Current Status of Tax and Other Legislative Actions
Background and Current Status
In my last blog, in mid-September, I predicted that the $1 trillion bi-partisan infrastructure bill, as passed by the Senate, “appeared to be on-track” to be passed by the House in a matter of days. However, my prediction was a bit optimistic as the vote on infrastructure became entangled in an internal democratic debate over the Build Back Better bill (BBB). Nevertheless, the House passed the infrastructure bill in November and it became law soon thereafter.
The result of the House committees work on BBB in late September was the initial approval of a $3.5 trillion bill, paid for by increases in income and capital gains taxes on individuals, as well as a corporate tax increase.
However, the continuing BBB debate amongst the progressive and moderate House Democrats (and Senators Manchin and Sinema) resulted in a final House bill reduced to $1.75 trillion, roughly half the size of the committee output. As I had predicted, the tax provisions in the initial BBB bill were not large enough to support such a $3.5 trillion bill through the Reconciliation process. As a result of this and the political debate, many social spending provisions were significantly trimmed or eliminated in the final House process. The increases in individual income and capital gains tax rates, and the corporate tax rate increases also fell when Senators Manchin and Sinema and other moderate House Democrats signaled disapproval.
As the bill hurtled towards passage in the House, the tax provisions went through a few additional modifications. Several provisions that had been strongly objected to by moderate Democrats, such as those related to gift and estate taxes, also fell. Some tax raisers aimed at corporations and higher-earning individuals were added to fill the revenue holes. Although a few existing international provisions were modified, new international provisions were not added.
On November 18, the Congressional Budget Office released its budget scoring of the non-tax provisions of the bill, which had been a bit overdue. The House passed BBB along party lines on November 19th (the Joint Committee on Taxation publicly released its tax estimates on November 19th). The House’s version of BBB was transmitted to the Senate.
Because the Senate is divided 50-50, and Committee leadership would, therefore, be split, the Senate has not held Committee mark-up hearings for BBB, but instead the Senate Finance Committee has issued discussion drafts, frameworks or preliminary legislative language of its proposed legislation. Thus, there has not been much open discussion in the Senate regarding BBB. Instead, Senator Manchin has dominated the headlines with his continual drip of piecemeal objections to bill provisions, in particular with respect to climate change and social benefit provisions. On December 16th, President Biden acknowledged that his direct talks with Senator Manchin were not progressing as he had hoped. The other shoe dropped on December 19th, when Senator Manchin appeared on Fox News to voice his intent to vote “no” on BBB, throwing the entire process (once again) into freefall and embarrassing President Biden.
A brief discussion of the status of BBB follows after a description of the key tax funding provisions of the final House bill.
The Key Tax Funding Provisions of the BBB as Passed by the Full House
Corporate and international taxes
Corporate tax rates: The full House bill would maintain the corporate tax rate at 21%. However, the House added a new corporate alternative minimum tax of 15% of adjusted financial statement income, reduced by a corporate AMT foreign tax credit. The AMT would be applicable to corporations with an average adjusted financial statement income over $1 billion during the prior 3 years, but certain foreign-parented corporations would be subject to a lower threshold of $100 million. (Effective for tax years beginning after 2022.) Most Democrats had initially wanted a large increase in the corporate tax rate.
Excise tax on stock repurchases: The full House bill would add a one percent excise tax on stock redemptions (or similar actions) by domestic corporations whose stock is traded on an established securities market. Affiliated subsidiary corporation stock redemptions, whether domestic or foreign, would be subject to parallel rules. (Effective for repurchases 2021.)
Section 250 deductions for FDII and GILTI: Currently, section 250 permits domestic corporations a deduction of 50% of GILTI and 37.5% of FDII. The full House bill would alter the amounts of the section 250 deductions to 28.5% of GILTI and 24.8% of FDII. (Effective for tax years beginning after 2022.)
Foreign tax credit modifications: The full House bill would modify the economic benefit FTC rules that apply primarily to foreign oil and gas operations, by codifying existing regulations. The full House also bill would also modify the foreign tax credit rules to apply on a country-by-country basis, as determined using a complex “taxable unit” standard. Cross-crediting between countries would not be permitted. It appears that this slice-and-dice approach would be a subdivision of each of the remaining foreign tax categories - passive, GILTI, and general). The full House bill would also eliminate the foreign branch category.
