On March 9, 2023, President Biden released his fiscal year 2024 budget blueprint (the “Budget”) which notably includes proposals to increase the corporate income tax rate, quadruple the new corporate stock buyback excise tax, and align US tax policy with the global minimum tax regime. This alert discusses the Budget’s key tax proposals.
The Department of the Treasury issued its summary of the Budget’s tax proposals on the same day. The overarching goal of the Budget is to raise $4 trillion in net revenue over the next 10 years based on key tax policy changes. Congressional Republicans have sharply criticized the Budget, and the tax proposals are unlikely to pass the Republican-controlled House.
Unless otherwise specified, each proposal would be effective for the tax years beginning after December 31, 2022. All Section references refer to the Internal Revenue Code of 1986, as amended (the “Code”).
Corporate Taxpayers: The Budget’s key proposals for corporate taxpayers are summarized below.
- Raise the Corporate Income Tax Rate to 28%: The Budget would increase the corporate income tax rate from 21% to 28%.
- Quadruple the Corporate Stock Buyback Excise Tax to 4%: The Budget would increase the corporate stock buyback excise tax from 1% to 4%. Previous alerts discuss how the Inflation Reduction Act of 2022 created the tax and the interim guidance issued by the IRS and Treasury.
- Tax Corporate Distributions as Dividends: The Budget introduces several proposals regarding transfers of property from corporations to shareholders to better reflect such corporation’s dividend-paying capacity.
- First, the Budget would amend Section 312(a)(3) so that earnings and profits (“E&P”) are reduced by the basis in any distributed high-basis stock, where the basis is determined without regard to basis adjustments resulting from actual or deemed dividend equivalent redemptions or any series of distributions or transactions undertaken with a view to create and distribute high-basis stock of any corporation. This proposal would be effective as of the date of enactment of the amended Section 312(a)(3).
- Second, the Budget would treat leveraged distributions as dividends directly received from a related lending corporation to the extent that the principal purpose of the leveraged distribution was to not be treated as a dividend from the funding corporation. This proposal would be effective for transactions occurring after December 31, 2023.
- Third, the Budget would treat a subsidiary’s purchase of hook stock for property as a deemed distribution from the purchasing subsidiary to the issuing corporation. The hook stock would then be treated as a contribution by the issuing corporation to the subsidiary. The Secretary of the Treasury would be granted the authority to prescribe regulations to (i) treat purchases of interests in noncorporate shareholder entities in a similar manner and (ii) regard hook stock in a consolidated group. This proposal would be effective for transactions occurring after December 31, 2023.
- Last, the Budget would repeal the boot-within-gain limitation in reorganizations where the shareholder’s exchange is treated as having dividend distribution effect under Section 356(a)(2). The Budget would determine E&P for the dividend distribution effect under Section 316. This proposal would be effective for transactions occurring after December 31, 2023.
- Limit Tax Avoidance Through Inappropriate Leveraging of Parties to Divisive Reorganizations: The Budget introduces two proposals intended to limit tax avoidance loopholes applicable to parent corporation monetization techniques carried out in divisive reorganizations. Both proposals would be effective for transactions occurring after enactment of such proposal.
- First, the Budget would modify existing safe harbors regarding the tax-free transfer of controlled corporation boot and securities to parent corporation creditors to eliminate tax-free monetization. Under this proposal, the parent corporation would recognize gain on (i) the lesser of (a) its excess monetization amount and (b) the amount of controlled corporation boot it transferred to its creditors and (ii) the excess, if any, of its excess monetization amount over the amount of controlled corporation boot that it transfers to its creditors.
- Second, the Budget would prevent tax avoidance under Section 355 through the transfer of contingent liabilities to the controlled corporation. Under this proposal, the controlled corporation must (i) be adequately capitalized as a result of the reorganization and (ii) continue to be an economically viable entity after the reorganization. The Budget would also grant the Secretary of the Treasury authority to prescribe regulations to carry out and prevent avoidance of this proposal.
- Limit Losses Recognized in Liquidation Transactions: The Budget would amend Section 267 to disallow losses on the stock and property of a liquidating corporation for a complete liquidation within a controlled group where the assets of the liquidating corporation remain in the controlled group after liquidation. The Budget would also grant the Secretary of the Treasury authority to (i) allow for deferral of such losses under Section 267(f) instead of a complete denial and (ii) address the use of controlled partnerships to avoid this proposed rule change.
