On March 28, 2022, the Biden Administration released its budget proposal for Fiscal Year 2023 (the Budget). We summarize below the tax aspects of the Budget of particular interests to U.S. corporate taxpayers, financial institutions, investment funds, and their investors.
The Budget builds on the policy themes of the Build Back Better Act (the BBBA, which we summarized here and here). The Budget generally does not contain provisions that overlap or conflict with the House-passed version of the BBBA, appearing instead to assume that the BBBA will proceed in parallel. New and notable proposals in the Budget include:
- Increasing the corporate income tax rate to 28%
- Increasing the top marginal income tax rate applicable to individuals to 39.6%
- Taxing certain carried interests as ordinary income
- Limiting the benefit of long-term capital gains and qualified dividend income for high earners
- Generally conforming rules applicable to digital assets (e.g., cryptocurrencies) with those applicable to other securities/commodities activities
Nearly all of the proposals in the Budget would require Congressional action, and so the prospects for enacting any or all of the proposals contained in the Budget is unclear at best.
Part II below discusses corporate tax measures. Part III discusses partnership tax measures, Part IV discusses individual tax measures, Part V discusses digital asset and cryptocurrency tax measures, and Part VI discusses procedural tax measures.
II. Corporation Tax Provisions
- Increase Corporate Rate. Effective for taxable years beginning after December 31, 2022, the Budget would increase the tax rate for C corporations to 28% (from the current 21%). A transition rule would apply a blended rate for taxable years straddling January 1, 2023.
- BEAT Reform. The Budget would repeal the “Base Erosion Anti-Abuse Tax” (BEAT) and replace it with an “Undertaxed Profits Rule” (UTPR). The UTPR is based on the OECD/G20 framework and provides that a parent entity will be subject to a “top-up” tax on low-taxed income earned by members of its financial reporting group and will lose deductions (or be subject to equivalent tax liability adjustments) to the extent low-taxed income of a group member is not subject to the top-up tax. The UTPR is primarily aimed at foreign-parented multinational groups operating in low-tax jurisdictions and is intended to ensure that U.S. subsidiaries of such groups, as well as U.S. branches of foreign corporations, pay at least a 15% minimum tax on a global basis.
The UTPR would apply only to groups that have global annual revenue of at least $850 million in two of the prior four years, and would include several de minimis exceptions. The repeal of the BEAT and the imposition of the UTPR would be effective for taxable years beginning after December 31, 2023.
- Onshore Credit. The Budget provides a new 10% general business credit for expenses paid in connection with onshoring a U.S. trade or business. “Onshoring a U.S. trade or business” includes reducing or eliminating a trade or business or line of business currently conducted outside the United States and starting up, expanding, or otherwise moving the same trade or business within the United States, to the extent the result is an increase in U.S. jobs. The credit would be available for expenses paid or incurred after the date of enactment.
- Conform Definition of Control. Under current law, the definition of “control” is not consistent across several provisions applicable to corporations. The Budget would replace the section 368(c) control test with the section 1504(a)(2) definition of control, which defines “control” as ownership of at least 80% of the total voting power and at least 80% of the total value of the stock of a corporation. The change is aimed at reducing taxpayers’ ability to control the qualification of a transaction as tax-free. This provision would be effective for transactions occurring after December 31, 2022.
III. Partnership Tax Provisions
- Tax Carried Interest in Investment Services Partnerships as Ordinary Income. For taxpayers with more than $400,000 of taxable income, the Budget would treat such taxpayer’s income attributable to an “investment services partnership interest” as ordinary, regardless of the character at the partnership level and would also require such partner to pay self-employment tax with respect to such income. Similarly, a portion of such a taxpayer’s gain on the disposition of an “investment services partnership interest” would be treated as ordinary income.
The Budget generally applies to service providers’ profits interests in an investment partnership, which is generally defined to include partnerships with substantially investment-type assets and passive investor partners.
Exceptions and reductions to recharacterization would be available to the extent a partner invests capital in the partnership and is subject to allocations in the same manner as non-service provider partnership interests. Invested capital would not include loan proceeds. An anti-abuse rule would apply similar rules to other interests held by service providers, including convertible or contingent debt, options, and derivatives.
The changes would be effective for taxable years beginning after December 31, 2022.
- Prevent Basis Shifting Between Related Partners. Under current law, a distribution of property by a partnership to one partner may result in a basis step-up of the partnership’s remaining property, generally based on the gain recognized by the distributee. The Budget would impose a matching rule for related-person partners aimed at preventing any partner from benefiting from a partnership’s basis step-up attributable to a distribution of property to a related-person partner until such related-person partner has disposed of the distributed property in a taxable transaction. This provision would be effective for partnership taxable years beginning after December 31, 2022.
- Elimination of Publicly Traded Partnerships with Fossil Fuel Qualifying Income. The Budget contains several provisions aimed at reducing tax benefits targeted towards oil, gas, and coal. In particular, the Budget would repeal the statutory exception to corporate tax treatment for publicly traded partnerships with qualifying income from activities related to fossil fuels. This provision would be effective for taxable years beginning after December 31, 2027.
