deduction related to GILTI would be reduced from 50% to 37.5% for tax years beginning after 2021, creating a GILTI tax rate of 16.5625%. 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.
Grant Thornton Insight: The changes are consistent with the general direction from Wyden and the Biden administration, but there are key differences. All three envision moving to a country-by-country approach (with some differences), but the House’s 16.5625% effective rate is lower than other proposals. The retention of QBAI is somewhat surprising, even at a reduced rate, as Democrats have railed against it as an incentive to invest in tangible assets abroad. Its retention would mean at least nominally keeping GILTI targeted to intangible income, rather than a true global minimum tax.
The FDII deduction would be reduced from 37.5% to 21.875% for years beginning after 2021. Against a 26.5% corporate rate, the new deduction results in an effective rate of federal tax of 20.7%. 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.
Grant Thornton Insight: The retention of FDII even at a reduced rate is somewhat of a surprise. Democrats have repeatedly criticized it and have pledged to replace it with a better incentive. Although it is retained in the House bill for now, it will remain a target as the legislation moves forward. While the reduction in the Section 250 deduction limits its benefit, the NOL treatment of the excess Section 250 deduction could provide potential benefits to a wide range of taxpayers that ordinarily would be limited or unable to benefit from the deduction.
The bill would expand the scope of BEAT and alter the calculation beginning in 2023. BEAT would still apply only to corporations with average annual gross receipts of $500 million or more over the past three years, but it would no longer be limited to companies with a 3% or higher base erosion percentage. The definition of base erosion payments would expand to include certain indirect costs like amounts capitalized to inventory under Section 263A.
The BEAT rate would increase to 12.5% in 2024 (it is currently scheduled to reach this rate in 2026), and increase again to 15% in 2026. It would repeal the provision that required adding general credits back to the regular tax liability before determining the BEAT. Thus, the bill would allow general business credits and other credits to offset BEAT liability. In addition, payments subject to U.S. tax and payments to foreign parties that are subject to foreign taxes at an effective rate greater than the applicable BEAT rate can be excluded from the BEAT provision. For this purpose, the effective tax rate is computed in the same manner as under the provisions of Section 904 and may be based on applicable financial statements. The exclusion of payments subject to a sufficient level of foreign taxes or subject to U.S. tax is notable. It would bring the BEAT regime more in line with the OECD’s “undertaxed payments rule,” which acts as a backstop for low-taxed group companies not subject to a global minimum tax within the group, including, for example, GILTI.
Grant Thornton Insight: With the new exception, it seems they intend to align with the administration’s proposed Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) regime, but they don’t go nearly as far as SHIELD. SHIELD would deny deductions for any deductible payments to related payees in countries with a rate below a minimum threshold, as well as a portion of certain payments made to a country with a rate above a minimum threshold when there is a low-taxed member in the group.
Other international provisions
The bill would substantially reform foreign tax credit rules, including provisions that would:
- Repeal the foreign branch income basket, thereby reducing the number of FTC limitation categories from four to three
- Apply the FTC limitation rules on a country-by-country basis
- Repeal the one-year FTC carryback and reduce the carryforward period from 10 years to five
- Codify a regulatory safe harbor method for determining foreign tax credits of a dual capacity taxpayer receiving specific economic benefits
The legislation also included international provisions that would:
New interest deduction limit
- 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)
- Restore former Section 958(b)(4), which was repealed by TCJA in an attempt to narrowly target “de-control” transactions, and add a narrower exception under new Section 951B with retroactive application to the last taxable year beginning before Jan. 1, 2018
- Expand Subpart F inclusion to U.S. shareholders who own stock in a CFC on any day during the taxable year and modify the rules determining a U.S. shareholder’s pro rata share of Subpart F income.
- 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 United States)
- Clarify the coordination of Section 951A with Sections 959, 961, 962 and potentially other sections with retroactive application to tax years beginning after Dec. 31, 2017
- Adopt modified Section 312(n) earnings and profits (E&P) rules for determining E&P of a CFC
- Treat domestic international sales corporation (DISC) gains and distribution of certain foreign shareholders as effectively connected income (ECI)
- Treat gains from the sale or exchange of, and distributions by, an IC-DISC to a foreign shareholder as ECI
- Modify the definition of “10% shareholder” to include shareholders with 10% or more by vote or value for the portfolio interest exemption
- Repeal the election for a one-month deferral in the determination of taxable year of specified foreign corporations
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.
In addition, disallowed interest expense under Section 163(j)(1) or the new Section 163(n)(1) could be carried forward for only up to five tax years. 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 proposal would be effective for tax years beginning after 2021.
