A&M Tax Advisor Weekly
On Monday, March 28th, the Biden Administration transmitted its fiscal year 2023 budget recommendations to Congress, which lay out the Administration’s discretionary spending plan for the fiscal year beginning October 1, 2022, along with its long-term infrastructure and social spending plans. In addition, Treasury released its General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals (the “Green Book”), most of the content of which was outlined in the Administration’s FY 2022 budget recommendations discussed in our alert last year.
When considering the new Green Book, it is important to keep in mind that the Administration has assumed, to some extent, that the House passed a version of the Build Back Better Act (BBBA) will be enacted, which means the FY 2023 revenue proposals are on top of the BBBA provisions discussed in our prior alert. With the uncertainty surrounding the BBBA, it is unclear whether any of these “new” proposals will be enacted by Congress, or if they are more akin to talking points in advance of the midterm elections. Nonetheless, we thought it would be helpful to highlight some of the proposals renewed from last year and what has changed, along with details on some new proposals.
Specifically, the following topics are covered in this alert:
A&M Insight: The proposal is the Administration’s attempt to address a perceived abuse regarding taxpayers’ use of high vote/low vote stock in structuring transactions to achieve either a tax-free or a taxable transaction. However, conforming the control test for purposes of certain corporate transactions and reorganizations with the test for affiliated companies raises the specter of valuation disputes as companies will need to determine the value of their different classes of stock to determine whether certain transactions are eligible for tax-free treatment. Also, because the affected transactions would involve individuals, rather than only affiliated corporations that generally wholly own their subsidiaries, taxpayers would have to address numerous complexities in determining value, such as applicable discounts and premiums. Further, it is unclear whether certain types of stock would be excluded from this determination, similar to the rules governing affiliated group determination, which would seem to provide a mechanism to circumvent the proposal.
A&M Insight: If the BBBA’s proposed changes to the GILTI regime and the UTPR are adopted, the U.S. would arguably be compliant with the OECD Pillar 2 model rules. However, that may be in doubt if the adopted UTPR preserves the benefits of U.S. tax credits and other tax incentives to allow an effective tax rate below 15%. Also, it is unclear what the effect would be on U.S. companies if other countries do not adopt Pillar 2. It appears that if most countries adopt Pillar 2, it may be beneficial for all countries to adopt the rules. But if several countries lag in adoption, or decline to adopt Pillar 2, companies in jurisdictions that have adopted the rules might be subject to higher worldwide effective tax rates than companies in jurisdictions that have not. Multinational groups with in-scope companies should actively monitor the Pillar 2 positions and plans for those jurisdictions in which they operate or derive revenue. It may become desirable to reposition activities or modify the group structure to minimize the impact of Pillar 2 taxes on the group’s ongoing worldwide effective tax rate.
It is also worth noting that, unlike last year’s Green Book, this year’s Green Book does not include a proposal to expand the scope of the inversion rules. While it is unclear why the Administration choose not to repropose the changes, as they are also not included in the BBBA, it is possible that it is due to the proposed implementation of the UTPR.
A&M Insight: While the proposal is intended to incentivize taxpayers to bring their businesses back to the U.S., the fact that this has been proposed could have the opposite effect until it is adopted. This is because companies that are currently considering bringing their businesses back to the U.S. are incentivized to wait because they will not be eligible for the credit unless they incur the expenses after enactment. Companies may also be incentivized to offshore their trades or businesses prior to enactment.
A&M Insight: The Green Book proposal would be a welcome relief for taxpayers who inadvertently failed to file a timely QEF election and cannot satisfy the existing requirements to obtain IRS consent. The proposed changes would also eliminate the need for a private letter ruling, reducing the burden and costs for taxpayers and the IRS. However, to permit taxpayers to make QEF elections affecting closed years raises some interesting questions that might need clarification to existing statutes of limitations. For example, would taxpayers be allowed a refund for a closed year to recover taxes paid on PFIC excess distributions.
A&M Insight: The inclusion of the increase to the top individual tax rate, as well as the corporate tax rate discussed above, in this year’s Green Book is interesting as Senator Sinema has been adamant that she would not support tax rate changes. However, it appears that Senator Sinema supports the BBBA’s individual surcharge. If the BBBA’s surcharge and net investment income tax (NIIT) changes are adopted, in addition to the two proposals discussed above, then tax liabilities for high-net-worth individuals will presumably increase significantly.
A&M Insight: The minimum income tax proposal, which is estimated to raise approximately $361 billion over 10 years — nearly 15% of the total estimated net receipts of $2.5 trillion — has already been nixed by Senator Manchin, at least regarding the taxing of unrealized gains, making it unlikely that it will advance. Taxing unrealized gains has been floated before without success, such as in Senate Finance Committee Chairman Ron Wyden’s 2021 proposed Billionaire’s Income Tax, although Biden’s proposal differs from Wyden’s in some respects.
A&M Insight: Because the BBBA would not have made broad changes to the taxation of estates, trusts, and gifts, many individuals took comfort that existing planning strategies remained useful and that no rush to implement any planned changes was needed. As noted in our analysis of last year’s Green Book, with these proposed changes, taxpayers will want to consider the implications of the proposals, while also noting the proposed effective dates to timely implement any changes to new or existing strategies.
A&M Insight: It is unclear to what extent abusive basis-shifting transactions occur, but the proposal is estimated to raise nearly $62 billion in revenue over 10 years. The approach seems analogous to the BBBA proposal in the corporate context regarding Granite Trust transactions and would have similar tracing concerns, as well as raise questions regarding related-party rules and tiered partnerships. Moreover, the anti-basis shifting proposed would likely sweep in legitimate transactions between related parties in a partnership that are not motivated by tax avoidance.
A&M Insight: The depreciation recapture proposal would have significant financial and administrative implications for certain real estate businesses, likely drawing the ire of industry advocates. Nevertheless, real estate businesses and their investors should keep an eye on potential changes to the depreciation recapture and like-kind exchange rules and be prepared to model scenarios and potential effects.
A&M Insight: For the most part, the Green Book’s proposals regarding digital assets, including cryptocurrency, are welcome news. In the meantime, as the use of cryptocurrency and other digital assets (e.g., non-fungible tokens (NFTs)) continues to increase, taxpayers are left wondering how to properly characterize their transactions. It is essential to receive proper tax advice regarding their treatment and A&M is happy to assist.
With all eyes on the Senate as to the potential passage of any tax reform proposals, many officials have stated that they are anticipating that any tax reform proposals that are adopted would generally be within the scope of the BBBA. In other words, proposals that were not passed by the House are unlikely to be included in a final bill. This casts a long shadow on the Administration’s hopes of including the proposals in the Green Book, as it has assumed that BBBA, at least to some extent, will be adopted. With that said, Congress has an unpredictable nature about adopting proposals and so corporations, partnerships, and individuals should consider “what-if” scenarios to understand the potential impact in the event a proposal starts to gain traction in Congress. The changes most likely to advance seem to be those that align with the OECD’s Pillar 2 rules, recognizing that even those proposals face some resistance, perhaps even more so if the effective tax rates on GILTI and FDII exceed the global minimum tax of 15%. A&M will continue to monitor the BBBA provisions and other tax reform legislation, if any, that could be enacted before the end of the year. As always, we are available to discuss the proposals and your specific business and tax challenges in managing through unprecedented times characterized in part by the Ukraine-Russia situation, lingering COVID-19 concerns, supply chain issues, and high inflation.