Treasury’s Green Book Provides Details on the Administration’s Tax Proposals
On Friday, May 28, 2021, the Treasury Department issued the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals.” Also known as the “Green Book,” the 114-page document is included in the Biden administration’s fiscal year 2022 budget submission to Congress. The Green Book provides more details regarding the administration’s tax proposals previewed in the American Jobs Plan and the American Families Plan.
The revenue proposals are just that, at this point – proposals that are not yet part of any bill introduced into Congress. The likelihood of any of these proposals being included in a bill and ultimately being enacted into law is uncertain. These proposals if enacted, however, would make very significant changes in a number of areas affecting business income taxes, as well as personal income, gift and estate taxes.
As promised in President Biden’s campaign, the proposals seek to raise more revenue from high income individual taxpayers and corporations, and allow more credits for low to moderate earning taxpayers. Unless otherwise noted, the following proposals are effective for the 2022 tax year. The following summary does not encompass all proposed changes, but does include some proposed changes that could have a material impact on your 2021-2022 tax planning. Additional details are available at the link to the Green Book in the first paragraph.
The significance of these proposals is depends on a person’s perspective, but some of the more impactful proposals include:
- increase in ordinary income tax rates, and the application of ordinary income tax rates to capital gains and qualified dividends for high income taxpayers;
- increase in corporate tax rates and the establishment of a corporate minimum tax on book earnings;
- recognition of capital gains by taxpayers transferring appreciated property in connection with certain events, including lifetime gifts, death transfers, transfer in-kind property to or from trusts partnerships, or other non-corporate entities; and
- expansion of self-employment taxes for certain pass-through entity owners.
Increased Individual Tax Rates and Capital Gains Rates for Certain Taxpayers
A notable change in the Green Book is to tax long-term capital gains and qualified dividend income as ordinary income to taxpayers to the extent their AGI exceeds $1 million ($500,000 for married filing separately). The proposed effective date would be for gains / qualified dividends recognized after the date of announcement, which is understood to be April 28, 2021, the date of President Biden’s first address to a joint session of Congress during which he introduced the American Families Plan. If the change in enacted, the actual effective date will depend on the language in the legislation as drafted. Previous changes in the capital gains rate have sometimes been effective on the date the legislation was introduced.
If the Green Book proposals are enacted “as is,” long-term capital gains after the effective date in 2020 will be taxed at 37% (40.8% with the net investment income tax ), instead of the prior highest 20% rate. Additionally, the proposal includes increasing the top ordinary tax rate from 37% to 39.6% beginning in tax year 2022, which would also increase the top long-term capital gains rate to 39.6% (43.4 % with net investment income tax). The Green Book also proposes that the threshold for applicability of the top marginal brackets be lowered compared to the threshold for applicability of the current top marginal backet of 37%.
Important Changes to C Corporation Tax
The two most notable changes that effect C corporations are an increase in the flat tax rate of 21% to 28% and a 15% minimum tax on book earnings of large C corporations. The 7% increase to C corporation tax begins in the 2022 tax year and applies to all C corporations, regardless of size or income. For fiscal year filers, the tax rate is 21% plus a phase-in of the 7% increase for the portion of the tax year that occurs in 2022.
Also effective in 2022 and beyond is a 15% minimum tax on book earnings. This means that beginning in the 2022 tax year, a 15% tax will apply on worldwide book income for corporations with income in excess of $2 billion. This minimum tax would equal the excess of book tentative minimum tax over regular tax due. Additionally, any minimum tax paid on book earnings can be credited against future regular tax liabilities, but cannot decrease the minimum book tax liability in subsequent years.
Transfers of Appreciated Property
Taxpayers transferring appreciated property during certain events would realize a capital gain based on the property’s fair market value at the time of the transfer. The proposal generally would be effective January 1, 2022. Recognition events include:
- Transfers of in-kind property to trusts (other than wholly revocable trusts)
- Distributions of in-kind property from a trust (other than to the grantor owner of a revocable trust or to a spouse of the grantor, as long as the distribution is not in discharge of an obligation of the deemed grantor owner)
- Terminations of revocable grantor trusts – at death or during life
- Transfers of in-kind property to partnerships or other non-corporate entities
- Distributions of in-kind property from partnerships or other non-corporate entities
- Holdings of trusts, partnerships or other non-corporate entities, when the property has not had a recognition event within the prior 90 years, measured as of January 1, 1940. The first recognition event under this 90-year rule would occur December 31, 2030.
The “deemed” gain would be taxable income to the donor or to the decedent. The amount of gain would be measured by the amount that the fair market value of the appreciated property exceeds the basis on the date of the gift or upon the date of death, whichever is applicable.
The proposal allows for some exclusions. Transfers by a decedent to a U.S. spouse would not be a taxable event, and the surviving spouse would receive the decedent’s carryover basis. Transfers to charity would not generate a taxable capital gain. Transfers of tangible personal property, such as household furnishings and personal effects (excluding collectibles), are excluded. The exclusion for small business stock would still apply.
The proposal would allow a $1 million per person exclusion from recognition of gain on properties transferred by gift or held at death. Any unused exemption by a deceased spouse will port to the surviving spouse making the exclusion effectively $2 million per couple. Generally, the cost basis of the transferee will be the fair market value of the property transferred. A donee receiving property that qualified for the $1 million exclusion of the donor will have a carryover basis.