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.
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.
Grant Thornton Insight: The proposal appears to target the private equity structure, which often takes the position that portfolio companies are not part of a common control group because the partnership is not involved in a trade or business. The change could be meaningful, as aggregation rules under Section 52 are used to determine limits on many credits and other code provisions.
Compensation deduction under Section 162(m)
The bill would accelerate a provision recently enacted in the American Rescue Plan Act of 2021 that expands the number of covered employees subject to the $1 million limit on the deduction for public company compensation under Section 162(m). The ARPA change added five additional covered employees: The five highest-paid employees other than the previously identified officers under the rules enacted in the Tax Cuts and Jobs Act (TCJA). With the minimum of five already covered under the existing rules, the $1 million deduction limit will apply to a minimum of 10 covered employees each year. These five additional employees will not be covered in future years unless they continue to meet the criteria. The ARPA change was scheduled to be effective in 2027, but the House bill would make it effective for tax years beginning after 2021. It would also 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.
Grant Thornton Insight: The Joint Committee on Taxation describes the five additional covered employees whose pay is subject the limit under the ARPA and this proposal as “officers.” The legislative language, however, does not appear to limit these covered employees to officers, and would potentially include any employee.
Auto-enrollment retirement plan mandate
The bill would create a new mandate requiring all employers with more than five employees receiving at least $5,000 in compensation to offer a retirement plan with an auto-enrollment feature that meets other new notice, eligibility, fee, and lifetime income requirements or pay an excise tax. The excise tax for failing to meet the requirements would generally be imposed at a rate of $10 per employee failure per day (adjusted for inflation), with some exceptions and exclusions. It would be effective for plan years beginning after Dec. 31, 2022.
Grandfathering rules would exempt most retirement plans established and maintained as of the date of enactment, including qualified retirement plans, qualified annuity plans, Section 403(b) plans, simplified employee pension plans (SEPs), and savings incentive match plans for employees (SIMPLE) IRAs. Plans established after the date of enactment would need to meet the new requirements, but the bill also creates a new simplified automatic IRA arrangement and a new Section 401(k) deferral-only arrangement that would fulfill the requirements. Similar to current Section 401(k) safe harbor plans, deferral-only Section 401(k) plans would be exempt from all nondiscrimination testing if they met requirements on automatic enrollment, elective contributions, and employee notices.
The bill would also create a new tax credit for small employers that facilitate auto-IRA arrangements or the new deferral-only arrangements. Employers with up to 100 employees that establish automatic IRAs or deferral-only arrangements would receive a tax credit of $500 for four years.
In addition, the bill would expand the employer pension plan startup credit. The credit would be extended from three years to four years and, for employers with up to 25 employees, the legislation would increase the credit from 50% of costs to 100% of costs (subject to the startup credit dollar cap).
The bill would also make up to $500 of the existing saver’s credit refundable if contributed to a tax-favored retirement account. Taxpayers could also elect to have tax refunds deposited directly into an IRA and have those amounts treated as contributions for tax return most recently filed.
Qualified small business (QSB) stock
The bill would repeal the 100% gain exclusion for QSB stock issued after Sept. 27, 2010, and the 75% exclusion for QSB stock issued after Feb. 17, 2009, and before Sept. 28, 2010, for taxpayers with adjusted gross income (AGI) exceeding $400,000. AGI would include all gain from QSB stock before any exclusion. The proposal would be effective for sales on or after Sept. 13, 2021, and these sales would qualify only for a 50% exclusion. The 50% exclusion would be applied against a 28% rate for an effective rate of 14% (compared to the proposed capital gain rate of 25%). The 50% exclusion would also be an AMT preference item. Grandfathering rules would be available for sales subject to a binding written contract in effect before Sept. 13, 2021.
Grant Thornton Insight: This proposal is unusual. First, it is effective based on when the stock is sold, not issued, and QSB stock must generally be held for at least five years. This makes it essentially retroactive, robbing taxpayers of a specific tax benefit they anticipated when they made the investment. It is rare for Congress to encourage specific investments by promising a future tax benefit, and then to repeal that benefit before it is realized. This effective date may be reconsidered during the legislative process as it could erode taxpayer confidence in other long-term incentives, such as opportunity zones or even Roth IRAs. The proposal is also unusual in that the income threshold is a cliff. The exclusion is fully reduced from 100% to 50% once AGI reaches $400,000 with no phaseout threshold.
