November 23, 2021 / North America
After months of negotiations and consideration of alternative proposals, the House Democrats advanced the Build Back Better Act reconciliation bill (the House Bill) on Friday. Now, the House Bill heads to the Senate where the Senate Parliamentarian will rule on whether provisions are directly applicable to spending and revenue, and therefore able to be included in a reconciliation bill, or whether they will need to remove the provision (or overrule the Senate Parliamentarian, which is a rather rare occurrence). Additionally, Senators Manchin and Sinema have not signed off on many of the provisions and Senators Sanders and Wyden want to add additional provisions. With that said, the proposed changes in the House Bill could have far-reaching implications on domestic and international corporations, private equity funds, and individuals. Although some provisions in the House Bill may change, and others could be added, we thought it would be helpful to discuss some of the implications of the bill, particularly noting several that would be effective upon enactment or beginning in 2022.
Highlights and observations of select tax provisions in the House Bill covered in this alert include those concerning:
Corporate Tax Provisions
Other Business Tax Provisions
Individual, Estate, and Trust Provisions
A&M Insight: Although lawmakers have said that the AMT is aimed at large corporations, the scope may be broader. The proposal potentially would sweep in private equity structures because the application of the proposal hinges on satisfying a threshold based on broad aggregation rules. If the AMT could apply to private equity funds under those rules, the funds may favor holding portfolio companies as passthrough entities rather than as corporations to avoid the AMT. Additionally, the proposed AMT would significantly increase the complexity of corporate tax compliance and administration because of book-tax differences and require significant clarifications.
A&M Insight: The excise tax could apply in unexpected cases, including reorganizations in which the shareholders recognize gain or loss, in transactions that are recharacterized under the Internal Revenue Code to include a deemed redemption, or on a distribution that is a return of capital if the corporation does not have sufficient earnings and profits (including de-SPACing transactions, where either the special purpose acquisition company (SPAC) does not find a viable target or the shareholder chooses not to participate in the SPAC’s acquisition transaction). Additionally, because the proposal would apply based on when the stock repurchases occur, mandatory redemptions that occur pursuant to the terms of stock issued prior to the enactment of the proposal could be subject to the excise tax.
A&M Insight: If adopted, corporations that are considering a divisive D reorganization would need to be very careful regarding the characterization of distributions to its creditors.
A&M Insight: This proposal is significant as selling shareholders may have inclusions based on the activities of a CFC after they sell shares and the tax consequences to the buying shareholders may depend on whether the CFC made a pre-transaction distribution. Additionally, it appears that the aggregate of all of the pro rata shares of subpart F and tested income/loss inclusions may be greater than the CFC’s actual subpart F and tested income/loss. Furthermore, this proposal places an even greater importance on the treatment of previously taxed earnings and profits (PTEP) and associated basis changes, for which Treasury and the IRS have yet to issue guidance on.
A&M Insight: In addition to potentially increasing the tax liability for multinational businesses, the country-by-country calculations could significantly increase the complexity of an already complicated US international tax regime. This may encourage different business decisions, as companies may choose to begin operations of a new venture in a jurisdiction they currently operate in and where the USSHs can immediately benefit from the losses that will be generated from the new venture. Fortunately, the proposal does allow for a carryover of GILTI-related country-specific net CFC tested losses and FTCs. However, if a USSH no longer owns an interest in a CFC that operates in such a jurisdiction, it appears that the net CFC tested losses and FTCs would remain suspended.
A&M Insight: Unlike prior proposals, this proposal would apply to US multinationals, regardless of whether they are foreign parented or not. Like the corporate AMT, the new interest deduction limitation hinges on financial statement reporting, which poses its own set of complications because of book-tax timing differences. Additionally, this proposal may incentivize companies to increase their foreign borrowings to create a higher limitation for US interest expense, even if the leverage is unnecessary for non-tax business reasons.
A&M Insight: While the purpose of this rule is unclear, it will pose a greater administrative burden as taxpayers will need to identify the event that establishes worthlessness.
A&M Insight: As discussed previously here, this proposal is to reverse a Tax Cuts and Jobs Act proposal that would have no longer allowed taxpayers to immediately deduct these costs beginning in 2022. While this proposal has bipartisan support, this provision increases costs during the budget period and may be revisited in the Senate.
A&M Insight: Although income tax and capital gains rates are not proposed to increase, the surcharge has the effect of raising tax rates for multi-millionaires and trusts and estates. As a result, they may want to consider whether to accelerate transactions to take advantage of the lower tax rates. Additionally, the tax would be based on the taxpayer’s adjusted gross income. To the extent deductions are factored into the calculation of taxable income but after adjusted gross income (e.g., charitable contributions for individuals), they would not reduce the amount of the surcharge. Lastly, this surcharge would not be treated as a tax for AMT purposes. As a result, the surcharge can apply on top of the AMT.
A&M Insight: Business owners who plan to remain active in the business post-disposition, may want to accelerate the sale of their business this year to avoid the application of the NIIT on their distributive shares of business income.
A&M Insight: This provision is taxpayer unfavorable and can have a significant effect when a taxpayer sells all of its trades or businesses and still has EBLs. In those cases, the losses cannot freely be used to offset the taxpayer’s income like an NOL. Rather, the small statutory amount of $250,000, or $500,000 if married filing jointly, would be allowed to offset other income.
While the House Bill currently includes several of the Democrats’ tax priorities, including increasing the deduction limit for state and local taxes and expanding the application of the international tax regime, it does not contain the corporate and individual tax rate increases, modification of the estate tax regime, or taxation of carried interest for which many Democrats were advocating. Nonetheless, the House Bill has far-reaching implications across the spectrum, including for domestic and foreign corporations, private equity funds, high income individuals, and some trusts and estates. The Senate is expected to make changes and push their version of the Build Back Better Act through before the end of the year, which presents tax planning challenges regarding the effects of the provisions that would be effective for tax years beginning after December 31, 2021. A&M can assist in evaluating the applicability of the myriad provisions, modeling scenarios, and assessing alternative structures, where applicable. If you would like to discuss your situation, the changes coming, and financial and operational challenges, please feel free to contact Kevin M. Jacobs, Ernesto Perez, Adam Benson, or Albert Liguori.