Fernway DiarySM

Oct 12, 2021

Continuing negotiations in the U.S. Congress have resulted in evolving changes to the proposed corporate and individual tax regulations that have been under discussion in 2021. For businesses and individuals trying to gauge the effect of possible updates to the tax code, here’s a summary of the latest information, as excerpted from the House Committee on Ways & Means document, breaking down current proposals. (For complete details and additional provisions not covered below, please read here.)

Corporate and International Tax Reforms

Increase in Corporate Tax Rate: Flat corporate income tax to be replaced with a graduated rate structure. The rate would be 18{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} on the first $400,000 of income, 21{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} on income up to $5 million, and 26.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} on income thereafter. The benefit of the graduated rate phases out for corporations making more than $10,000,000. Personal services corporations would not be eligible for graduated rates. The domestic dividends received deduction would be adjusted to hold constant the tax on domestic corporate-to-corporate dividends.

Limitation on Deduction of Interest by Certain Domestic Corporations Which Are Members of an International Financial Reporting Group: Would limit the interest deduction of certain domestic corporations which are members in an international financial reporting group to an allowable percentage of 110{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} of net interest expense.

Modifications to Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income: Would reduce the deduction with respect to both FDII (to 21.875{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}) and GILTI (to 37.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}). In combination with the proposed 26.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} corporate rate, this would yield a 16.5625{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} effective GILTI rate and a 20.7{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} effective FDII rate. If the deduction with respect to GILTI or FDII exceeds taxable income, the excess would be allowed as a deduction, which would increase the net operating loss for the taxable year. A transition rule would be provided for taxable years that include but do not end on December 31, 2021.

Repeal of Election for 1-Month Deferral in Determination of Taxable Year of Specified Foreign Corporations: Would strike section 898(c)(2) of Section 138122 of the tax code, which previously allowed the choice of a taxable year beginning 1 month earlier than the majority U.S. shareholder year.

Modifications of Foreign Tax Credit Rules Applicable to Certain Taxpayers Receiving Specific Economic Benefits: Would provide that any amount paid by a dual capacity taxpayer to a foreign country will not be considered a tax to the extent it exceeds the generally applicable income tax of that country, to ensure such taxpayers cannot claim foreign tax credits for payments not deemed to be income taxes.

Modifications to Foreign Tax Credit Limitations: Would require foreign tax credit determinations on a country-by- country basis for purposes of sections 904, 907, and 960 of Section 138124. These foreign tax credit computations entail assigning each item of income and loss to a taxable unit of the taxpayer which is a tax resident of a country (or, in the case of a branch, has a taxable presence in such country). Additionally, this provision would repeal the foreign branch income basket, limit the carryforward of excess foreign tax credit limitation to five succeeding taxable years (compared with 10 years under current law), and repeal the carryback of such foreign tax credit limitation (compared with 1 year carryback under current law).

Modifications to Inclusion of Global Intangible Low-Taxed Income: Would amend section 951A of Section 138126 to provide for country- by-country application of the GILTI regime. Other items and amounts including net CFC tested income, net deemed tangible income return, qualified business asset investment (QBAI), and interest expense would be determined on a country-by-country basis as well.

Modifications to Determination of Deemed Paid Credit for Taxes Properly Attributable to Tested Income: Would substantially reduce the 20{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} haircut on foreign tax credits by increasing from 80{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} to 95{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} the deemed paid credit for taxes attributable to GILTI (80{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} to 100{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in the case of taxes paid or accrued to U.S. territories). This provision would also ensure that a corporation is treated as a controlled foreign corporation only if it has direct U.S. shareholders and applies special rules to foreign owned U.S. shareholders.

Deduction for Foreign Source Portion of Dividends Limited to Controlled Foreign Corporations, etc.: Current law provides a 100{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} participation exemption for foreign portions of any dividends received from a specified 10-percent owned foreign corporation, even in cases where the foreign corporation is not a controlled foreign corporation (and therefore not subject to subpart F and GILTI regimes). This amendment would limit the exemption to foreign portions of dividends received only from controlled foreign corporations.

Limitation on Foreign Base Company Sales and Services Income: Would limit Foreign Base Company Sales and Services Income to residents of the U.S. and passthrough entities and branches in the U.S. and close loopholes that cause shareholders of a controlled foreign corporation to avoid tax on some income from their controlled foreign corporations.

Modifications to Base Erosion and Anti-Abuse Tax (BEAT): The BEAT rate in section 59A(b)(1)(A) of Section 138131 would be amended to 10{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in taxable years beginning after December 31, 2021, and before January 1, 2024; to 12.5{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in taxable years beginning after December 31, 2023, and before January 1, 2026; and to 15{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in any taxable year beginning after December 31, 2025. The rules for determining modified taxable income would also be modified. Base erosion payments would be amended to include amounts paid to a foreign related party that are required to be capitalized in inventory, as well as amounts paid to a foreign related party for inventory which exceed the costs of the property to the foreign related party. A safe harbor would be available to deem base erosion payments attributable to indirect costs of foreign related parties as 20{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} of the amount paid to the related party. The provision would provide an exception for payments subject to U.S. tax, and for payments to foreign parties if the taxpayer establishes that such amount was subject to an effective rate of foreign tax not less than the applicable BEAT rate. The provision would also limit the exception to the provision for taxpayers with a low base erosion percentage to taxable years beginning before January 1, 2024.