Other business provisions
The bill would also:
Individual marginal rate
- Exclude from qualifying REIT income any rent from correctional, detention, or penal facilities, tax years beginning after 2021
- Expand the wash sale rules to include commodities, currencies and digital assets
- Expand the constructive sale rules to include digital assets
The bill proposes to return the top individual marginal rate on ordinary income to 39.6% beginning in 2022. This bracket would begin at $400,000 of taxable income for singles and $450,000 for joint filers. Under current law, the 37% bracket begins at $523,600 for single filers and $628,301 for joint filers in 2021. This means that some income currently subject to the 35% rate would also be captured under the 39.6% rate.
The legislation would also impose a 3% surtax to the extent AGI exceeds $5 million ($2.5 million for married filing separately). The tax would apply to estate and trusts at a $100,000 threshold.
Grant Thornton Insight: The surtax brings the true top proposed rate to 42.6% before any Medicare or NII tax, although at a higher threshold than the traditional bracket (and tied to AGI instead of taxable income). The surtax could generate significant pushback from moderates.
Capital gains rate increase
The legislation would raise the top rate on long-term capital gains and qualified dividends from 20% to 25% and impose it beginning in the new 39.6% bracket. The 3% surtax would also apply to this income to the extent the income increased AGI above the $5 million threshold. The true top rate of 28% before NII tax is still much lower than Biden’s proposed 39.6% rate, but the 25% rate would begin at a lower threshold than the $1 million AGI threshold proposed by Biden.
The realignment of the new 25% bracket would not be effective until 2022, but the 25% rate would generally apply to gain from transactions and dividends paid after Sept. 13, 2021. There is a grandfathering rule for transactions pursuant to a written binding contract in place on or before Sept. 13, 2021, and which is not modified in any “material respect.”
Grant Thornton Insight: The statutory language does not specifically define written binding contract, but this phrase has been used in transition rules before. The bonus depreciation regulations generally defined a written binding contract as a contract that is enforceable under state law and does not limit damages to a specified amount.
The bill would amend Section 1061 to increase the holding period from three years to five years for taxpayers with AGI of $400,000 or more to receive long-term capital gains treatment on carried interests in certain partnerships. The bill would also add new rules for measuring the holding period and tighten the rules for tiered partnerships. It would also expand the definition of specified assets, and give the IRS broader authority to write rules to prevent abuse.
Grant Thornton Insight: It is somewhat surprising that the bill did not seek to recharacterize all gain from profits interests in investment services partnerships, as Democrats have previously proposed. This provision instead builds off a TCJA change made by Republicans, which increased the holding period from one to three years. However, the changes to the rules for measuring the holding period could still have the effect of eliminating capital gains treatment for many partners in investment funds. The holding period will generally start on the later of when the taxpayer acquired substantially all of the partnership interest or the date the partnership acquired substantially all of the assets, with look-through rules for tiered structures. Progressive lawmakers will undoubtedly seek an even stronger carried interest provision than this, while the investment industry will seek to curb this version. Senate Majority Leader Chuck Schumer, D-N.Y., remains sympathetic to the financial industry, while Wyden has proposed the most aggressive carried interest proposal to date, which would create deemed compensation income before a realization event.
The legislation would cap the Section 199A deduction at $500,000 for joint filers, $400,000 for single filers, and $10,000 for estates and trusts. This cap is on the deduction amount itself, which equates to a full 20% deduction on up to $2.5 million of eligible income for joint filers.
Grant Thornton Insight: The fate of Section 199A remains one of the biggest open questions. The administration did not propose to cap or repeal it, but many other Democrats have. Wyden’s proposal would phase out the deduction once income reaches $500,000 (joint) and $400,000 (single), and repeal it for estate and trusts altogether. Wyden, however, would also repeal rules barring the deduction for certain specified businesses and limiting the deduction based on wages and tangible investment.
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.
Grant Thornton Insight: The change in treatment of suspended losses in future years represents a significant and unfavorable change. The current provision acts more like a one-year delay, as suspended losses can generally be taken as an NOL the following year against other types of income.
New loss rules
The House bill would make several changes to loss rules, including:
Personal casualty losses
- 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 debut 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
The bill would repeal the temporary limitation on personal casualty losses—striking Section 165(h)(5) and thus removing the TCJA requirement in place for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, that personal casualty loss deductions are only permitted if attributable to a federally declared disaster. This would expand the personal casualty loss deduction to things like theft, and a plethora of natural disasters that do not meet the criteria to be declared a federal disaster. The amendment would be effective retroactive to Dec. 31, 2017.
