On March 28, 2022, President Biden released his fiscal year 2023 budget (the “Fiscal Year 2023 Budget”) and the US Treasury released the so-called “Green Paper,” which provides details on the provisions FY2023 budget revenue proposals. FY2023 budget revenue proposals are based on a baseline that generally assumes the enactment of the revenue provisions of the Build Back Better Act ( the “BBBA”) as passed by the House of Representatives on November 19, 2021. Accordingly, the revenue proposals outlined in the Green Paper are intended to be in addition to the provisions included in the BBBA. It should be noted that the BBBA has been stuck in the Senate since late 2021. The current status of the BBBA is not entirely clear, but it would appear that the most likely way forward may be tighter tax legislation In this regard, the revenue proposals in the budget of the 2023 financial year could be interesting, since some of these proposals could be included in future legislation.
The FY2023 budget includes several proposals that were first proposed in the administration’s FY2022 budget, but were not included in the BBBA. Notably, the FY2023 budget again proposes:
- an increase in the corporate C tax rate from 21% to 28%;
- an increase in the top marginal tax rate from 37% to 39.6% for taxable income over $450,000 for married individuals filing jointly ($400,000 for unmarried individuals);
- a limitation of the deferred gain under section 1031 to $500,000 ($1 million in the case of married persons filing jointly) per taxpayer per year;
- subject long-term capital gains and eligible dividends to ordinary income rates for taxpayers with taxable income over $1 million;
- for partners whose taxable income (from all sources) exceeds $400,000, by submitting a partner’s attributable share of income from beneficial interests in investment partnerships (i.e. partnership level;
- a permanent extension of the new markets tax credit; and
- treat transfers of assets appreciated by gift or death as realization events subject to capital gains tax, subject to a lifetime exclusion of $5 million per donor.
Below is a high-level summary of some revenue proposals included in the fiscal year 2023 budget that were neither proposed in the fiscal year 2022 budget nor included in the BBBA.
Minimum tax on net worth. A 20% minimum tax that includes a mark-to-market regime with respect to unrealized capital gains for taxpayers with net worth over $100 million. The proposal would include installment payment options as well as a choice for “illiquid taxpayers” to only include unrealized gains from marketable assets in calculating their tax liability; however, such illiquid taxpayers would be subject to a deferral charge (up to 10%) upon recognition of a gain on elected non-marketable assets. For this purpose, a taxpayer is illiquid if the negotiable assets represent less than 20% of his wealth. The proposal would apply to taxation years beginning after December 31, 2022.
Extension of recovery under section 1250. For capital cost allowances taken on section 1250 property (for example, depreciable real estate) after the effective date of the proposal, the gain on the disposition of such property would be treated as ordinary income. Capital cost allowances taken from section 1250 property before the effective date of the proposal would be subject to the current rule and recaptured as ordinary income (subject to a maximum rate of 25% at the for unincorporated taxpayers) to the extent that such depreciation exceeds the accrued entitlement -line depreciation. The proposal would not apply to unincorporated taxpayers with adjusted gross income of less than $400,000 and would be effective for the depreciation and disposition of Section 1250 property in taxation years beginning after on December 31, 2022.
G&S overview: The recovery proposal could have a significant impact on real estate investors. Individual taxpayers would see more of the gain on disposition reclassified as ordinary income and subject to full ordinary income rates. Corporate taxpayers may also be affected to the extent that they have capital losses. Assuming Section 1031 remains in its current form, this change may increase the gain recognized on otherwise tax-exempt Section 1031 exchanges involving the exchange of a Section 1250 property (e.g., building) against property not covered by Section 1250 (for example, land).
Undertaxed profit rule. Repeal the Base Erosion Anti-Abuse Tax (“BEAT”) and replace it with an Undertaxed Profits Rule (“UTPR”) based on the OECD second pillar model rules. Model second pillar rules include an all-encompassing minimum tax that would impose (i) an additional tax on group parents with respect to the low-taxed income of members of its financial reporting group and (ii) a UTPR, which denies deductions to the extent that the low-taxed income of a group member is not subject to additional tax. It would appear that the proposed UTPR would deviate from the model second pillar rules by including an adjustment to ensure that US taxpayers continue to benefit from certain US tax credits and other incentives that promote jobs and investment in United States. In addition, the proposal would include a minimum domestic top-up tax to protect US earnings from the imposition of UTPR schemes by other countries. Given the application of low-taxed existing global intangible income, or
GILTI, a regime applicable to multinational groups with US parentage, the Treasury anticipates that the proposed UTPR would apply primarily to multinationals with non-US parentage operating in low-tax jurisdictions. disallowed US tax deductions to the extent necessary to collect the hypothetical additional tax required for the financial reporting group to pay an effective tax rate of at least 15% in each jurisdiction in which the group earns profits. For this purpose, the group’s income and effective tax rate would be calculated on a jurisdiction-by-jurisdiction basis subject to certain adjustments. Only financial reporting groups with at least $850 million in annual revenue in at least two of the previous four years would be subject to the tax. In addition, the proposal includes a de minimis exception that would exclude certain jurisdictions from the calculation to the extent the reporting group has less than $11.5 million in revenue and $1.15 million in profit in that jurisdiction based, in both cases, a 3-year moving average. The proposal also includes an exception for groups that are in the early stages of international expansion to the extent that such groups operate in up to five jurisdictions (other than the primary jurisdiction of the group) and the book value of the tangible assets of the group in these jurisdictions is less than $57 million. The proposal would apply to taxation years beginning after December 31, 2023.
Modification of the “control” criterion under section 368(c). The current test of control under section 368(c), which applies to tax-exempt contributions under section 351 and certain tax-exempt reorganizations, requires at least 80% of the vote of all classes of shares with voting rights and at least 80% of the total number of shares of each class of shares without voting rights. The proposed change would bring the control test in section 368 into line with the test for affiliation in section 1504(a)(2), which is a vote and value test. Among other things, this change would eliminate the use of certain high-vote/low-value arrangements that are permitted under the current Section 368(c) control test. The proposal would be effective for transactions made after December 31, 2022.
LIHTC Core Boost. The proposal would allow public housing credit organizations to give impetus on a non-geographical basis to certain low-income housing tax credit projects financed by passive activity obligations. The proposal would only be effective for buildings that receive more than the minimum funding from passive activity bonds that are part of a bond issue with an issue date after the date of enactment.