- Accelerate and Tighten Rules on Excess Employee Remuneration: The Budget introduces several proposals to address the Section 162(m) deduction disallowance for compensation in excess of $1 million paid by publicly traded corporations to covered employees. Each of these proposals would be effective for tax years beginning after December 31, 2023.
- First, the Budget would accelerate the effective date of the expanded definition of covered employees (i.e., the CEO, the CFO, the three highest-paid non-CEO/CFO officers and the next five highest-paid employees).
- Second, the Budget would create an aggregation rule to treat all members of a Section 414 controlled group as a single employer for determining covered employees and applying the Section 162(m) deduction disallowance.
- Third, the Budget would amend Section 162(m) so that otherwise deductible compensation paid to a covered employee is considered applicable employee remuneration, whether or not paid directly by the publicly held corporation.
- Require 100% Recapture of Depreciation Deductions as Ordinary Income for Certain Depreciable Real Property: The Budget would cause any gain on Section 1250 property (i.e., buildings and certain other real property) held for more than one year to be treated as ordinary income, to the extent of the aggregate depreciation deductions taken after the effective date of the proposal. Depreciation deductions taken prior to the effective date of the proposal would continue to be ordinary income only to the extent that the depreciation taken exceeded the depreciation that would have been allowed in such year under the straight-line method of depreciation. Any gain in excess of the recaptured depreciation would be treated as Section 1231 gain. Any unrecaptured gain would continue to be taxable to noncorporate taxpayers at a maximum rate of 25%. This proposal would be effective for depreciation deductions taken on Section 1250 property and dispositions of Section 1250 property in tax years beginning after December 31, 2023.
Multinational Corporations: The Budget contains several international tax reform provisions with the overall intention of more closely aligning US tax policy with the global minimum tax regime under the Pillar Two proposal from the Organization of Economic Co-Operation and Development Model Rules. The Budget would do so by (i) overhauling the global intangible low-tax income (“GILTI”) regime and (ii) repealing and replacing the base erosion anti-abuse tax (“BEAT”). These regime proposals and the Budget’s other key proposals for multinational corporations are summarized below.
- Overhaul the Current GILTI Regime: The Budget proposes an extensive overhaul of the current GILTI regime.
- The Budget would reduce the Section 250 deduction for GILTI inclusion from 50% to 25%. This change, along with the proposed corporate tax rate of 28%, would effectively bring the GILTI rate to 21%.
- The following additional changes to the GILTI regime would be effective for tax years beginning after December 31, 2023:
- Change the determination of the GILTI inclusion and residual US tax from a worldwide basis to a country-by-country basis.
- Repeal the current exemption for qualified business asset investment (commonly referred to as “QBAI”).
- Reduce the disallowance of foreign tax credits (“FTCs”) from 20% to 5%.
- On a country-by-country basis, allow the carry forward of net operating losses and FTCs for 10 years.
- Subject foreign oil and gas income (commonly referred to as “FOGEI”) to the GILTI regime and expand the definition of FOGEI to include income derived from shale oil and oil sands activity.
- Repeal and Replace the Current BEAT Regime: The Budget would repeal the current BEAT regime and replace it with two Pillar Two proposals—the Undertaxed Profits Rule and a qualified domestic minimum tax. These proposals would be effective for tax years after December 31, 2023.
- Other Proposals Relating to Multinational Corporations: The Budget includes several other notable proposals for multinational corporations.
- Repeal the Foreign Derived Intangible Income (“FDII”) Deduction: The Budget would repeal the current 37.5% FDII deduction. This proposed repeal would be effective for tax years beginning after December 31, 2023.
- Revise the Rules Allocating Subpart F Income and GILTI Between Taxpayers to Ensure That Subpart F Income and GILTI Are Fully Taxed: The Budget would require a US shareholder of a CFC that owned a share of CFC stock for part of the CFC’s tax year, but not on the last day of the foreign corporation’s tax year on which it is a CFC, to include in its gross income calculation a portion of the foreign corporation’s Subpart F income that is allocable to when it was a CFC. The intended goal of this proposal is to ensure that all Subpart F income is fully taxed. This proposal would be effective for foreign corporations’ tax years beginning after the date of enactment and to US shareholders’ tax years in which or with which such foreign corporations’ tax years end.