Estate and gift tax changes
The legislation would cut in half the lifetime unified gift and estate tax exemption beginning in 2022. The exemption was recently doubled by the TCJA, and is scheduled to revert in half in 2026 absent legislative change. The exemption reached $11.7 million in 2021, and is expected to top $12 million in 2022. The House bill would reduce it to approximately $6 million in 2022.
In addition, the legislation targets specific planning techniques with provisions including:
Grant Thornton Insight: House Democrats abandoned a proposal to repeal the step-up in basis at death and require heirs to pay the gain immediately (with exceptions). Many Democrats had been quietly pushing back against that proposal for months, though its possible progressive Democrats attempt to resurrect it at some point in the legislative process.
Individual retirement accounts
- Changes to the grantor trust rules to shut down certain transfer tax planning opportunities effective for trusts formed after the date of enactment, though the changes could have much broader effects
- Barring the use of valuation discounts (such as for lack of marketability or control) on nonbusiness assets for transfer tax purposes, effective for transfers after the date of enactment
The bill heavily targets IRAs with several major changes. The bill would bar contributions to IRAs once aggregate retirement accounts reached $10 million in value for taxpayers whose income exceeds $450,000 (joint) or $400,000 (single). In addition, the bill would require minimum distributions of 50% of any amounts of aggregate retirement accounts exceeding $10 million and 100% for any amounts exceeding $20 million. The 10% early distribution penalty would not apply to these distributions. The bill also includes proposals that would:
- Bar any rollovers from a traditional IRA to a Roth IRA for taxpayers exceeding the income thresholds
- Bar all taxpayers from Roth conversion if it includes any nondeductible contributions
- Bar IRAs from holding interest in an entity in which the account holder has a 10% ownership interest
- Bar IRAs from holding any security if the issuer requires an individual to make a representation to the issuer that the individual holds a license or credential, has completed a specified minimum level of education, or has a specified minimum amount of income or assets.
The last change is meant to capture investments offered to accredited investors that are not registered under federal securities laws. It would provide a two-year transition period for IRAs to divest these assets. The changes are generally otherwise effective beginning in 2022, apart from the ban on Roth rollovers for high-income taxpayers, which would not be effective until 2032. This delay is presumably meant to push the cost outside the budget window.
The bill would make a number of amendments to bond financing, including bringing back tax-exempt advance refunding bonds, enacting a new credit for issuers of certain infrastructure bonds, modifying the small issuer exception to tax-exempt interest expense allocation rules for financial institutions, and expanding certain exceptions to the private activity bond rules for first-time farmers.
Infrastructure financing and community development credits
The bill includes a number of provisions geared toward encouraging development in underserved areas, including:
Renewable energy production and investment tax credits
- New Markets Tax Credit: The bill would make the New Markets Tax Credit permanent with a funding allocation of $5 billion per year (indexed for inflation), except for in 2022 and 2023, which would receive $7 billion and $6 billion, respectively.
- Rehabilitation tax credit: The bill would temporarily increase the rehabilitation tax credit from 20% to 30% for tax years 2020 through 2025, then lower the credit to 26% in 2026, 23% in 2027, and 20% in 2027 and beyond. The credit would also be increased to 30% for certain smaller projects.
- Low-income housing credit: The bill would increase state allocation for the low-income housing credit ceiling through 2028—raising the ceiling to $3,711,575 in 2022, $4,269,471 in 2023, $4,901,620 in 2024, $5,632,880 in 2025, and then indexing the 2025 amount to inflation for years 20262028.
- Neighborhood homes credit: The bill would create a new neighborhood homes credit to promote affordable, owner‐occupied housing located in distressed neighborhoods. The credit would generally allow project sponsors to claim a credit covering the difference between the costs to rehabilitate a home in a distressed neighborhood—or build a new home on an empty lot—and the price for which the home is sold. Each state would receive an allocation equaling its state population multiplied by $6 (with a minimum allocation of $8 million per state).
The bill would extend and reform the Section 45 production tax credit (PTC) and Section 48 investment tax credit (ITC) in a complex regime of tiered rates. The beginning construction deadline for the PTC would generally be extended for 12 years through 2033, and would add solar property. A phasedown period would begin in 2032. The full credit rate (and current wind rate) would generally be available only if the project met prevailing wage and apprenticeship requirements. Projects failing these requirements would only be allowed 20% of the otherwise available credit. Facilities with less than 1 megawatt of capacity would be exempt from the 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 for 10 years from 2024 through 2033 at the full 30% rate (microturbine and combined heat and power property would remain at 10%), with a phasedown beginning in 2032. Like the Section 45 credit, facilities with at least 1 megawatt of capacity would be eligible for the full credit only if meeting prevailing wage and apprenticeship requirements, with similar rules for domestic suppliers. 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), but it could be reduced 90% of the credit amount unless certain requirements are met.
