House Ways & Means Committee Tax Proposal – Business Tax
On September 13, 2021, the U.S. Ways and Means Committee released draft legislation advancing a number of tax increases and changes. The proposed changes would help to pay for the social and economic policies advanced in the $3.5 trillion budget reconciliation package Congress has been working on, which the Democrats and President Biden hope to pass this fall. The text of the proposals are here.
Note: the Ways & Means Committee’s proposals are still being crafted and finalized, and these proposals still need to be crafted into legislation. Accordingly, this article should be used as a view to what tax changes may be coming on the horizon legislatively.
Included in the proposed legislation are a series of domestic tax modifications for businesses. A few of the major changes are summarized below:
i. Increases (and Decreases) in Corporate Tax Rate
The Ways and Means Committee has proposed replacing the flat corporate income tax with a progressive rate structure. The top rate would increase to 26.5 percent for corporations with net incomes exceeding $5 million. Corporations with net income up to $5 million would be taxed at 21 percent. The rate would decrease to 18 percent for corporations with income less than $400,000. Personal services corporations would be ineligible for these rates.
Benefits of the lower end of the graduated rates would phase out for corporations with income in excess of $10 million. These changes would apply to taxable years beginning after December 31, 2021.
ii. Modification of “Profits Interests” and “Carried Interest” Rules
“Carried interests” or “profits interests,” while long a preferred equity incentive for partners in partnerships and LLCs, have been viewed by many in Congress with skepticism. The proposal would significantly amend Section 1061 of the Internal Revenue Code, which governs the character of gain on the sale of an applicable partnership interest granted to a service provide. In effect, the goal of Section 1061 is to limit the availability of long-term capital gains for these equity incentives upon sale.
First, this proposal would provide long-term capital gain treatment only to applicable partnership interests held longer than 5 years (up from 3 years). The three year holding period would apparently still be allowed for certain real property trades or businesses and taxpayers with adjusted gross income less than $400,000. The proposal would add rules for measuring these three and five year holding periods.
Second, the proposal would extend Section 1061 to all assets eligible for long-term capital gains rates. This presumably would include partnership interests in all kinds of businesses, rather than just businesses affected by current Section 1061—those involved in raising or returning capital or investing in securities, commodities, rental real estate, and options and derivatives. Additionally, the proposal would modify rules on sale or exchange transactions. Finally, the proposal would also extend regulatory authority to address arrangements that avoid the purposes of Section 1061.
These changes would apply to taxable years beginning after December 31, 2021.
iii. Temporary Rule to Allow Certain S Corporations to Reorganize as Partnerships without Tax
The Ways and Means Committee has proposed a rule that would temporarily allow eligible S corporations to reorganize as partnerships without triggering tax. To be eligible, a corporation must have been an S corporation on May 13, 1996, before the current “check the box” regulations were published. Under this proposal, an eligible S corporation must liquidate and transfer substantially all its assets to an entity taxed as a domestic partnership during a two-year period beginning on December 31, 2021.
iv. Limitations on Exclusion of Gains from Section 1202 Stock
Ways and Means has also proposed additional limitations to an oft-used corporate tax benefit—the exclusion of capital gains from the sale of qualified stock under Section 1202. Currently, special 75% and 100% exclusion rates can apply for sales of qualified stock. The proposal would make the 75% and 100% exclusions unavailable under Section 1202 for shareholders that have adjusted gross income equal to or exceeding $400,000. Notably, this proposal, as currently drafted, would take effect for sales and exchanges occurring after September 13, 2021.
As the proposed legislation has only been approved at the Committee level, it remains somewhat speculative. Before passing into law, the proposed legislation will be subject to review and approval by both Houses of Congress and the President. Nonetheless, a shakeup of the tax rules applicable to businesses seems probable in the near future.
Tristin S. Taylor