Tax Alert: The Implications of the Build Back Better Act

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Updates and negotiations for President Biden’s tax plan continue to filter through Congress. The House Ways and Means Committee recently passed the Build Back Better Act (the “Act”), and it is now on its way for the Senate’s consideration.

This is an update to our prior blog post about the tax plan released by House Democrats in September. We have noted the differences between the two proposals accordingly.

Corporate Tax Provisions

Corporate AMT. The Act imposes a 15% alternative minimum tax on the excess of “adjusted financial statement income” (calculated under Section 56A) over the corporate AMT foreign tax credit for corporations with a three-year average of such financial statement income in excess of $1 billion. The three-year average income threshold is reduced to an amount in excess of $100 million for “foreign-parented corporations.”

Stock Redemption Excise Tax. The Act imposes a 1% excise tax on publicly traded U.S. corporations based on the value of the stock that is repurchased by the corporation, effective after December 31, 2021.

GILTI and FDII Modifications. Among other changes, the Act reduces the Section 250 deduction with respect to both FDII (to 24.8%) and GILTI (to 28.5%). In combination with the current corporate rate, this yields an effective 15% GILTI rate and 15.8% FDII rate. Both rates are lower than previously proposed. The GILTI provision generally applies to tax years beginning after December 31, 2021, with certain specified exceptions, and the FDII provision applies to tax years beginning after December 31, 2022, (with a transition rule for fiscal-year taxpayers).

Other Business Tax Provisions

  • Portfolio Interest. Consistent with the September version, the revised bill modifies the definition of “10-percent shareholder,” whose interest is exempt from portfolio interest. For an obligation issued by a corporation, any person who owns 10% or more of the total vote or value of the stock of such a corporation is not eligible for the portfolio interest exemption. This provision applies to obligations issued after the date of the enactment of the Act.
  • 1202 Stock. The revised bill carries over the language from the September version, including the September 13, 2021 effective date, by amending Section 1202(a) to provide that the special 75% and 100% exclusion rates for gains realized from certain qualified small business stock will not apply to taxpayers with adjusted gross income equal to or exceeding $400,000 for sales and exchanges after September 13, 2021, subject to a binding contract exception. The baseline 50% exclusion remains available for all taxpayers.
  • Interest Expense Limitations. The Act adds a new Section 163(n) that subjects members of a foreign reporting group to additional limitations on their business interest expense deductions. It also changes the application of the Section 163(j) limitation for flow-through entities so that the limitation is applied at the partner or shareholder level rather than the entity level. These provisions apply for tax years beginning after December 31, 2022.

Exclusions from Prior Proposal:

  • The graduated rate proposal that would have taxed income at rates equal to 18% on the first $400,000 of income; 21% on income up to $5 million, and 26.5% on income thereafter. The graduated rate would have phased out for corporations making more than $10 million.
  • The Carried Interest holding period extension which would have (i) extended from three to five years the holding period required for gain attributable to an applicable partnership interest to qualify for long term capital gain treatment; (ii) added rules for measuring the holding period, including in the context of tiered partnerships; and (iii) modified the rules applicable to sale or exchange transactions and extend regulatory authority to address carry waivers and arrangements that avoid the purposes of Section 1061.
  • The “free” S corporation to partnership conversions previously proposed was removed in the revision. Under the prior proposal, it would have allowed certain S corporations organized prior to May 13, 1996 to reorganize as domestic partnerships (or LLCs) without triggering tax during a two-year period beginning on December 31, 2021.
  • The previous proposal would have amended the Section 199A deductions to provide for maximum allowable deductions of $400,000 (single filer), $500,000 (joint filer), and $10,000 for trusts and estates.

Individual Income Tax Provisions

Surtax on High Income Taxpayers. The Act revises the previous proposal to impose a 5% tax on modified adjusted gross income(adjusted gross income reduced by any deduction allowed for investment interest) in excess of $10 million ($5 million for taxpayers filing as married filing separately). An additional 3% tax would apply to modified adjusted gross income over $25 million ($12.5 million for taxpayers filing as married filing separately). This shall apply to tax years beginning after December 31, 2021.

3.8% Net Investment Income (“NII”) Tax to Trade or Business Income. Currently, trade or business income earned by an individual that materially participates in a given business (e.g., spends 500 hours or more per year on said business) is not subject to the 3.8% tax on NII. This exception is eliminated under this Act. Instead, all trade or business income would be subject to the 3.8% tax for tax years beginning after December 31, 2021. The NII tax already applies to investment income (e.g., interest, dividends, and capital gains). Pursuant to the Act, the new NII tax treatment for trade or business income would apply to taxpayers earning more than $400,000 annually ($500,000 for married filing jointly). Net operating losses would no longer be accounted for in determining NII.

State and Local Tax (SALT) Deduction Limitation: Currently, the SALT deduction is limited to $10,000. Effective for tax years beginning 2021 through 2030, the threshold will be raised to $80,000, before being reduced back to $10,000 for 2031. It would then expire permanently as of 2032.

Exclusions from Prior Proposal:

  • The increase to a top individual ordinary income tax rate of 39.6%, and a long term capital gains rate of 25% are no longer included in the revised Act.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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