White House releases budget; Treasury releases FY 2023 Greenbook
TAX ALERT | March 30, 2022
Authored by RSM US LLP
Springtime in DC. Peak bloom for the cherry blossoms around the Tidal Basin and peak season for an administration to release its FY2023 budget proposal. Included in the President’s budget, and detailed by the concurrently released Treasury Greenbook, is a request for over $2.5 trillion in revenue proposals.
The Greenbook can be seen as a signal of the priorities of an administration, as well as a bit of a wish list. The FY 2023 Greenbook takes things a step further by estimating revenue using a baseline assumption that almost all revenue provisions in the House-passed version of the Build Back Better Act (BBBA) are in effect. The BBBA has been stalled since late December and while a sign of life has popped up every once in a while, the clock is ticking for Democrat members of the House and Senate who are running for re-election. Overall chances of both the BBBA and the revenue proposals in the Greenbook being enacted this year are like picking a certain Northeast-based team to make the Elite Eight – it could happen, but odds are highly against it.
Even with the slight chance that all of these provisions are enacted, any time an administration releases its Greenbook, it’s important to walk through some of the key provisions to get a sense of priorities. One such priority is improving tax administration and compliance and RSM will be issuing a separate alert.
Business and international taxation
Increased corporate tax rate
The proposal would increase the corporate income tax rate from 21% to 28%. A corresponding increase would be made to the GILTI (global intangible low-tax income) tax rate.
The increased corporate tax rate would apply to be taxable years beginning after Dec. 31, 2022. For taxable years straddling Dec. 31, 2022, a blended rate would apply.
The Administration isn’t giving up on increasing the corporate tax rates. Almost any hope for increase in tax rates was scuttled by Sen. Sinema so it may be unlikely that Dems could get 50 votes in the Senate to increase rates in this new budget.
Buried GILTI rate change
The House-passed Build Back Better Act (BBBA) reduces the section 250 deduction for global intangible low-taxed income (GILTI) resulting in a 15% rate on GILTI (15.8% factoring in the 5% haircut on GILTI foreign tax credits). The Greenbook assumes that the House-passed changes to section 250 will be enacted into law. Therefore, the proposal to increase the corporate tax rate to 28%, without any further adjustments to section 250, means the GILTI effective tax rate would increase to 20%.
Interestingly, the Treasury Greenbook one year ago proposed swapping the Foreign Derived Intangible Income (FDII) deduction for “additional support for research and experimentation expenditures.” Although not explicit, this was widely seen as a proposal to restore full, immediate deductibility of research and experimentation expenditures, probably on a permanent basis, as was the law from 1954-2021. The Greenbook released this week, however, has no mention whatsoever of research and experimentation, or of FDII, or of section 174.
Aligning tax free treatment more closely with control of stock vote and value
The proposal would require shareholder groups to control of 80% of both stock vote and value to qualify for tax-free corporate contribution or reorganization treatment in certain situations. This proposal would limit situations where a transaction’s treatment as taxable or tax-free can be impacted by utilizing a class of stock with little or no voting power; it would be effective for transactions occurring after Dec. 31, 2022.
Repeal the BEAT and replace it with an UTPR
The Greenbook is proposing scrapping the Base Erosion and Anti-Abuse Tax (BEAT) and replacing it with an undertaxed profits rule (UTPR) that is consistent with the UTPR described in the OECD’s Pillar Two model rules (also referred to as the Anti Global Base Erosion or GloBE rules). These model rules seek enforcing a minimum 15% effective tax rate on profits earned by large multinational enterprises in each jurisdiction where they earn profits. Where a jurisdiction has companies that do not pay a minimum effective tax rate of 15%, the jurisdiction in which the parent company is based will collect the additional top-up tax by way of the Income Inclusion Rule (IIR). Should the parent jurisdiction not implement an IIR, the tax is collected in other jurisdictions through the UTPR, by way of denying tax deductions (or other equivalent mechanisms) to collectively pay the top-up tax amount locally.
The Greenbook proposal states that the UTPR would not apply with respect to income subject to an IIR, including income that is subject to GILTI, and therefore generally would not apply to US-parented multinationals. In addition, the UTPR would apply only to financial reporting groups that have global annual revenue of $850 million or more in at least two of the prior four years.
