In April 2021, President Joseph R. Biden Jr. proposed the “American Jobs Plan, a comprehensive proposal aimed at increasing investment in infrastructure, the production of clean energy, the care economy, and other priorities. Combined, this plan would direct approximately 1 percent of GDP towards these aims, concentrated over eight years.”
President Biden has also announced the Made In America tax plan, which comprises the tax proposals to carry out the objectives of the American Jobs Plan. For ease of reference, the Made in America tax plan is hereafter referred to as the Plan.
The U.S. Department of the Treasury has released a report describing the tax proposals of the Plan. The Treasury report describes the goals for the Plan as follows:
[T]o make American companies and workers more competitive by eliminating incentives to offshore investment, substantially reducing profit shifting, countering tax competition on corporate rates, and providing tax preferences for clean energy production. Importantly, this tax plan would generate new funding to pay for a sustained increase in investments in infrastructure, research, and support for manufacturing, fully paying for the investments in the American Jobs Plan over a 15-year period and continuing to generate revenue on a permanent basis.
The report states that the Plan is guided by six principles:
1) collecting sufficient revenue to fund critical investments;
2) building a fairer tax system that rewards labor;
3) reducing profit shifting and eliminating incentives to offshore investment;
4) ending the race to the bottom around the world;
5) requiring all corporations to pay their fair share, and
6) building a resilient economy to compete.
Each of these principles is more fully explained in the Treasury report. To accomplish these six principles, the Plan proposes to implement “a series of corporate tax reforms to address profit shifting and offshoring incentives and to level the playing field between domestic and foreign corporations. These include:
a. Raising the corporate income tax rate to 28 percent;
b. Strengthening the global minimum tax for U.S. multinational corporations;
c. Reducing incentives for foreign jurisdictions to maintain ultra-low corporate tax rates by encouraging global adoption of robust minimum taxes;
d. Enacting a 15 percent minimum tax on book income of large companies that report high profits, but have little taxable income;
e. Replacing flawed incentives that reward excess profits from intangible assets with more generous incentives for new research and development;
f. Replacing fossil fuel subsidies with incentives for clean energy production; and
g. Ramping up enforcement to address corporate tax avoidance.”
This article will review some of the proposed changes to the federal corporate income tax proposed by the Plan. Nevertheless, as the proposals are reviewed, it is necessary to recognize that they are found in a report released by the Department of the Treasury, and that legislation to enact the Plan has not yet been submitted to Congress. Additionally, as with all policy proposals, it is far from certain what will ultimately be enacted, if anything. This commentary, therefore, is speculative. As each business’ and business owner’s financial and tax situation is unique, before acting based on administration proposals or proposed legislation, you should talk with your attorney, accountant and other tax and financial advisors.
Q: How would the Plan impact corporate income tax rates?
In 2017, the Tax Cuts and Jobs Act (TCJA) reduced the U.S. top marginal income tax rate on corporations from 35% to 21%. “Prior to changes made by the [TCJA] [Internal Revenue Code (IRC)] §11(b) provided that the amount of tax imposed [on a corporation] was based on a graduated rate structure starting at 15 percent of the corporation’s taxable income and increasing to 35 percent of taxable income.” Following enactment of the TCJA, a flat tax of 21% was, and is still, imposed on the taxable income of corporations. The Plan would increase the corporate tax rate to 28% of taxable income. Although not stated in the Treasury report, it would appear that the corporate tax would remain a flat tax on taxable income, at an increased rate.
The TCJA repealed the corporate alternative minimum tax. The Treasury report notes that “[i]n a typical year, around 200 companies report net income of $2 billion or more. Of these, a significant share pay zero or negative federal income taxes, despite reporting hundreds of billions of dollars in profits to shareholders in the aggregate.” The Plan would restore a minimum tax equal to 15% of the amount by which a corporation’s book income exceeds its regular tax liability. According to the Treasury report, “[f]irms would be given credit for taxes paid above the minimum book tax threshold in prior years, for general business tax credits (including R&D, clean energy and housing tax credits), and for foreign tax credits.” The Plan does not provide details, so how these credits would be calculated and applied remains to be seen.
Planning Opportunity: Consider whether it makes sense to accelerate income into a year with a lower tax rate and/or defer deductions into a year with a higher tax rate.
It is axiomatic that, all other things being equal, the application of a higher tax rate will produce a higher tax. A corollary to this axiom is that deductions are worth more when tax rates are higher. For example, assuming a dollar-for-dollar correlation, with a flat tax rate of 21%, a $100 deduction will save $21 of tax, whereas with a flat tax rate of 28%, the same deduction would save $28 of tax. If tax rates are expected to rise, by working with your tax advisors it may be possible to accelerate income into the current lower tax rate year and defer deductions into the next higher tax rate year to produce an optimal tax cost when both years are considered together. Of course, this assumes that any rate increase is not retroactive and that the business is able to accurately forecast its income and deductions for the upcoming year.