IV. Individual Tax Provisions
- Increase Individual Marginal Income Tax Rates. The Budget would increase the top marginal tax rate applicable to individual’s income to 39.6% (from the current 37%). The top marginal tax rate would apply to taxable income over $450,000 for married individuals filing a joint return, $400,000 for unmarried individuals (other than surviving spouses), $425,000 for head of household filers, and $225,000 for married individuals filing a separate return. After 2023, the thresholds would be indexed for inflation. The change would be effective for taxable years beginning after December 31, 2022.
- Tax Long-Term Capital Gain at Ordinary Income Rates. To the extent that a taxpayer’s taxable income exceeds $1 million (indexed for inflation after 2023), the Budget would subject long-term capital gains and qualified dividends to tax at ordinary rates. The proposal would be effective for gain required to be recognized and for dividends received on or after the date of enactment.
- Minimum Tax on Wealthy Taxpayers. The Budget would impose a 20% minimum tax on all taxpayers with net wealth greater than $100 million. The minimum rate would be applied to both taxable income and unrealized gains of the taxpayers (including unrealized capital gain and gain on ordinary assets). Payments of minimum tax would reduce subsequent tax liability on realized gains. Taxpayers with net wealth over $100 million would be required to report their total basis and estimated asset values (by class) annually. Tax on illiquid assets would be based on an assumed annual return (the 5-year Treasury rate plus two percentage points). The proposal would be effective for taxable years beginning after December 31, 2022.
- Treat Transfers of Appreciated Property by Gift or on Death as Realization Events. Under current law, a donor of an appreciated asset does not recognize gain upon donation, and the recipient’s basis in the gifted property is the same as the donor’s. If an appreciated asset is held until a taxpayer’s death, there is no realization event when the property passes to the taxpayer’s heirs, and the heirs’ basis in such property is the fair market value of the property on the date of the taxpayer’s death. The recipient’s basis in such property would always be the property’s fair market value at the time of the gift or the decedent’s death.
The Budget provides that a donor or decedent would recognize capital gain upon the transfer of an appreciated asset to a donee or heir, subject to certain exceptions for (i) transfers to a U.S. spouse or to charity, (ii) transfers of tangible personal property, and (iii) certain other property that is currently subject to special rules, such as a principal residence and certain small business stock. The Budget also allows a $5 million per-donor exclusion (effectively $10 million for married couples) that would be indexed for inflation after 2022. The Budget also provides for deferral elections, including a 15-year payment plan and a deferral until disposition for family-owned operating businesses.
These changes 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.
- Limitation of Like-Kind Exchange Rules. Under the Tax Cuts and Jobs Act of 2017, the ability to exchange like-kind trade or business or investment property was limited to real property. The Budget would further limit this rule by allowing the deferral of gain only up to an aggregate amount of $500,000 for each taxpayer ($1 million in the case of married individuals filing a joint return) each year for real property exchanges that are like-kind. The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2022.
V. Digital Asset and Cryptocurrency Tax Provisions
- Application of Securities Loan Rules to Digital Assets. Under current law, securities loans do not result in the recognition of gain or loss (either on initial transfer or return) if made pursuant to agreements that meet certain requirements. The Budget would apply these rules applicable to securities loans to loans of actively traded digital assets (including cryptocurrency) for taxable years beginning after December 31, 2022.
- Mark-to-Market Rules for Digital Assets. Current law allows commodity dealers and security or commodity traders to elect to use the mark-to-market method (generally recognizing ordinary gain or loss on an annual basis based on the change in value of such securities or commodities). The Budget would permit dealers and traders of actively traded digital assets (including cryptocurrencies) and derivatives on or hedges of such assets to elect to use the mark-to-market method. Digital assets would constitute a new class of assets eligible for mark-to-market treatment separate from securities or commodities for purposes of the existing rules. These changes would be effective for taxable years beginning after December 31, 2022.
- Digital Asset Information Reporting. As part of an expanded information reporting regime, the Budget would require brokers (including U.S. digital asset exchanges) to report gross proceeds (and such other information as Treasury may require) regarding sales of digital assets (including cryptocurrencies) with respect to customers and, in the case of certain passive entities, their substantial foreign owners. The United States would then share the reported information with partner jurisdictions as part of its current automatic information-sharing network.
The Budget would also require foreign asset reporting with respect to accounts that hold digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider. The current $50,000 threshold for foreign asset reporting would include the value of such digital assets.
These changes would be effective for returns required to be filed after December 31, 2022.
VI. Procedural Tax Provisions
- Affirmative Requirement to Disclose Positions Contrary to a Regulation. The Budget would require taxpayers affirmatively disclose any position taken on a tax return that is contrary to a regulation. Failure to do so (other than due to reasonable cause) would result in a penalty equal to 75% of the reduction in tax attributable to such position (with a minimum penalty of $10,000 and a maximum of $200,000). There would be no penalty to the extent that the taxpayer reasonably and in good faith believed its position was consistent with the relevant regulation. This rule would be effective for returns filed after the date of enactment.
- Expanded Statute of Limitations for Certain Tax Assessments. Effective for returns filed after the date of enactment, the Budget would provide a six-year statute of limitations if a taxpayer omits from gross income more than $100 million on a return.