Under the UTPR, domestic group members would be disallowed US tax deductions to the extent necessary to collect the hypothetical amount of top-up tax required for the financial reporting group to pay an effective tax rate of at least 15% in each foreign jurisdiction in which the group has profits. The amount of this top-up tax would be determined based on a jurisdiction-by-jurisdiction computation of the group's profit and effective tax rate consistent with the GloBE model rules. The top-up amount would be allocated among all of the jurisdictions where the financial reporting group operates that have adopted a UTPR consistent with the GloBE model rules. When another jurisdiction adopts a UTPR, the proposal also includes a domestic minimum top-up tax that would protect US revenues from the imposition of UTPRs by other countries.
The computation of profit and the effective tax rate for a jurisdiction is based on the group’s consolidated financial statements with certain adjustments. In addition, the computation of a group’s profit for a jurisdiction is reduced by an amount equal to 5% of the book value of tangible assets and payroll with respect to the jurisdiction. The deduction disallowance applies pro rata with respect to all otherwise allowable deductions and applies after all other deduction disallowance provisions in the Internal Revenue Code, with an excess amount of UTPR disallowance carried forward indefinitely.
The proposal to repeal the BEAT and replace it with a UTPR would be effective for tax years beginning after Dec. 31, 2023.
Create a new general business credit for onshoring a US trade or business
Similar to last year’s Greenbook, the proposal would create a new general business credit equal to 10% of the eligible expenses paid or incurred with onshoring a US trade or business. ‘Onshoring’ means reducing or eliminating a business or line of business currently conducted outside the US and starting up, expanding, or otherwise moving the same business within the US, but only to the extent that this action results in an increase in US jobs. Eligible expenses are limited solely to expenses associated with the relocation of the business and do not include capital expenditures or costs for severance pay and other assistance to displaced workers. While the eligible expenses may be incurred by a foreign affiliate of the US taxpayer, the tax credit would be claimed by the US taxpayer.
Additionally, the Greenbook proposal would disallow deductions for expenses paid in connection with offshoring a US trade or business, to the extent that this action results in a loss of US jobs. In addition, no deduction would be allowed against a US shareholder's GILTI or Subpart F income inclusions for any expenses paid or incurred in connection with moving a US trade or business outside the US
The proposal would be effective for expenses paid or incurred after the date of enactment.
Prevent basis shifting by related parties through partnerships
The proposal reduces the ability of related partnerships to shift basis amongst themselves and introduces a matching rule to prohibit any related partner in the distributing partnership from benefitting from the step-up if the related partner disposes of the distributed property in a fully taxable transaction.
Expand access to retroactive QEF elections
Currently, taxpayers are allowed to make a retroactive Qualified Electing Fund (QEF) election with respect to a passive foreign investment company (PFIC) only with the consent of the Commissioner of Internal Revenue and only if the taxpayer relied on a qualified tax professional in failing to make the election earlier, granting consent does not prejudice the interests of the government, and the request is made before a PFIC issue is raised on audit. The proposal would modify section 1295(b)(2) to permit a QEF election by taxpayers at such time and in such manner as shall be prescribed by regulations.
The proposal would be effective on the date of enactment. The Greenbook proposal states it is intended that regulations or other guidance would permit taxpayers to amend previously filed returns for open years.
Expand the definition of ‘foreign business entity’ to include taxable units
Section 6038 of the Internal Revenue Code requires a US person who controls a foreign business entity (a foreign corporation or foreign partnership) to report certain information with respect to the entity. The Greenbook proposal would modify the reporting rules in section 6038 to treat any taxable unit in a foreign jurisdiction as a ‘foreign business entity’ for purposes of section 6038. Thus, a single legal entity operating in multiple foreign jurisdictions would be treated as a separate ‘foreign business entity’ in each jurisdiction and the reporting rules in section 6038 would be applied separately for each foreign business entity.
The proposal would apply to tax years of a controlling US person that begin after Dec. 31, 2022, and to annual accounting periods of foreign business entities that end or are within such tax years of the controlling US person.
Increase threshold for simplified foreign tax credit rules and reporting
At present, individuals may elect to claim a foreign tax credit without filing Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), by entering the credit directly on his or her return. To be eligible to make this election, all of the individual’s foreign source income must be passive income, all of the income and any foreign taxes paid on the income must be reported on a qualified payee statement, and the total creditable foreign taxes must be less than $300 ($600 for joint filers). The Greenbook proposal would increase the threshold in the last requirement to $600 ($1,200 in the case of a joint return) and index this amount to inflation.
