Tracking Potential Tax Revenue Offsets in Reconciliation Package    

September 10, 2021

In order to pay for $3.5 trillion in new social spending and tax cuts, the Biden administration and congressional Democrats have proposed several changes to the tax code that would raise revenue to cover the cost. President Biden has said the new spending will be paid for, and many moderate Democrats have expressed their desire to avoid deficit spending (though the FY22 budget resolution allows for an increase to the deficit of $1.7 trillion over ten years). Some of the key proposed changes in the House and Senate include: increasing the corporate tax rate; increasing some capital gains taxes and eliminating the step up in-basis; partnership tax rule changes, including possible changes to carried interest allocations; SALT deductions (as a revenue hit); reforming international tax provisions created in the 2017 tax law; and the potential enactment of retroactive taxes.

Currently, Congressional leadership, along with Senate Finance Committee and House Ways and Means Committee chairs and members, are rifting over the size and details over plans to pay for the $3.5 trillion economic agenda. Senate Finance Committee Chairman Ron Wyden (D-OR) said, “we’re committed to raising the revenue needed to pay for critical priorities for American families.” While House Ways and Means Committee Chairman Richard Neal (D-MA) has less forthcoming about what the House tax package will look like. This reflects House leadership’s challenge to round up enough votes in the House for passage. Both Chairs are negotiating differences and it is expected that the revenue committees to release their proposed revenue provisions in the next few days. In the meantime, here are some key issues to track. Our team will continue to monitor proposed provisions and update accordingly.

Corporate Rate

President Biden has proposed raising the corporate tax rate from 21%to 28% after the 2017 Tax Cuts and Jobs Act reduced it from 35%to 21%. Some moderates have indicated that they want a smaller rate increase than what has been proposed. Notably, Sen. Joe Manchin (D-WV), a key moderate, has said he would prefer a corporate tax rate of 25%. The smaller the corporate rate increase, the less revenue generated to offset the cost of Democrats’ spending priorities. The Treasury Department estimated that raising the corporate rate to 28% would bring in about $858 billion over 10 years.

CORPORATE TAX
BY THE NUMBERS

21%

CURRENT RATE

28%

PROPOSED RATE

Capital Gains/Step Up In-Basis

The President has also proposed a rate of 39.6% on long-term capital gains and qualified dividends. Along with average state taxes and a 3.8% federal surtax, wealthy individuals could pay roughly 49%. Manchin and some other moderate Democrats have called for a smaller increase, raising the rate to 28%. The current rate is at 20%. Others have suggested the new rate could be 25% or 30%.

Additionally, is the President has proposed taxing capital gains at death, with an exemption of $1 million per person. Democrats, especially from agriculture-heavy states, have concerns with this proposal. Senate Finance Committee Democrats are floating an exemption of $5 million per person from capital gains taxes at death. Also, they suggest a $25 million exemption per couple for family farms, an additional exemption to the general exemption.

Separately, Senate Democrats are calling for billionaires to pay taxes on their investment gains annually, as opposed to when the investments are sold. Biden has not offered a similar proposal. The top individual income tax rate could increase from 37% to 39.6% for those making more than $400,000 a year.

Carried Interest

Another proposed tax law change, which has bipartisan support, would level the playing field by taxing carried interest as ordinary income instead of as capital gains. Senate Finance Chairman Ron Wyden (D-OR) and Sen. Sheldon Whitehouse (R-RI) introduced S. 2617, the Ending the Carried Interest Loophole Act, which would tax individuals who acquire a carried interest upon receipt of the interest and require private equity, hedge fund and real estate managers to recognize a deemed compensation amount annually, taxed at ordinary rates and subject to self-employment taxes. This proposal would tax carried interest as ordinary income. Unlike previous bills, the Wyden/Whitehouse bill would raise $63 billion over 10 years. It also addresses re-characterization of income from wage-like income to lower-taxed investment income & deferral of tax payments.

SALT Deductions

Democrats are expected to include some type of change to the $10,000 cap on the state and local tax (SALT) deduction that Republicans enacted as part of their 2017 tax law. But it remains to be seen exactly how lawmakers plan to roll back the cap. Many lawmakers from high-tax states, such as New York, New Jersey and California, strongly oppose the cap, and members have threatened to vote against the $3.5 trillion bill if it doesn’t repeal the $10,000 limit.

But fully repealing the cap is expensive, and analysts across the ideological spectrum have estimated that doing so would primarily benefit high-income households. A one-year suspension would cost roughly $83 billion. The changes to the SALT deductions could range from elimination of the cap, to a short-term suspension of the cap, or the possibility of a permanent change such as doubling the deduction.

International Tax (GILTI/BEAT/FDII)

Biden and Democrats have concerns with the international provisions in the 2017 Tax Cuts and Jobs Act, aiming to broadly reform the international tax regime. The three major international taxes that would be reformed are: GILTI; BEAT; and FDII.