Q: Does the higher corporate tax rate proposed under the Plan apply to a corporation taxed under Subchapter S of the IRC, or to shareholders of an S Corporation?
Not necessarily, although other tax proposals may impact the taxation of income attributable to a corporation subject to tax under Subchapter S (an S Corporation) of the IRC. Generally, an S Corporation does not pay a corporate level income tax. Rather the income, deductions and other tax attributes of the corporation are passed through to its shareholders for taxation on the shareholders’ individual returns.
However, special rules apply to an S corporation that was previously a corporation taxed under Subchapter C of the IRC (a C Corporation) that would be impacted by an increase in the corporate tax rate. If an S corporation has accumulated earnings and profits (generally, from when it was a C corporation) at the end of its taxable year and its income from passive investments is more than 25% of its gross receipts, the S corporation may face an income tax on its excess net passive income at the highest marginal corporate tax rate. If a C Corporation converts to an S Corporation and disposes of property having an accrued gain from when it was a C Corporation within 5 years of the date that begins the first day of the first taxable year that it was an S Corporation, the gain will be subject to a corporate level tax at the highest corporate rate. Also, a C Corporation that uses the “last in first out” (LIFO) method of accounting with respect to its inventory must recapture in its last taxable year before it becomes an S Corporation the benefit of using that accounting method instead of the “first in first out” (FIFO) accounting method. The recapture amount is “included in the gross income of the corporation for such last taxable year.”
Nevertheless, individual taxpayers, including the shareholders of S Corporations, may be impacted by the president’s tax proposals regarding personal income taxes.
On April 28, 2021, President Biden proposed The American Families Plan (the Families Plan) and the White House briefing room issued a fact sheet (the Fact Sheet) outlining what the Families Plan is intended to accomplish and from what sources revenue would be generated to implement it. The Families Plan provides that the top marginal personal income tax rate would be increased to 39.6%.
Additionally, under the Families Plan, income tax rates on capital gains would also increase for some taxpayers. According to the Fact Sheet, “[h]ouseholds making over $1 million . . . will pay the same 39.6 percent rate on all their income, equalizing the rate paid on investment returns and wages.” Therefore, an increase in personal income tax rates with respect to ordinary income and capital gain income could increase the tax on the income of S Corporation income passed through to the corporation’s shareholders.
Further, the TCJA enacted IRC §199A, which provides owners of business entities taxed as pass-through entities (which include S Corporations) a deduction of up to 20% of qualified business income (QBI). The rules with respect to qualifying for and calculating the deduction can be nuanced and complex (and beyond the scope of this article). Further, not all business owners will qualify for the deduction as most traditional professional service providers are engaged in the practice of specified service trade or business (an SSTB) and generally cannot take advantage of the QBI deduction if the owner’s taxable income exceeds the phase out/in level. For 2021, the phase out/in threshold is $329,800 for married taxpayers filing jointly, $164,925 for married taxpayers filing separate returns, and $164,900 for single and all other taxpayers. QBI from an SSTB cannot be deducted if the taxpayer has taxable income over the phase out/in levels. On the other hand, subject to the wage and asset test limitations, a deduction for QBI not from an SSTB may still available even when an owner’s taxable income exceeds the phase out/in levels. If Congress takes no further action, the deduction for QBI will no longer be available for tax years beginning after December 31, 2025. At this time, neither the Plan nor the Families Plan proposes to eliminate this deduction prior to its scheduled expiration at the end of 2025.
Planning Opportunity: Before corporate or individual tax rates go up, consider whether making distributions from a C Corporation is appropriate.
If you have been considering converting your C Corporation to an S Corporation, it may make sense to do so before tax rates go up. In connection with the conversion, consider whether it makes sense to distribute earnings and profits to the shareholders.
For example, even though dividends paid from a C Corporation are subject to two levels of tax (income tax is paid by the corporation on its taxable income and income tax is paid by the shareholders on dividends paid by the corporation), it may make sense to remove earnings and profits from the corporation today when qualified dividends are taxed at the more favorable rates applied to capital gains. This would allow the C Corporation to remove its accumulated earnings and profits before converting to an S Corporation thereby being able to avoid a tax on excess passive income (should it become applicable).
Also, it might be appropriate to compare whether removing investment assets from a C Corporation today, notwithstanding the two levels of income tax, would produce a lower aggregate income tax over time. If the Plan is enacted, a C Corporation’s taxable income could be taxed at a flat rate of 28%. Compare that to spreading those investment assets among the corporation’s shareholders, some of whom may be subject to personal income tax at lower marginal rates (in a graduated tax system, rather than a flat tax).
Of course, each taxpayer’s situation is different and before making distributions from a corporation, careful analysis by your legal, tax and financial advisors is necessary.