The proposal would be effective for foreign income taxes paid or accrued in tax years beginning after Dec. 31, 2022.
Eliminate fossil fuel tax preferences
The Administration proposes to do away with tax preference items for taxpayers in the oil, gas and coal industries. The tax preference items are relatively unchanged from the prior Greenbook and can be reviewed in our prior alert.
Taxation of high-income taxpayers/estate and gift
The Biden Administration reiterates its desire to increase the top marginal income tax rate for high-income earners as well as tax capital income for high-income earners at ordinary rates. Unlike the prior year proposal, which referenced a ‘date of announcement’ for the capital gain effective date, this year’s Greenbook provides an effective date on or after the date of enactment. These provisions also include taxation of gains upon death or gift effective after December 31, 2022. New this year, though, is a minimum tax on the wealthiest taxpayers.
Minimum tax on the wealthiest taxpayers
The Treasury proposed in the Greenbook a minimum 20% tax on certain wealthy individual taxpayers’ total income, which includes unrealized capital gains. Taxpayers subject to this minimum tax would lose the benefit of deferring taxation on appreciated assets until such asset is disposed of and would lose the benefit of the basis step-up for appreciated assets held at death. The minimum tax would apply to taxpayers with wealth of an amount greater than $100 million. To prevent the double taxation on the appreciation of assets subject to the minimum tax, taxpayers may offset the tax on realized capital gains with a credit for prior minimum taxes paid. Taxpayers meeting the wealth thresholds would be subject to annual basis and estimated value reporting. The estimated value of assets depends on market prices for tradable assets and, for non-tradable assets, either cost basis or recent transactions setting the value, as increased by a floating annual return.
Never say never, but this proposal may be dead on arrival. Sen. Manchin has already expressed reservations after the release of the budget about taxing unrealized gains.
Elimination of certain income and transfer tax advantages of grantor trusts
The Greenbook proposes two important changes with respect to grantor trusts. First, under the proposal, transfers of assets for consideration between the grantor and certain grantor trusts would be taxable dispositions. Currently, exchanges between the grantor and an irrevocable grantor trust are not recognized for income tax purposes, allowing grantors to transfer the subsequent appreciation of assets to a grantor trust for the benefit of their family at little to no income or gift tax cost. The proposed rule would cause sales or exchanges of appreciated property to grantor trusts to be subject to income taxation in the year of the transfer. Secondly, the Greenbook proposes to treat the grantor’s payment of income tax on the income of certain grantor trusts as a taxable gift. Under current rules, the payment of income tax on the grantor trust’s income is not a taxable gift, allowing the grantor trust to grow free of income taxes while the grantor’s taxable estate is reduced by the income taxes paid. The Greenbook’s proposal to treat the payment of income taxes as taxable gifts diminishes the advantage of grantor trusts in estate and gift tax planning.
New restrictions on grantor retained annuity trusts (GRATs)
The Greenbook provides for additional restrictions on Grantor Retained Annuity Trusts that would eliminate their effectiveness as a tax efficient strategy to transfer appreciation of assets at little to no gift tax cost. The proposal would eliminate zero-gift GRATs with the requirement that GRATs involve a minimum gift transfer of greater than 25% of the value of the property contributed to the GRAT or $500,000 (but not greater than the value of the contributed property). Additionally, the proposal will require GRATs to have a minimum term of ten years. The extended GRAT term exposes any appreciation in the GRAT to subsequent losses or underperformance, which would reduce the amount of assets transferred to remainder beneficiaries. Lastly, the proposal would recognize as a taxable disposition any exchanges of assets between the grantor and the GRAT. This requirement makes it more costly for a grantor to lock in any gains in the GRAT over the 10 year GRAT term.
The Greenbook proposes limits on the GST tax exemption, eliminating the ability to set aside assets in dynasty trusts that are perpetually exempt from transfer taxes. The proposal limits the use of GST exemption to direct skips and taxable distributions to beneficiaries no more than two generations below the transferor and to younger generation beneficiaries living at the creation of the trust (‘second generation beneficiaries’). Additionally, the GST exemption would only apply to taxable terminations occurring while second generation beneficiaries are beneficiaries of the trust. The proposal would apply on and after the date of enactment to all trusts subject to GST tax, regardless of the trust’s inclusion ratio on the date of enactment. As a result of these rules, the benefit of GST exemption that shields property and trust distributions from GST tax would not last as long as the trust, and a previously GST tax exempt trust may become subject to GST taxes when making distributions to later generations.