The White House has proposed increasing a minimum tax on U.S. companies’ foreign earnings to 21 percent, while negotiating an agreement through the Organization for Economic Cooperation and Development, to implement a global minimum tax rate of 15 percent. Treasury’s plan to raise corporate income tax aims to “moderately” increase corporate revenues relative to GDP and to help attenuate inequality. The plan would change the GILTI regime by eliminating offshore tangible asset incentives but ending the tax exemption for the first 10 percent on foreign assets and would calculate the GILTI minim tax on a per-country basis. The plan calls for a GILTI minimum tax of 28 percent, mirroring the corporate tax rate. Also, the plan would repeal and replace BEAT to counter profit shifting of foreign headquartered multinational companies, to collect over $2 trillion in tax revenue over the next decade.

The White House plan proposed replacing BEAT to transform and incentivize large economies to join the U.S. in taking the first step to adopt strong minimum taxes on corporations and level the playing field between the taxation of domestic and foreign corporations. The replacement for BEAT would adopt an OECD/G20 rule where the U.S. would turn off the BEAT regime when entities are resident in countries that adopt the globally agreed upon minimum tax. The plan proposed Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD), which denies multinational corporations U.S. tax deductions by reference to payments made to related parties that are subject to a low effective rate of tax, would generate $390B.

Also, Treasury’s plan proposes a minimum book tax that would eliminate the disparity of labor vs. corporate tax revenues. The book tax would require large corporations to pay at least a minimum amount of tax on out-sized returns. The minimum tax would be set at 15 percent on book income, under this proposal.

Chairman Wyden and Sens. Sherrod Brown (D-OH) and Mark Warner (D-VA) recently released their international taxation framework, which would overhaul Global Intangible Low-Taxed Income (GILTI), Foreign Derived Intangible Income (FDII) and the Base Erosion and Anti-abuse Tax (BEAT). The framework calls for:

GILTI:

  • Ends the incentives to offshore factories;
  • Increases the GILTI rate;
  • Move GILTI to a country-by-country system; and
  • Add an incentive to offshore research and management jobs.

BEAT:

  • Provide full value to domestic business tax credits; and
  • Increase the BEAT rate on base erosion payments.

FDII:

  • Repeal the incentive to offshore factories;
  • Provide the FDII benefit to companies that continually invest in innovation in the U.S.; and
  • Equalize the FDII and GILTI rates.

Retroactive Taxes

President Biden is proposing retroactive capital gains tax increases but there are potential legal concerns with this approach. As proposed, the rate hike would go in effect for sales after April 28, 2021. The bill may pass in with this current effective date or with a different effective date. However, if the law passes as Biden has proposed, there will most likely be legal fights following enactment. The biggest question is whether retroactive taxation is constitutional. Justice Sandra Day O’Connor previously stated that retroactivity over one year would likely violate the Due Process Clause. Additionally, the late Justice Antonin Scalia and current Justice Clarence Thomas called retroactive taxation “bait-and-switch taxation.” It is not clear if the April 28, 2021, retroactive effective date would legally hold up.

Those opposed to retroactive taxes state they violate the fundamental principles of transparency and stability. Further, they state that retroactive tax increases undermine certainty in the law and the ability of taxpayers to plan their affairs by relying on the law today, not based on what legislators in the future decide the law was. Retroactive taxes have been struck down under other provisions of the Constitution and challenged at the state level. Lastly, very few retroactivity cases make it to trial or appeals.

Plastics Packaging Materials

Additionally, Senate Finance Committee Democrats are considering a variety of other taxes including plastic packaging materials, which may include fees on carbon and plastic resins. Another option may be putting a price on carbon paired with a border adjustment tax for carbon-intensive imports and rebates. There is a new proposal, proposed by Senator Sheldon Whitehouse (D-RI), circulating to charge a fee on sales of “virgin plastic” used to make single-use plastics.

Senator Whitehouse’s proposal would tax at 10 cents per pound, beginning next year and scale up over the following two years. It would apply to resins extracted from crude oil or natural gas that are used to produce petrochemicals, including plastics. It would tax sales of resins used to make single-use plastics like beverage containers, bags and packaging.

Carbon Pricing

A carbon border adjustment was discussed earlier this summer, while a carbon tax applying to all emitters has not previously been discussed. It is uncertain whether carbon pricing proposals have enough political support to pass, even among Democrats. The potential taxes proposed include a $15-per-ton tax on fossil fuel extraction and a tax on industrial emissions from manufacturers of steel, cement, chemicals and other carbon-intensive goods.

Qualified Retirement Plans

Taxpayers could face a new cap on deductions including charitable contributions as well as IRA/401(k) contributions. An individual paying the top 37% rate would no longer receive deductions applied at that full rate; the benefit of deductions would be capped at a 28% or 26% rate.