The credit carryover rules would generally remain the same under the full House bill, but (i) would now include the GILTI basket, and (ii) carry-forwards in the GILTI basket would be limited to 5 years until 2031. Only the portion of the section 250 deduction relating to GILTI and any state and local income tax imposed on the GILTI amount would be allocated to the GILTI basket under the full House statute, although some discretion would be granted to Treasury for additional allocable deductions.
Also, under the full House bill, the “haircut” on GILTI deemed paid taxes would be decreased from 20% to 5%, and this haircut would also apply to foreign withholding taxes imposed on GILTI previously taxed earnings and profits (PTEP), according to the same haircut rate applicable to the deemed paid taxes for the year the PTEP was earned. The combined effect of all these changes would be that U.S. shareholders of CFCs would have no residual tax liability on GILTI with respect to countries with an effective tax rate of 15.8% or greater. (In general, these provisions are effective for tax years beginning after 2022).
GILTI inclusion modifications: Under the full House bill, GILTI would also be calculated on a country-by-country basis using the same taxable unit standard as in the foreign tax credit area, as applicable to controlled foreign corporations (CFC). The currently exempt portion of income, i.e., 10% of net tangible assets (QBAI), would be reduced to 5% of QBAI (except in the case of U.S. possessions). Foreign oil and gas extraction income (FOGEI) would no longer be exempt from tested income. On the positive side, a CFC’s tested losses could be carried forward for netting against tested income in succeeding years. (In general, these provisions are effective for tax years beginning after 2022).
Coordination of inclusions and PTEP with tax basis: The full House bill would also expand the existing provision (sec. 961) that adjusts the basis of lower tier CFC stock held by an upper tier CFC for amounts of subpart F income and PTEP to include GILTI inclusions and distributions of GILTI PTEP. (In general, these provisions are effective for tax years beginning after 2021).
Reinstatement of sec. 958(b)(4) and addition of new sec. 951B: The full House bill would reinstate sec. 958(b)(4), the repeal of which in 2017 caused so much pain to taxpayers. In its place, new sec. 958B would replicate certain income inclusions for U.S. shareholders that resulted from the 2017 repeal of sec. 958(b)(4) without replicating all of the consequences of repeal. (Effective for tax years beginning after the enactment date).
Limitation of availability of 100% sec. 245A dividends received deduction: The full House bill would limit the availability of the 100% sec. 245A dividends received deduction to dividends received from a CFC of which the recipient is a 10% U.S. shareholder. (Effective for distributions after the enactment date).
CFC election: The full House bill would also provide for an election to treat a foreign corporation as a CFC. (Effective for tax years beginning after the enactment date).
Limitations on foreign base company sales and services income: The full House bill would limit these two types of foreign base company (subpart F) income to transactions involving a related person that is a taxable unit resident in the United States. It appears that current foreign base company sales and services income that is exempted from subpart F income under this limitation would be treated as GILTI. (Effective for tax years beginning after 2021.)
Modifications of base erosion and anti-abuse tax (BEAT): The full House bill would make several changes to the current BEAT rules. The BEAT remains applicable only to corporate taxpayers with average gross receipts over $500 million, so it does not affect smaller businesses.
Other domestic corporate and business provisions: The full House bill would make a number of changes to domestic tax corporate and business provisions, including capital loss treatment for sales of worthless securities or partnership interests and modifications to the wash sale rules.
High income individuals – tax increases
Although the ordinary income and capital gains tax rate increases were dropped from the package as it proceeded through the legislative process, there remain several provisions increasing taxes on high-income individuals, plus a few new ones added.
Application of net investment income tax (NIIT) to all trade or business income of high-income individuals: The House bill would expand the 3.8% NIIT to cover net investment income derived in the ordinary course of a trade or business, whether passive or active, for taxpayers with greater than $400,000 in taxable income ($500,000 for joint filers). (Effective for tax years beginning after 2021.)
Limitation on excess business losses of noncorporate taxpayers: Under current law, a deduction for the excess of aggregate business deductions of an individual taxpayer over the gross income of the taxpayer attributable to business income is limited. The amount of the limitation depends on filing status; for example, for 2021 the limitation for joint filers is $524,000. The current rules are scheduled to expire after 2026. The final House bill would make this limitation permanent.