- Revise the Methods Required for Determining the E&P of CFCs: The Budget would require the following methods to be used in determining the E&P of CFCs: LIFO, installment sales and the completed contract method of accounting. Generally, these methods are not used to determine a CFC’s E&P but are used to determine a CFC’s Subpart F income. Accordingly, a CFC’s current year E&P is usually lower than its current year Subpart F income. The Budget would remove this disparity. This proposal would be effective for foreign corporations’ tax years beginning after December 31, 2023, and for US shareholders’ tax years in which or with which such foreign corporations’ tax years end.
- Limit the Section 245A Dividends Received Deduction (“DRD”) for Non-CFCs: The Budget would revise the Section 245A DRD, which is currently available as a 100% DRD to shareholders that own at least 10% of stock in a foreign corporation. Instead, the Budget would revise Section 245A to (i) limit the Section 245A DRD to only dividends remitted by a CFC or a qualified foreign corporation, (ii) allow a 65% DRD to shareholders that own at least 20% of stock in a qualified foreign corporation that is not a CFC, and (iii) allow a 50% DRD to shareholders that own less than 20% of stock in a qualified foreign corporation that is not a CFC. The Budget would not change the 100% DRD for dividends received from CFCs. This proposal would be effective for distributions after the date of enactment of the amended Section 245A.
- Create Onshoring Tax Credits and Disallow Offshoring Tax Deductions: The Budget would create a new general business credit for expenses in connection with onshoring a US trade or business. The Budget would also disallow deductions for expenses in connection with offshoring a US trade or business. These proposals would be effective for expenses paid or incurred after the date of enactment of the new credit.
Individuals: The Budget’s key proposals for individuals are summarized below.
- Increase Income Tax Rate for High-Income Earners: The Budget would increase the top marginal tax rate for individuals from 37% to 39.6% and lower the taxable income thresholds for the top marginal tax rate brackets.
- Impose a Minimum Income Tax on the Wealthiest Taxpayers: The Budget would impose a 25% minimum tax on the sum of taxable income and unrealized gains (including on ordinary assets) for taxpayers with $100 million in net assets. This proposed tax would be effective for tax years beginning after December 31, 2023.
- Apply the Net Investment Income Tax (“NIIT”) to Pass-Through Business Income of High-Income Taxpayers: The Budget would expand the NIIT base for high-income taxpayers ($200,000 for single filers and $250,000 for joint filers) so that all pass-through business income of such taxpayers is subject to either the NIIT or self-employment tax.
- Increase the NIIT Rate and the Additional Medicare Tax for High-Income Taxpayers: The Budget would increase the additional Medicare tax rate from 3.8% to 5% for taxpayers with more than $400,000 in modified adjusted gross income. The Budget would also increase the NIIT rate from 3.8% to 5% for taxpayers with more than $400,000 in modified adjusted gross income. The Budget would direct revenue generated from the NIIT to the Hospital Insurance Trust Fund, which is currently projected to be exhausted in 2028.
- Reform the Taxation of Capital Income: The Budget would reform the taxation of capital income for high-income taxpayers and appreciated property through two proposals.
- First, the Budget would tax the capital income of high-income taxpayers at ordinary income rates instead of capital gains rates. Specifically, long-term capital gains and qualified dividends would be taxed at ordinary rates to the extent that a taxpayer’s taxable income exceeds $1 million. This proposal would be effective as of the date of enactment of such proposal.
- Second, the Budget would treat transfers of appreciated property by gift or death as realization events. Gifts of appreciated property would result in a capital gain to the donor based on the fair market value of the property at the time of the gift. Transfers of appreciated property by death would result in a capital gain to the decedent’s estate based on the fair market value of the property at the time of the decedent’s death. This proposal would be effective for appreciated property transferred by gift or death after December 31, 2023.
- Apply the Wash Sales Rules to Digital Assets: The Budget would add digital assets to the list of assets subject to the wash sale rules in Section 1091. Under this proposal, losses from the sale of digital assets would be disallowed if the same or substantially identical digital assets were purchased by the taxpayer within 30 days of the sale of such digital assets. This proposal would be effective for tax years beginning after December 31, 2023.
- Repeal Deferral of Gain from Like-Kind Exchanges: The Budget would limit the ability of a taxpayer to defer taxable income with respect to Section 1031 like-kind exchanges. The proposal would allow for the deferral of up to $500,000 of gain for a taxpayer each year (or $1,000,000 of gain for married individuals filing jointly). Any gain in excess of $500,000 in a tax year would be recognized by the taxpayer in the year of the exchange. This proposal would be effective for exchanges completed in tax years beginning after December 31, 2023.
