The Biden Administration released its revenue raising proposal for the Fiscal Year 2023 Budget (“FY2023 Budget”). The stated goals of the FY2023 Budget are to bolster critical investments that prioritize security, boost the economy, promote health, tackle climate change initiatives, and open more opportunities for all. The US Department of Treasury, in a press release announcing the FY2023 Budget publication, claimed the FY2023 Budget investments are “more than fully paid for through tax code reforms requiring corporations and the wealthiest Americans to pay their fair share, closing loopholes, and improving tax administration.” The Department of Treasury also released a document to explain the Biden Administration’s proposal, called the “General Explanations of the Administration’s FY2023 Revenue Proposals” or “Greenbook” for short. The Greenbook categorized revenue measures in the FY2023 Budget as:
- Reforming Business and International Taxation;
- Supporting Housing and Urban Development;
- Modifying Fossil Fuel Taxation;
- Strengthening Taxation of High-Income Taxpayers;
- Supporting Families and Students;
- Modifying Estate and Gift Taxation;
- Closing Tax Loopholes;
- Improving Tax Administration and Compliance;
- Modernizing Rules, Including those for Digital Assets; and
- Improving Benefits Tax Administration.
While this article focuses on some of the proposed changes that have the greatest potential to impact our clients, it is important to note the FY2023 Budget remains just a proposal at this stage. We anticipate further changes and refinements as the political and legislative processes move forward.
The FY2023 Budget proposes to raise the corporate income tax rate to 28%. Previously, Donald Trump’s TCJA replaced a graduated corporate tax schedule (with most corporate income then taxed at a marginal and average rate of 35%) with a flat income tax of 21% applied to all C corporations. The Greenbook states, “Raising the corporate income tax rate is an administratively simple way to raise revenue to pay for the Biden Administration’s infrastructure proposals and other longstanding fiscal priorities.” Thus, it is the goal of the Biden Administration to increase corporate taxes to partially pay for some of the costs associated with its programs and initiatives.
Further, with respect to trade and business, the FY2023 Budget seeks to incentivize bringing jobs that are currently offshore back to the United States. The FY2023 Budget proposes a general business credit equal to 10% of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business. The hope is that this tax benefit will result in significant onshoring.
Beyond corporations, the FY2023 Budget addresses partnerships as well. Partnerships are currently permitted to make a Section 754 election to adjust the basis of property when certain distributions of property are made to a partner. This election allows the partnership to “step-up”, or increase, the basis of non-distributed property. These rules create perceived loopholes where partnerships with related partners can design transactions to shift basis from non-depreciable assets to depreciable assets, resulting in immediate increases to depreciation deductions. The FY2023 Budget proposes to reduce the ability of related parties to use a partnership to shift basis among themselves by applying a matching rule that would prohibit any partner in the partnership that is related to the distributee-partner from benefiting from the partnership’s basis step-up until the distributee-partner disposes of the distributed property in a fully taxable transaction. The FY2023 Budget further states that the Treasury will have the authority to draft rules associated with this proposal.
With respect to the stated goal of supporting housing and development, the FY2023 Budget seeks to make the New Markets Tax Credit permanent. The New Market Tax Credit is an up-to-39% credit for qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership, that qualifies as a community development entity. The FY2023 Budget proposes to make this credit permanently available to foster continued investments in low-income communities, with a goal of revitalization and increased opportunity for residents.
With respect to high-income taxpayers, the Greenbook states, “Substantial revenues come from strengthening the taxation of high-income taxpayers.” And so the FY2023 Budget proposes to increase the top marginal rate sooner than previously planned. The current top rate for individuals is 37% and is scheduled to revert to 39.6% in 2026, after provisions of the TCJA sunset. The FY2023 proposal seeks to increase the top rate to 39.6% in 2023 rather than waiting for 2026. The current top tax rate applies to single taxpayers with income over $539,900 or married filing joint taxpayers with income over $647,850. However, the FY2023 Budget proposes to apply the top rate to those taxpayers earning over $400,000 (single) or $450,000 (joint).