Modifications to Treatment of Certain Losses: Would provide that losses with respect to securities are treated as realized on the day that the event establishing worthlessness occurs. In addition, partnership indebtedness would be treated in the same manner as corporate indebtedness, and a loss on a worthless partnership interest would be subject to the same rules as a loss in a sale of a partnership interest. The treatment of taxable liquidations of corporate subsidiaries would also be changed; a loss in a taxable liquidation would be deferred until the property received in the liquidation is sold to a third party.

Tax Increases for High-Income Individuals

Increase in Top Marginal Individual Income Tax Rate: The top marginal individual income tax rate would increase to 39.6{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}. This marginal rate would apply to married individuals filing jointly with taxable income over $450,000, to heads of households with taxable income over $425,000, to unmarried individuals with taxable income over $400,000, to married individuals filing separate returns with taxable income over $225,000, and to estates and trusts with taxable income over $12,500.

Increase in Capital Gains Rate for Certain High-Income Individuals: Would increase the capital gains rate to 25{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f}. A transition rule would provide that the preexisting statutory rate of 20{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} continues to apply to gains and losses for the portion of the taxable year prior to the date of the new law’s introduction.

Application of Net Investment Income Tax to Trade or Business Income of Certain High-Income Individuals: Would expand the net investment income tax to cover net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer), as well as for trusts and estates. This tax would not be assessed on wages on which FICA is already imposed.

Limitation on Deduction of Qualified Business Income for Certain High-Income Individuals: Would set the maximum allowable deduction at $500,000 in the case of a joint return, $400,000 for an individual return, $250,000 for a married individual filing a separate return, and $10,000 for a trust or estate.

Limitations on Excess Business Losses of Noncorporate Taxpayers: Would permanently disallow excess business losses (i.e., net business deductions in excess of business income) for noncorporate taxpayers. The provision would allow taxpayers whose losses are disallowed to carry those losses forward to the next succeeding taxable year.

Surcharge on High-Income Individuals, Trusts, and Estates: Would impose a tax equal to 3{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} of a taxpayer’s modified adjusted gross income in excess of $5,000,000 (or in excess of $2,500,000 for a married individual filing separately).

Termination of Temporary Increase in Unified Credit: Would terminate the temporary increase in the unified credit against estate and gift taxes, reverting the credit to its 2010 level of $5,000,000 per individual, indexed for inflation.

Certain Tax Rules Applicable to Grantor Trusts: Would pull grantor trusts into a decedent’s taxable estate when the decedent is the deemed owner of the trusts. Previously, taxpayers were able to use grantor trusts to push assets out of their estate while controlling the trust closely. This provision would also treat sale between grantor trusts and their deemed owner as equivalent to sales between the owner and a third party. These amendments would apply only to future trusts and future transfers.

Valuation Rules for Certain Transfers of Nonbusiness Assets: Would clarify that when a taxpayer transfers nonbusiness assets, those assets should not be afforded a valuation discount for transfer tax purposes.

QSBS Limitation for Certain High-Income Individuals: This provision would amend Section 1202(a) to eliminate the 75{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} and 100{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} exclusion on capital gains realized from certain qualified small business stock for taxpayers with adjusted gross income exceeding $400,000. The baseline 50{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} exclusion would remain applicable. This applies on sales and exchanges after September 13, 2021, subject to a binding contract exception.

Modification of Rules Relating to Retirement Plans

Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances: Would prohibit further contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceed $10 million as of the end of the prior taxable year. The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). This provision would also add a new annual reporting requirement for employer-defined contribution plans on aggregate account balances in excess of $2.5 million. The reporting would be to both the Internal Revenue Service and the plan participant whose balance is being reported.

Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances: If an individual’s combined traditional IRA, Roth IRA and defined contribution retirement account balances generally exceed $10 million at the end of a taxable year, a minimum distribution would be required for the following year. In addition, to the extent that the combined balance amount in traditional IRAs, Roth IRAs and defined contribution plans exceeds $20 million, that excess would be required to be distributed from Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of (1) the amount needed to bring the total balance in all accounts down to $20 million or (2) the aggregate balance in the Roth IRAs and designated Roth accounts in defined contribution plans.

Tax Treatment of Rollovers to Roth IRAs and Accounts: Would eliminate Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). Would also prohibit all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level.

Other Provisions

Temporary Rule to Allow Certain S Corporations to Reorganize as Partnerships Without Tax: Would allow eligible S Corporations (that is, any corporation that was an S corporation on May 13, 1996, prior to the publication of current law “check the box” regulations with respect to entity classification) to reorganize as partnerships without such reorganizations triggering tax. The eligible S Corporation would have to completely liquidate and transfer substantially all of its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.

As noted in previous articles, none of the changes detailed here have been enacted yet, and further modifications can certainly be made. Those concerned about the potential impact on their business or individual financial picture are advised to monitor ongoing legislative negotiations, and seek professional advice to determine their best course of action from a financial and tax planning perspective.

For more information, please contact your US tax advisory team at youradvisor@fernwaysolutions.com or visit us at www.fernwaysolutions.com.

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The above content is intended to support the marketing of professional services and should not be construed as written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular tax situation. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Fernway Solutions assumes no obligation to inform the reader of any such changes.