On March 28, 2022, President Biden released his FY2023 budget (the “FY2023 Budget”), and the U.S. Treasury released the so-called “Green Book," which provides details related to the revenue provisions in the FY2023 Budget. This FGMK Tax Alert provides a summary of the salient tax provisions offered under this proposal.
Increased Tax Rates, New Wealth Tax, and Other General Tax Law Changes
- Individual income tax increase. The proposal would increase the top marginal tax rate from 37 percent to 39.6 percent for taxable income over $450,000 for married individuals filing a joint return ($400,000 for unmarried individuals), effective for taxable years beginning after December 31, 2022.
- Subject long-term capital gains and qualified dividends to ordinary income rates. This would be applicable for taxpayers with taxable income exceeding $1 million.
- Creation of a net wealth minimum tax. A 20 percent minimum tax that includes a mark-to-market regime with respect to unrealized capital gains for taxpayers with a net worth exceeding $100 million. The proposal would be effective for taxable years beginning after December 31, 2022.
- Corporate Rate Increase. The proposal would increase the income tax rate for C corporations from 21 percent to 28 percent, effective for taxable years beginning after December 31, 2022.
- Change in “control” test under Internal Revenue Code (“IRC”) Section 368(c). The current control test under IRC Section 368(c), which is relevant to tax-free contributions under IRC Section 351 and certain tax-free reorganizations, requires at least 80 percent of voting power of all classes of voting stock and at least 80 percent of the total number of shares of each class of nonvoting stock. The proposed change would eliminate the use of certain high-vote/low-value arrangements that are permitted under the current IRC Section 368(c) control test. The proposal would be effective for transactions occurring after December 31, 2022.
- Prohibition of basis shifting by related parties through partnerships. The step-up of the basis of the partnership’s non-distributed property via a related party transaction using IRC Section 754 election would not be available unless the distributee-partner disposes of the distributed property in a fully taxable transaction.
- Limitation of favorable carried interest tax treatment. For partners with taxable income (from all sources) exceeding $400,000, the provision would subject a partner’s allocable share of income from profits interests in investment partnerships (i.e., carried interest) to tax as ordinary income and self-employment tax regardless of the character of the income at the partnership level.
- Limitation on gain deferred under IRC Section 1031. Gain deferral would be capped at $500,000 ($1 million in the case of married individuals filing a joint return) per taxpayer per year. This would be effective for exchanges completed in taxable years beginning after December 31, 2022.
- Expansion of recapture under IRC Section 1250. With respect to depreciation deductions taken on IRC Section 1250 property (e.g., depreciable real estate) after the effective date of the proposal, depreciation recapture on the disposition of such property would be treated as ordinary income, as opposed to the current law which only taxes such depreciation at ordinary rates to the extent the depreciation exceeds straight-line depreciation (a rare event in the current tax environment), and then taxes the unrecaptured 1250 gain at 25 percent. The proposal would not apply to non-corporate taxpayers with adjusted gross income of less than $400,000 and would be effective for depreciation taken in taxable years beginning after December 31, 2022. This would require partnerships and S corporations to report separately the character of gains under the “old law” and “new law”.
Estate, Trust, & Gift Tax Changes
- Taxation of Grantor Trusts. The proposal provides for the following changes related to grantor trusts.
- The transfer of a trust asset in kind to the trust grantor or beneficiary would be a realization event for income tax purposes. This proposal would apply to all transactions between a grantor trust and its deemed owner occurring on or after the date of enactment.
- Payments of the income tax on the income of a grantor trust will be deemed a gift occurring on December 31 of the year in which the income tax is paid unless the deemed owner is reimbursed by the trust during that same year. This proposal would apply to all trusts created on or after the date of enactment.
- Taxation of Grantor Retained Annuity Trusts (GRATs). The proposal provides for the following changes related to GRATs.
- The proposal would eliminate the ability to make a zeroed-out contribution to a GRAT and would require that the remainder interest in a GRAT at the time the interest is created have a minimum value for gift tax purposes equal to the greater of 25 percent of the value of the assets transferred to the GRAT or $500,000 (but not more than the value of the assets transferred).
- The proposal would prohibit any decrease in the annuity during the GRAT term and would prohibit the grantor from acquiring in an exchange an asset held in the trust without recognizing gain or loss for income tax purposes.
- The proposal would require that a GRAT have a minimum term of ten years and a maximum term of the life expectancy of the grantor annuitant plus ten years. These proposals would apply to all GRATs created on or after the date of enactment.
- Forced Gain Recognition of Gift or Bequest. The proposal would require the following:
- The donor or deceased owner of an appreciated asset would need to realize a capital gain at the time of the transfer. The amount of the gain realized would be the excess of the asset's fair market value on the date of the gift or on decedent’s date of death over the decedent’s adjusted tax basis in that asset.
- Furthermore, the gain on unrealized appreciation also would be recognized by a trust, partnership, or other non-corporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years. This provision would apply to property not subject to a recognition event since December 31, 1939, so that the first recognition event would be deemed to occur on December 31, 2030.
- The proposal would allow a $5 million per donor exclusion on property transferred by gift during life for which any exclusion remaining at death could be used to exclude gain realized on death. Any unused exclusion could be transferred to a surviving spouse at death.
- These proposals would be effective for gains on property transferred by gift, and on property owned at death by decedents dying, after December 31, 2022, and on certain property owned by trusts, partnerships, and other non-corporate entities on January 1, 2023.
- Generation-Skipping Transfer (GST) Tax Exemption. The proposal limits the length of the GST exemption from GST tax to no longer than the life of any trust beneficiary who either is no younger than the transferor's grandchild or is a member of a younger generation but who was alive at the creation of the trust. Solely for purposes of determining the duration of the exemption, a pre-enactment trust would be deemed to have been created on the date of enactment. This proposal would apply on and after the date of enactment to all trusts subject to the generation-skipping transfer tax, regardless of the trust’s inclusion ratio on the date of enactment.
- Consistent Valuation of Promissory Notes. The new proposal would require that if a taxpayer treats any promissory note as having a sufficient rate of interest to avoid the treatment of any foregone interest on the loan as income or any part of the transaction as a gift, that note subsequently must be valued for federal gift and estate tax purposes by limiting the discount rate to the greater of the actual rate of interest of the note, or the applicable minimum interest rate for the remaining term of the note on the date of death. This proposal would apply to valuations as of a valuation date on or after the date of introduction.
International Tax Provision of Note
- International Tax and Adoption of the Undertaxed Profits Rule. The 2017 Tax Cuts and Jobs Act enacted IRC Section 59A, which imposes a Base Erosion Anti-Abuse Tax (“BEAT”) liability on certain large multinational corporate taxpayers that make "base erosion payments" (e.g., interest, royalties, service payments) to foreign related parties. The Build Back Better Act would have made several modifications to the BEAT. However, on October 8, 2021, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting reached a comprehensive agreement on a 15 percent global minimum tax under Pillar Two.
In order to increase alignment between the US international tax rules and the international system emerging from Pillar Two, for taxable years beginning after December 31, 2023, the proposal would repeal the BEAT and replace it with an Undertaxed Profits Rule (“UTPR”) that is consistent with the UTPR described in the Pillar Two Model Rules.
- Under the UTPR, domestic group members would be disallowed U.S. 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 percent 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 Pillar Two Model Rules.
- 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 percent 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 Code, with an excess amount of UTPR disallowance carried forward indefinitely.
While there are no current tax law changes pending, these proposals are worth noting as taxpayers look ahead and plan for the future. FGMK will continue to monitor the Congressional landscape and provide updates as they arise.
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
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