Required reporting of estimated value of trusts
The Greenbook proposes to require that trusts report annually the estimated value of their assets. This reporting requirement would apply to trusts that have assets valued at more than $300,000 or that have gross income over $10,000. The reporting would be made on an annual tax return or other form. This reporting requirement will increase the compliance costs of affectd trusts.
Consistent valuation requirement of promissory notes
The Greenbook would require any taxpayers that make loans at sufficient rates to avoid below market loan treatment for income and gift tax purposes (the “safe harbor rate”) must value that note for any subsequent gift or estate tax purposes by limiting the discount rate applied to the note to the greater of the actual interest rate of the note or the applicable minimum interest rate for the term of the note. This consistency requirement would prevent taxpayers from taking a favorable gift tax position when making a low interest loan at the safe harbor rate and later discounting the value of that note for estate or gift tax purposes at a higher rate.
Provisions to close perceived loopholes
The Administration again returns to familiar targets, like taxing carried interest as ordinary income and repealing gain deferral from like-kind exchanges. However, some new items are provided, including a limitation on a deduction in certain syndicated conservation easement transactions and clarifications on taxes due on employer-related payments.
If a nonqualified deferred compensation plan fails section 409A rules, the failure results in additional taxes at the individual level that employers currently do not have to withhold. The proposal would require the employers to withhold these amounts, which will also allow the IRS to assess the amounts upon an examination of the employer without examining the individual recipient.
The exclusion of gross income from employer health and accident plan benefits applies under section 105(b) only for medical expenses. Certain fixed payments paid upon health-related events are not necessarily covering medical expenses and, thus, are compensation. The proposal clarifies these payments need to be reported by the employer as wages subject to withholding.
Employers that provide on-demand pay (essentially giving employees access to their payroll outside of regularly scheduled payroll dates) will be required to withhold weekly for on-demand pay.
Business-owned life insurance may currently have interest expense that is deductible if an employer uses a pro rata allocation rule for allocating expense to insurance contracts. The proposal would exclude insurance contracts covering employees, officers or directors from the pro rata allocation rule so that the interest expense that is tied to the tax-exempt income from the life insurance is not deductible.
Post-retirement health benefits as currently structured can allow front-loaded contributions (usually into a VEBA trust) and corresponding tax deductions at the time of the contributions. The budget report notes that these future benefits may not always be provided. The proposal would require the funding to occur over the working life of a covered employee or 10 years unless the benefits are maintained for at least 10 years.
Gain deferral limited for like-kind exchange
The Greenbook proposals reaffirmed the Administration's interest in scaling back gain deferral through like-kind exchange. The proposal in the Greenbook would impose a cap of $500,000 on deferred gain (or $1 million for married individuals filing jointly). All gains over that cap would be subject to tax and treated like a typical sale of real property. This proposal would be effective for like-kind exchanges completed in taxable years beginning after Dec. 31, 2022.
This proposal accords with earlier publications and statements; the Administration has periodically emphasized that it views like-kind exchange as a loophole and proposed its elimination as a way to raise revenue. Support for, and skepticism of, like-kind exchange cut across party lines and the appetite among lawmakers to roll back like-kind exchanges of real estate is not clear. However, given the 180-day span available for like-kind exchange transactions, taxpayers may wish to begin planned transactions in the earlier half of 2022 to avoid completing transactions after the effective date, should the proposal pass into law.
Require 100%recapture of depreciation deductions for certain real property
The Administration’s proposal requires taxpayers to treat any gain on section 1250 property held for more than one year as ordinary income to the extent of the cumulative depreciation deductions taken after the provision’s effective date. The current rules would continue to apply to prior depreciation deductions (with recapture to the extent depreciation exceeds the straight-line method and unrecaptured section 1250 gain for noncorporate taxpayers taxed at a maximum of 25%).
The proposal does not apply to taxpayers with adjusted gross income below $400,000 ($200,000 for married individuals filing separate returns). Partnerships and S corporations must report to their owners the unrecaptured section 1250 gain under both ‘new law’ and ‘old law’. Individual taxpayers at or above the threshold amounts must use the ‘new law’ amounts in computing taxable income.