Noncorporate Taxpayers: The Budget’s key proposals for noncorporate taxpayers are summarized below.
- Strengthen Limitations on Losses for Noncorporate Taxpayers: Currently, Section 461(l) limits individual taxpayers from using excess business losses to offset unrelated income. While Section 461(l) is set to expire after 2028, the Budget would make Section 461(l) permanent. Additionally, the Budget would amend Section 461(l) so that any excess business losses disallowed under Section 461(l) would carryforward as current-year losses instead of as net operating losses.
- Prevent Basis Shifting by Related Parties Through Partnerships: The Budget would eliminate the ability for related parties to use partnerships to shift partnership basis among themselves to create advantageous tax results without a meaningful change in the partner’s economic arrangements. This proposal would be effective for tax years beginning after December 31, 2023.
- Tax Carried (Profits) Interests as Ordinary Income: The Budget would repeal Section 1061 for any taxpayer with taxable income in excess of $400,000, and replace it with a new regime whereby income allocated to certain service partners would be taxed as ordinary income, regardless of the character of the income at the partnership level. Any gain on the sale of such partnership interest would also be taxed as ordinary income to the seller. The proposal includes an exception with respect to capital interests held by a service provider. The proposal also includes an anti-abuse rule to prevent avoidance of the proposal’s application through the use of compensatory arrangements other than partnership interests. This proposal would be effective for tax years after December 31, 2023.
- Prevent Prison Facility Rent Payments from Contributing to Qualification as a REIT: The Budget would exclude from the 75% and 95% income tests—any rent received from any rented property which is substantially used in connection with punishment, detention or correction. The proposal would prevent the Secretary of the Treasury from either treating that income as qualifying income or excluding it from gross income for purposes of the REIT rules. This proposal would be effective for tax years beginning after December 31, 2023.
Energy-Related Tax Provisions: The Budget reissues prior proposals designed to diminish the economics associated with the production of fossil fuels. The Budget would repeal the following provisions beneficial to the domestic oil and gas industry.
- Limiting the Amount of Creditable Foreign Tax Arising in a Dual-Capacity Context: US taxpayers operating in foreign countries are often subject to high tax rates, exceeding the generally applicable rates of tax, on oil production. The Budget proposal would restrict the credibility of foreign tax imposed by a country to the generally applicable rate of tax under the relevant country’s income tax system.
- Expensing of Intangible Drilling Costs (Commonly Referred to as “IDCs): Expensing of drilling costs have been allowed since the inception of the US tax income system. Producers are permitted to immediately deduct 70% of drilling costs. The remainder are capitalized and deducted over five years. The Budget would reverse this long history and require capitalization.
- Repeal of Percentage Depletion for Fossil Fuel Production and Hard Minerals: Percentage depletion has been available to domestic producers for nearly a century. This form of depletion is available to independent producers, not large oil companies. The Budget proposal would eliminate this fundamental part of oil and gas taxation.
- Partnership Classification for Publicly Traded Oil and Gas Partnerships (Commonly Referred to as “Master Limited Partnerships” or “MLPs”): Partnerships that derive at least 90% of gross income from depletable natural resources are eligible to be taxed as partnerships. The Budget would force MLPs into corporate classification for federal tax purposes. This proposal would have a delayed effective date, coming into effect for taxable years starting in 2029.
- Credits for Enhanced Oil Recovery and Oil and Gas Produced From Marginal Wells: A credit of 15% is allowed for eligible costs attributable to enhanced oil recovery projects. Another credit is allowed for oil and natural gas produced from marginal wells. Both credits are subject to various parameters affecting their usability. The Budget repeals both.
- Elimination of Other Provisions Specific to the Oil and Gas Industry: The Budget would end the deduction for costs paid or incurred for any qualified tertiary injectant, the exception to passive loss limitations provided to working interests in oil and natural gas properties, the two-year amortization of geological and geophysical expenditures by independent producers, expensing of exploration and development costs, capital gains treatment for royalties, the exemption from the Oil Spill Liability Trust Fund and Superfund excise tax for crude oil derived from bitumen and kerogen-rich rock and accelerated amortization for air pollution control facilities.