Surcharge on high income individuals, trusts and estates: The final House bill includes new IRC section 1A, which would impose a tax equal to the sum of (i) 5% of a taxpayer’s modified adjusted gross income (MAGI) in excess of $10 million ($200,000 in the case of an estate or trust), plus (ii) 3% of a taxpayer’s MAGI in excess of $25 million ($500,000 in the case of an estate or trust). MAGI means AGI, less deductions allowed for investment or business interest.
Changes to the small business stock rules (sec. 1202): The final House bill would apply a reduction of the 100% (or 75%) benefit to 50% for individuals with AGI of $400,000 or more and to all non-grantor trusts and estates. The effective date was also made retroactive, with an effective date “after September 13, 2021.”
Retirement plan changes: Several provisions included in the final House bill are intended to curtail what many considered to be abusive actions by high-income, high-net worth taxpayers:
- No new IRA contributions would be allowed for those who have $10,000,000 or more in retirement plan accounts, but only for “applicable taxpayers” -- those making more than $400,000 filing single or $450,000 filing jointly. (Effective as of January 1, 2029.)
- For applicable taxpayers who have retirement plan accounts valued in the aggregate at more than $10,000,000, there would be a new Required Minimum Distribution (RMD) requiring a withdrawal equal to 50% of the value over the $10,000,000 limit. (Effective as of January 1, 2029.)
- Applicable taxpayers who have aggregate retirement plan accounts over $20,000,000 would be required to draw down 100% of any Roth accounts to bring the value down to $20,000,000. (Effective as of January 1, 2029.)
- No after-tax Roth conversions would be allowed after 2021. (This change affects very few taxpayers who own or are employed by small businesses.)
- No Roth conversions would be allowed for applicable taxpayers after 2031. This represents a significant change which is mitigated by the 10-year delay in the effective date. It is deemed to be a revenue raiser because it will incentivize applicable taxpayers to do a Roth conversion before 2031. When a taxpayer converts all or a portion of a traditional IRA to a Roth IRA, income tax on the entire amount converted is due, thus raising extra revenue in the short term.
- An IRA provision from an earlier version of the House bill was eliminated to allow IRAs to continue to invest in private equity. (The original version of BBB included prohibitions against IRAs being invested in assets for accredited investors.)
Limitation on deduction of qualified business income (QBI): The final House bill would eliminate the provision applying a dollar limitation, depending on filing status, to the deduction of QBI.
Estate and gift tax changes: As noted above, the final House bill would drop the taxpayer-unfavorable estate and gift tax provisions included in previous versions of the bill.
SALT (state and local taxes) deduction limit: The final House bill would increase the deduction limit to $80,000 until 2031, at which point the deduction would revert permanently to the $10,000 limitation as enacted under TCJA (2017). This is considered to be a revenue raiser since under the current law, the $10,000 limitation is set to sunset at the end of 2025 and would otherwise revert to prior law with an unlimited SALT deduction in 2026.
Other Key Recent Congressional Actions in the Finance Area
- Congress passed a bill to keep the government funded through mid-February, and the President signed the bill on December 2nd, avoiding a government shutdown.
- Congress passed a $2.5 trillion debt ceiling increase. The President signed the measure on December 16th.
Conclusion: Have We Reached the End of the BBB Bill Show or Is This Just an Interlude?
At this point, it seems to be anybody’s guess whether BBB is dead or just seriously injured. It may be that BBB can be slimmed down to a point that it will be acceptable to Senators Manchin and Sinema. Both votes are needed in the Senate to pass the bill. Majority Leader Schumer has pledged to keep trying in January, and to hold votes on the bill. It appears, therefore, that this may not be the end of this legislative melodrama.
Expectantly waiting in the wings of this theater are several of Senate Finance Committee Chairman Wyden’s reform proposals, including a significant “loophole-closing” overhaul of partnership rules that would limit the flexibility of the partnership rules in multiple ways, replacement of FDII with a domestic R&D incentive, and an overhaul of the tax treatment of derivatives, all of which would probably raise additional revenue that could potentially help to satisfy the Senate Democratic nay-sayers.
We will all have to wait until January, and possibly later, to see if the Senate Democrats are capable of reaching an agreement on BBB that will allow the Senate to move the bill forward. If the spending provisions are reduced under such an agreement, it is an open question which, if any, tax funding provisions will also shrink.
Allen is an attorney and a CPA who has an international tax practice focused on working and consulting with accounting and law firms, businesses, and investors on international tax planning, M&A, tax controversy, legislative and regulatory matters.