Contributions of appreciated property to split-interest trusts, such as charitable remainder trusts, will no longer have the favorable treatment afforded under current law – likely making that deferral planning technique no longer viable. Transfers to S corporations and C corporations do not appear to generate gain, assuming those transfers qualify for the deferral provisions of Section 351.
This proposal radically alters the rules for recognition of income when it comes to capital assets. Under current law, there generally must be a sale or exchange of property to generate a capital gain. Because the proposal would “deem” a sale when in fact there was no sale, the taxpayer will not necessarily have the cash to pay the capital gains tax. Thus, the utmost care would need to be exercised to avoid the liquidity issues created by a “deemed” sale.
Expand SECA Tax
The Green Book subjects all pass-through entity business income of high-income taxpayers to either the Net Investment Income Tax (NIIT) or the Self-Employment Contributions Act (SECA) tax. The Green Book defines “high-income” as taxpayers with AGI over $400,000. The Green Book defines net investment tax to include gross income and gain from any trades or businesses that are not otherwise subject to self-employment tax. Limited partners, LLC members, and S corporation owners who materially participate in their trade or businesses would be subject to SECA tax on their distributive shares. Contrast this with current tax law, under which S corporation shareholders who materially participate can legally avoid NIIT and SECA tax on their distributive share. The primary goal is to achieve a minimum of 3.8% Medicare tax to all pass-through income.
Carried (Profits) Interest
A partner’s share of profits and gain from an investment services partnership would be taxed as ordinary income if the partner’s taxable income from all sources exceeds $400,000. The income would no longer be eligible for capital gain rates, and self-employment taxes also would apply. Income attributable to invested capital would continue to be treated as capital gain.
Increase Employer Provided Childcare Credit
Under current law, employers receive a nonrefundable credit of 25% of qualified care expenses for a maximum total credit of $150,000. The Green Book allows a credit for 50% of the first $1 million of expenses for a maximum total credit of $500,000.
The proposals also attempt to implement climate change policy by eliminating at least a dozen fossil fuel incentives, while increasing incentives related to alternative energy. Currently, only owners of electric passenger vehicles and light duty trucks receive a non-refundable tax credit. The Green Book expands the credit to businesses and includes medium and heavy duty “zero emission” vehicles. The vehicles must be acquired for use, not resale, and the taxpayer must commence the use of the vehicle. Thus, the credit does not apply if someone else has used the vehicle before the taxpayer. The amount of the credit depends on various factors but ranges from $10,000 to $120,000. Additionally, there is an option to elect a cash payment in lieu of the credit.
The Green Book includes a number of proposals that will affect taxation of international operations. Changes to the Global Intangible Low-Taxed Income (GILTI) application and calculations are proposed. The deduction for foreign derived intangible income (FDII) would be repealed. Base Erosion and Anti-Abuse Tax (BEAT) would be repealed and replaced with a Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rule. A number of other international proposals beyond the scope of this summary are also included in the Green Book.
Other Previous Tax Proposals Not Included in the Green Book
The Green Book does not discuss eliminating the state and local taxes limitation, repealing or modifying the qualified business income deduction, reducing the lifetime estate tax exemption, or increasing the estate tax rate. These items were proposed during President Biden’s election campaign, in the American Families Plan, or in other proposals; however, the mere absence of these items in the Green Book does not mean that they are not still in play. They may become important bargaining chips as the Green Book proposals are discussed in Congress.
Prospects of Green Book Proposals Being Enacted
Although the White House, House of Representatives and Senate are each in Democratic hands, the path to enacting tax legislation remains unclear. With a narrow majority in the House and a 50-50 margin in the Senate (with the Vice President breaking any tie), all Democratic members of Congress must agree to move forward. The Senate, in particular, must be watched closely, as its current filibuster rules essentially allow any senator to block legislation, requiring 60 votes to invoke “cloture,” or to end the filibuster block. It is unlikely that 60 senators will agree to invoke cloture for any legislation.
In the face of certain filibuster, the only other option available to pass tax legislation in the Senate is the budget reconciliation process, which ultimately requires only a simple majority to pass budget-related legislation, which can include tax. The budget reconciliation process was utilized to pass the American Rescue Plan in March 2021.
Passing tax legislation through budget reconciliation does, however, have its drawbacks, such as policy changes that can be effective only during the budget window, which generally is 10 years. Most importantly, recent remarks from some moderate Senate Democrats suggest that they may resist further use of the budget reconciliation process this year, making the path to any tax legislation in the near future uncertain.
In conclusion, the proposed changes in the Green Book could have a material impact on your taxes in the future. The Green Book makes significant changes to many tax code provisions – some that have been in place for many years and others that are more recent provisions from the Tax Cuts and Jobs Act of 2017. Some of the changes, the SECA changes and the stepped-up basis for decedents to mention a couple, involve topics that have been talked about for years, but have seen no Congressional action to date. We will continue to monitor developments on these proposals and provide updates as they occur. If you wish to discuss how these proposals might affect the tax situation for you or your business, please contact your BMSS tax professional.
 Net Investment income tax is 3.8% surtax imposed on higher income taxpayers. This tax would almost certainly apply to all taxpayers effected by the increase in long-term capital gains rate.