Grant Thornton Insight: These provisions align fairly closely to Biden’s proposals and an energy package passed by the Senate Finance Committee, which also seek to impose wage and apprenticeship requirements and provide for direct payments. The Senate bill takes a slightly different technology neutral approach, but the House’s extension of the ITC to cover general zero emission property in many ways echoes the Senate bill. The Senate bill also repeals normalization requirements and phases out its credit regime based on market penetration of alternative energy projects.
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 48E zero-emissions facility credit
- Section 45W zero-emission nuclear power production credit
- Section 45X clean hydrogen production credit
The direct payments would be available for tax-exempt entities and would be claimed by pass-throughs at the entity level. The direct payment could be reduced to 90% of the credit amount in some circumstances.
Grant Thornton Insight: The ability to take the credit as payment will likely transform project financing and may reduce the need for tax equity financing.
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 $50 per metric ton of carbon oxide captured and sequestered and $35 per metric ton of carbon oxide captured and used as a tertiary injectant or otherwise used in an approved manner. 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.
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.
Publicly traded partnerships
The 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.
Grant Thornton Insight: This provision is meant to offer an additional financing option to alternative energy projects by allowing them PTP structure often used for oil and gas ventures. This provision is at odds with draft partnership reform from Wyden, which seeks to curb PTPs.
Section 48C advanced energy project credit
The bill would revive the Section 48 credit by providing an annual $2.5 billion credit allocation 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).
Grant Thornton Insight: A similar version of this provision was originally included in a bipartisan infrastructure bill that passed the Senate, but was removed before the vote.
The bill would reinstate the Hazardous Substance Superfund excise tax on crude oil and imported petroleum products at an increased rate of 16.4 cents per gallon, indexed to inflation, in addition to reinstating the tax on the sale of certain chemicals.
The bill would extend several excise tax credits related to alternative fuels, biodiesel and renewable diesel, and biodiesel mixtures through Dec. 31, 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 2032.
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.
Green incentives for individuals
The bill includes several provisions aimed at consumers, including:
Energy efficient commercial buildings
- Extending and increasing the nonbusiness energy property credit under Section 25C
- Extending the residential energy efficient credit under Section 25D and increases it to 30% of qualified property expenditures (e.g., solar electric supplies, solar water heating, geothermal heat pumps) through Dec. 31, 2031, before phasing the credit to 26% in 2032 and 22% in 2033
- Creating a new plug-in electric vehicle credit
The bill would increase the maximum Section 179D energy-efficient commercial building deduction 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.
Family, health and education incentives
The bill includes a substantial package of enhancements and extension of credits for health care, child care, education, and low- to middle-income taxpayers. The costliest provision is the four-year extension of the enhanced child tax credit, through 2025, which is estimated to cost roughly $100 billion per year.
The bill also would make permanent the expanded child and dependent care tax credit, which would cost roughly $104 billion over 10 years, along with making permanent enhancements to the earned income tax credit, which would cost $105 billion over 10 years.
In addition, the bill would also make a number of amendments related to higher education, including instituting a new credit for public university research infrastructure and reducing the excise tax on investment income for colleges and universities providing certain qualified aid.
Grant Thornton Insight: These provisions are very expensive, costing a combined $834 billion. Democrats may be forced to dial back some of these incentives under cost pressure, especially if moderates push for a more modest overall bill.
Taxpayers finally have concrete legislative language to assess the true potential impact of the proposal on tax and business planning decisions. The current version, however, is still far from finished product and success of the bill is not assured. Taxpayers should continue to monitor the legislative process to see how the proposals evolve. Some taxpayers may also benefit from pre-emptive tax planning. Most of the proposals include prospective effective dates, meaning there is a potential window of opportunity to plan in front of changes, seizing rate arbitrage opportunities and blunting the impact of unfavorable proposals. It is critical to understand the whole picture, modeling potential outcomes and weighing risks on both sides. Taxpayers should remember that rates may not change when expected—or go as high as expected—and that liquidity and the time value of money can still make deferral valuable.
For more information, contact:
Washington National Tax Office
Grant Thornton LLP
+1 202 861 4144
Washington National Tax Office
Grant Thornton LLP
+1 202 521 1559
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