Q: Is income tax from foreign operations impacted by the Plan?
The Plan proposes many changes to provisions of the IRC relating to the taxation of foreign income, particularly taking aim at those provisions that the Plan characterizes as promoting the shifting of profits to low tax countries and avoiding U.S. taxation. “Under the TCJA, a U.S. person that owns at least 10 percent of the value or voting rights in one or more [controlled foreign corporations] will be required to include its global intangible low-taxed income as currently taxable income, regardless of whether any amount is distributed to the shareholder. A U.S. person includes U.S. individuals, domestic corporations, partnerships, trusts and estates.” Global intangible low tax income (GILTI) for the year is included in a taxpayer’s gross income in a manner similar to which the taxpayer includes subpart F income. Although the GILTI rules are beyond the scope of this article,
GILTI is calculated as the total active income earned by a US firm’s foreign affiliates that exceeds 10 percent of the firm’s depreciable tangible property. A corporation (but not other businesses) can generally deduct 50 percent of the GILTI and claim a foreign tax credit for 80 percent of foreign taxes paid or accrued on GILTI. Thus, if the foreign tax rate is zero, the effective US tax rate on GILTI will be 10.5 percent (half of the regular 21 percent corporate rate because of the 50 percent deduction). If the foreign tax rate is 13.125 percent or higher, there will be no US tax after the 80 percent credit for foreign taxes.
The Plan proposes to end “the tax exemption for the first 10 percent return on foreign assets. It would also calculate the GILTI minimum tax on a per-country basis, ending the ability of multinationals to shield income in tax havens from U.S. taxes with taxes paid to higher tax countries [citation omitted]. The plan would also increase the GILTI minimum tax to 21 percent (up to three-quarters of the proposed new 28 percent corporate tax rate, as opposed to the current one-half ratio).”
The Plan would make a number of other changes to taxes impacting foreign operations and profits from foreign jurisdictions. Among these are:
- The Treasury report states that the Plan would “put in place strong guardrails against corporate inversions.” A corporate inversion “is a transaction in which a US-based multinational company merges with a smaller foreign company and then establishes its residence in the foreign company’s country. As a foreign resident, the company can sometimes significantly reduce its taxes without changing the location of any real business activities.” “The proposal would strengthen the anti-inversion rules by generally treating a foreign acquiring corporation as a U.S. company based on a reduced 50 percent continuing ownership threshold or if a foreign acquiring corporation is managed and controlled in the United States.” The current continuing ownership threshold is 80%.
- The Plan proposes to deny multinational corporations U.S. tax deductions by reference to payments made to related parties that are subject to a low effective rate of tax. What is considered a low effective rate of tax would be defined by reference to the rate agreed upon in the multilateral agreement or in the absence of such agreement, the default rate trigger would be the tax rate on the GILTI income, as modified by the Plan.
- To encourage exports, TCJA reduced the tax rate on a portion of income from a U.S. corporation’s exports to 13.125% from the regular 21%. A domestic C Corporation that has foreign-derived intangible income (FDII) may deduct 37.5 percent of its FDII. Such a deduction results in rate of 13.125% on such income. For tax years beginning after December 31, 2025, the deduction is reduced to 21.875% of FDII. That deduction results in an effective tax rate of 16.406% on such income. The Plan would repeal this provision.
Q: Does the Plan make other changes to the corporate tax system?
According to the Treasury report, “the . . . [P]lan would remove subsidies for fossil fuel companies, while providing incentives to reposition the United States as a global leader in clean energy...... ” Although the Treasury report does not provide many details, it indicates that the Plan would:
- Remove subsidies for fossil fuel companies. Although not stated in the Treasury report, under current law, such incentives include depletion allowances and the expensing of intangible drilling costs.
- The Plan would provide a 10-year extension of the renewable electricity production tax credit and investment tax credit for clean energy generation and storage. Those credits would be made “direct pay” (similar to a refundable tax credit), relieving a project developer from having to rely upon the tax equity markets to find investors in a clean energy project.
- Although the Treasury report does not provide any detail, it indicates that the Plan would:
- create a new tax incentive for long-distance energy transmission lines and would expand tax incentives available for electricity storage projects.
- create tax incentives for state-of-the-art carbon capture and sequestration projects.
- support for clean energy manufacturing, which would include an extension of the tax credit for investment in qualifying advance energy projects.
- include a blender’s tax credit for sustainable aviation fuel.
- penalize polluters through tax disincentives, restoring a tax on polluters to pay for EPA clean-up costs associated with Superfund sites.
Q: What happens next?
Proposed legislation necessary to enact the Plan has not yet been introduced into Congress.
Even after proposed legislation has been introduced, no one knows how the proposal will be amended in Congress or if Congress will even consider it.
With a narrowly divided Congress, the extent to which President Biden’s agenda will be enacted is anybody’s guess.