Currently, the top income tax rate applied to qualified dividends and long-term capital gains is only 20%. The FY2023 Budget proposal suggested increasing the top rate on such transactions to align with the top ordinary income tax rate, which again is currently 37% but proposed to increase to 39.6%. Unlike the income rate adjustments above, the proposed tax increase on qualified dividends and long-term capital gains would only apply to taxpayers with income over $1 million ($500,000 married filing separately). The Greenbook provides a reason for this change by stating, “Preferential tax rates on long-term capital gains and qualified dividends disproportionately benefit high-income taxpayers and provide many high-income taxpayers with a lower tax rate than many low- and middle-income taxpayers.”
The FY2023 Budget proposal is also seeking to adjust the tax treatment of property. Currently, property gifted or transferred at death is subject to a basis step-up and is generally not taxed until a “realization” event occurs, such as a sale. The FY2023 Budget is now, however, proposing to treat transfers of appreciated property by death or by gift as a “realization event” and therefore subject to capital gains tax. Additionally, it proposes to impose a 20% minimum tax on total income, including unrealized capital gains, for the wealthiest taxpayers, defined as taxpayers having more than $100 million in assets.
To support families and students, the FY2023 Budget desires to make adoption tax credits refundable and allow certain guardian ships to qualify. Currently, the law provides two (2) tax benefits to taxpayers that adopt children: (a) a nonrefundable 100% tax credit for a limited amount of qualified expenses incurred in connection with the adoption; and (b) an exclusion from gross income of a limited amount of qualified adoption expenses paid or reimbursed by an employer under an adoption assistance program. The FY2023 Budget seeks to lower the costs of adoptions and make adoption more accessible to lower- and moderate-income families. Therefore, the proposal is to make the adoption credit fully refundable. This beneficial tax treatment would also be extended under the proposal to families that enter into a guardianship arrangement with a child.
The FY2023 Budget also addresses certain trust vehicles commonly used in tax planning strategies. For example, it is currently possible to create a short-term grantor retained annuity trust (“GRAT”) that zeros out after it has made its periodic distributions over a defined term. Biden is proposing that GRATs be required to have a minimum 10-year life and remainders of at least 25% of the value of assets contributed to the GRAT. These changes would impact common GRAT strategies. The proposal would also prohibit the grantor from engaging in tax-free exchanges of assets in the trust, which was another common tool used to lock in a GRAT’s appreciation by replacing appreciated securities with cash equivalents. These strategies are commonly employed with high-net-worth individuals as a means of reducing the value of a taxable estate.
Grantor trusts received further attention in the FY2023 Budget proposal whereby, if the trust was not fully revocable at the time of creation (i.e., taxable) then any sales between the grantor and the trust would now be taxable. Finally, if the grantor were to pay any income tax on the trust’s income and gains, then it would be treated as a taxable gift.
In addition to raising revenue, the FY 2023 Budget proposal also focused on changing the administration of trusts and estates. For estates, if no executor or administrator is appointed, then any person with actual or constructive control of the decedent’s property would be deemed a “statutory executor” for estate tax purposes. The IRS would be charged with drafting and adopting rules to address any potential conflicts that may arise in the event of there being multiple individuals qualifying statutory executors. Currently, trusts are not required to report their asset values. The Biden Administration is proposing to require reporting by trusts that have assets with a value greater than $300,000 or gross income over $10,000.
The FY2023 Budget is also proposing to have assets that are held in trust or partnerships to be “marked to market” every 90 years, beginning with a look back to January 1, 1940. Marking an asset to market means recording its value at the then prevailing current fair market value and treating it as a recognition event for tax purposes. The first recognition event would occur in 2030. Transfers to or from most trusts or partnerships would also constitute recognition events subject to tax.
As stated above, it is critical to note these changes are merely a proposal from the Biden Administration and constitute talking points at this time. These changes have not been put forward in any sort of bill or legislation and neither open debate nor political negotiation have taken place. We will continue monitoring activity in Washington D.C. to be ready to discuss personal planning with clients.
Should you have any questions about tax planning or strategy, please contact one of our tax attorneys by requesting a consultation or by giving us a call at 216-696-1422
