On March 28, 2022, President Biden announced his 2023 federal budget (Budget), which is often referred to as the President’s Green Book. While much of the Budget harkens back to the “Build Back Better Framework” (Framework), the Budget narrows down some of the Framework’s loftier goals and re-focuses on Biden’s “new economic vision,” which consists of reducing costs for families, reducing the deficit, and building a better America. More specifically, Biden stated that:
“[i]t fulfills my ironclad promise that no one earning less than $400,000 per year would pay an additional penny in new taxes–while ensuring that the wealthiest Americans and the biggest corporations begin to pay their fair share.” That said, the Budget contains a myriad of proposals including:
- Increasing the top individual marginal rate from 37% to 39.6% for those that qualify as: (1) married filing jointly with taxable income in excess of $450,000; (2) heads of household with taxable income in excess of $425,000; and (3) single filers with taxable income in excess of $400,000. These rates would become effective in 2023.
- Raising the corporate income tax to 28% from the Trump-era corporate tax reduction of 21%.
- $14.1 billion for the IRS to expand customer service, improve technology, and improve digital compliance tools.
- $331 million for the Community Development Financial Institutions Fund.
- $210 million for the Financial Crimes Investment Network.
- The Budget proposes a new tax credit “equal to 10[%] … of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business.” The tax code would also be amended to prevent business from deducting expenses related to moving jobs or businesses overseas.
- Partnership Tax § 754 Overhaul. Currently, a partnership may make an election under § 754 of the Code (§754 election), which allows that partnership to adjust the basis of property distributed to a partner. The Budget purports to shut down the §754 election when made between related partners because the Treasury claims it allows parties to shift basis amongst themselves in a manner that has been perceived as abusive.
- Make the New Markets Tax Credit Permanent. This is an up-to-39% credit for making a qualified investment in low-income communities which was set to expire at the end of 2025.
- Elimination of Fossil Fuel Tax Preferences. This proposal includes eliminating: (1) the enhanced oil recovery credit for certain projects; (2) the credit for oil and gas extraction from marginal wells, intangible drilling costs; (3) expensing exploration and development costs; and (4) the accelerated amortization for air pollution control facilities.
- Reinstating and increasing the Superfund excise tax on crude oil and imported petroleum productions to 16.4 cents per barrel.
- Like-Kind Exchanges. The deferral of gain from the exchange of real property used in a trade or business or held for investment would be limited to $500,000 per taxpayer and any gains in excess of that would be subject to tax in the year the like-kind exchange occurs.
- Limiting GST Exempt Status of Trusts. The Green Book proposes limiting the duration of a trust’s exempt status for generation-skipping transfer (GST) tax purposes so that it lasts no further than the lives of great-grandchildren who were alive: (1) when the trust was created (for trusts to be created in the future); or (2) on the date of this proposal’s enactment (for pre-existing trusts). Reforming the Taxation of Capital Gains Currently, capital assets held for more than a year receive preferential long-term capital gains treatment and are taxed at 20%. One effective tax planning tool is transferring a capital asset, either through donation or upon death of the taxpayer, to a new owner. There are two tax savings with this approach: first, the new owner receives a step-up in the asset’s basis to the asset’s then-applicable fair market value; and second, the taxpayer doesn’t trigger any tax recognition at that time because the capital asset is not considered “sold” (and the recognition of gain or loss is typically only triggered when sold). The Budget proposes to eradicate this tax benefit for some taxpayers. First, the Budget would require taxpayers with taxable annual income in excess of $1 million to treat long-term capital gains and qualified dividends as ordinary income, subject to ordinary income rates of 37%-39.6%. Second, the Budget would also create a taxable event when a taxpayer transfers an appreciated capital asset to another taxpayer in any of three primary situations; namely: (1) at death; (2) by lifetime gift; or (3) via a trust that holds such assets past a specified time period of 90-years. For example, if a taxpayer bought stock for $1 and left that same stock to his daughter in his will when it was worth $10,000, then the daughter would have to pay tax on gain inherent in that transferred stock. In other words, the daughter would have to pay tax on that $9,999 of built-in gain that was realized (but not recognized) during her father’s ownership period. There are, however, two primary exceptions to this proposed new treatment. First, gifts made during the taxpayer’s lifetime or upon death to a “U.S. spouse” would be excluded and that tax would only apply when the U.S. spouse dies or no longer possesses the asset through subsequent sale or transfer. Second, donations to a charity made during the taxpayer’s lifetime or upon death would not trigger a taxable event. The proposals fail to offer any adjustment for the portion of realized capital gains which represent only the effects of inflation, as is done in some other national tax systems. “Billionaires’ Tax” The Budget also contemplates a minimum tax on wealthy individuals, often dubbed the “Billionaires’ Tax.” This tax would be a 20% tax on total income, including unrealized capital gains, for those individuals with wealth exceeding $100 million. Taxpayers can prepay this tax in installments, similar to the quarterly estimated payments required of some taxpayers. Those prepayments would offset any taxes owed at the end of the year and the Billionaires’ Tax would be credited to the taxpayer when a capital asset is eventually sold, so as to avoid any double taxation. The Budget also proposes valuation methods, including using the end-of-year market price for tradable assets, but wouldn’t require valuations for non-tradable assets. Instead, non-tradable assets could be valued by reference to the adjusted cost basis, by using the valuation listed in financial statements, or by another accepted method and would increase in value each year by a “conservative floating annual return (the five-year Treasury rate plus two percentage points)”. This concept was also discussed in the Framework and continues to receive pushback from several members of Congress. Grantor Trusts and GRATS Grantor Retained Annuity Trusts (GRATs) and Grantor Trusts are tax advantageous estate planning techniques used to limit taxes while transferring wealth from one generation to another. However, the Budget would greatly minimize the benefits of these options by implementing the following changes that would: (1) require a minimum taxable gift portion of the trusts of either 25% of the trust assets or $500,000; (2) mandate a ten-year minimum GRAT term life; (3) limit the ability of a grantor to grow assets tax-free inside of a GRAT; (4) tax the transfer of assets into a GRAT; and (5) cause any tax paid by the grantor to be treated as additional taxable gifts to the trust. Conservation Easements The IRS continues to crackdown on the use of conservation easements as perceived tax shelters through civil and criminal enforcement. As President Biden suggested in the Framework, the Budget also includes a proposal to disallow conservation contributions in excess of two-and-a-half times the donor-partner’s basis in the entity. However, the rule wouldn’t apply to real property held by the partnership for more than three years. The Budget didn’t include several provisions that were included in the Framework and prior Congressional tax bills such as: (1) the 15% minimum tax on large corporations and a 1% surcharge on corporate stock buybacks; (2) the Millionaires’ Surtax; (3) changes to the taxation of S-Corporations; (4) changes to the taxation of Cryptocurrency; (5) changes to credits for state and local taxes; or (6) student loan forgiveness. While the President’s budget proposals are typically more properly conceived of as a “wish list” of sorts, many similar proposals received significant pushback in 2021 and the outlook for 2022 doesn’t look any brighter. Adding to the madness, the IRS is still processing thousands of tax returns in its backlog and many taxpayers will still be waiting months before tax refunds are issued. While tax increases are rarely met with cheering crowds, after years of pandemic living and the clouds of a potential recession looming, it’s unlikely that any of these proposed tax changes will be met with glowing support.