The proposal applies to depreciation deductions taken on section 1250 property for taxable years beginning after Dec. 31, 2022, and certain dispositions of section 1250 property completed in taxable years beginning after Dec. 31, 2022.
Shareholder liability for corporate tax authorized in certain situations
The proposal would subject corporate shareholders to secondary liability for unpaid tax owed by certain corporations. It would focus on corporations with two-thirds or more of their assets comprised of cash, passive investment assets, or assets that have been sold. The proposal generally would not apply to transactions involving stock publicly traded on a US exchange. While directed at intermediary transactions, which are listed transaction identified by the IRS as tax avoidance transactions, the secondary liability rule would not be limited to tax avoidance transactions. The proposal would be effective retroactively, for stock sale transactions occurring on or after Apr. 10, 2014.
Limit a partner’s deduction in certain syndicated conservation easement transactions
The Administration proposes disallowing the charitable contribution deduction for certain partnerships that contribute conservation easements under the following circumstances;
- The amount of the contribution exceeds 2.5 times the sum of each partner’s relative basis in the partnership;
- The partnership has not satisfied a three-year holding period;
- The partnership (or other pass-through entity) is not held directly or indirectly by an individual and family members of such individual; and
- The contribution was made in taxable years ending after Dec. 23, 2016 (or, in the case of certified historic structures, taxable years beginning after Dec. 31, 2018).
Limit use of donor advised funds to avoid private foundation payout requirements
The Administration proposes amending the definition of a ‘qualifying distribution for payments made by a private foundation to a donor advised fund’ (DAF). Specifically, the Administration’s proposal would permit a private foundation to claim a qualifying distribution for a grant made to a DAF only when (1) the DAF expends such funds as qualifying distributions by the end of the following taxable year; and (2) the private foundation maintains adequate records showing that the DAF made the qualifying distribution within the required timeframe.
Current law does not limit a private foundation’s ability to make grants to a DAF in satisfaction of the annual payout requirement. In addition, current law does not impose a minimum payout requirement on DAFs. Therefore, some private foundations may make distributions to DAFs in satisfaction of their annual distribution requirement even though the dollars are not currently being used for charitable purposes. The IRS currently gathers information about foundations that generally utilize DAFs on Form 990-PF, Part VI-A, Line 12, which asks whether the private foundation made a distribution to a DAF over which the foundation or a disqualified person had advisory privileges.
Although current law does not impose a minimum payout requirement on DAFs, both houses of Congress have proposed legislation with bipartisan support that would effectively impose certain payout requirements by tying the charitable contribution deduction to whether and when the DAF is required to expend such funds. For an overview of the Accelerating Charitable Efforts (ACE) Act, introduced by Senators King and Grassley, read ACE Act introduced, SCOTUS overturns donor disclosure mandate and more.
The Administration’s proposal would appear to treat private foundation distributions to DAFs similar to how current law treats private foundation distributions to other private foundations by requiring the grantee to redistribute the funds as qualifying distributions by the end of the following taxable year in order for the grantor private foundation to treat the grant as a qualifying distribution.
Modernization of tax code related to digital assets
Modernization of rules related to digital assets
Greenbook proposals would include digital assets in section 1058 for tax-free lending, section 475 for the broker and trader mark-to-market election, and FATCA reporting for both institutions and individuals (Form 8938). These proposals would provide much needed clarity for institutions looking to expand into digital asset business lines.
Forty-four percent of the budgeted digital asset revenue raise ($4.8b) is from the first year of the mark-to-market election changes. But most dealers and traders already consider bitcoin and Ethereum as commodities and eligible for the election, and those that don't have very little built-in gain due to the high volume of digital asset trading.
Expanded financial information reporting
The proposal would expand reporting of financial interests to include certain digital assets, insurance, and annuity contracts, via separate sets of rules applicable to (1) US exchanges, and (2) US taxpayers. These two sets of proposed rules would be effective, respectively, for returns required to be filed after Dec. 31, 2023, and (2) returns required to be filed after Dec. 31, 2022.
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This article was written by Adam Chesman, Anne Bushman, Jamison Sites, Stefan Gottschalk and originally appeared on 2022-03-30.
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