On March 28, 2022, the U.S. Department of the Treasury released its General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals, otherwise known as the “Greenbook.” Generally, the Greenbook details the various tax proposals to fund the Biden administration’s proposed 2023 fiscal year budget (the “Budget”). While it remains uncertain whether these proposals will be enacted into law, taxpayers should consider, evaluate, and be prepared for the impact that such proposals will have on their own planning, compliance, and potential future audits.
Treasury has stated that the Budget’s investments will be “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.”
This Article summarizes some of these key changes targeted at corporations, partnerships, and high-net-worth individuals, specifically focusing on the following: (1) Close Loopholes;1 (2) Improve Tax Administration and Compliance;2 (3) Modernize Rules, Including those for Digital Assets;3 (4) General Increases to Tax Rates, Capital Gains, and Minimum Taxes;4 and (5) Modify Estate and Gift Taxation.5
(1) Close Loopholes
The Administration proposes various changes to the Internal Revenue Code to close “loopholes” that advantage large corporations and high-net-worth individuals. The Administration proposes to:
(a) Modify the treatment of carried profits interests in partnerships to tax them as ordinary income.
(b) Limit the deferral of gain on like-kind exchanges of real property to $500,000 for each taxpayer ($1 million for married filing jointly).
(c) Require the recapture of 100% of depreciation deductions as ordinary income for certain depreciable property.
(d) Restrict partner deductions in certain syndicated conservation easement transactions to 2.5 times the sum of each partner’s basis in the partnership.
(e) Limit the use of donor advised funds to avoid private foundation payout requirements.
(f) Extend the period for assessment of tax for certain qualified opportunity fund investors.
(g) Establish untaxed income accounts for certain small insurance companies, which could result in increased recognition of income by “micro captive” insurance companies that have made an election under I.R.C. § 831(b) to be taxed on investment income.
(h) Expand pro rata interest expense disallowance for business-owned life insurance.
(i) Clarify terms and/or correct other drafting errors in the Tax Cuts and Jobs Act of 2017.
Baker Botts Notes:
- Increased Enforcement Likely. Even if the Administration’s proposals are not enacted, taxpayers can expect significant and rigorous enforcement in each of these areas. For example, for over a year, several proposals (e.g., the STOP CHEATERS Act) have been made to substantially increase IRS funding, specifically for the purpose of enhanced enforcement and system modernization. In March 2022, President Biden signed H.R. 2471, Consolidated Appropriations Act, 2022, into law. An important component of this spending package included a $675 million increase in funding for the IRS (a portion of which was expressly earmarked for enforcement). We also are aware that the IRS is in the process of actively hiring and onboarding auditors and attorneys.
- “Loopholes”. Many of the items that the Administration has identified as a “loophole” were intentionally created by Congress. For example, I.R.C. § 1031 allows for deferral of like-kind exchanges. Carried interests commonly utilized by private equity, hedge funds, and the real estate industry are similarly allowed under the Internal Revenue Code, and, in 2017, Congress adjusted carried interest to include a 3-year holding period under I.R.C. § 1061.
(2) Improve Tax Administration and Compliance
The Administration proposes to enhance the accuracy and accessibility of tax information available to the IRS for audits by expanding the Secretary’s authority to require taxpayers to electronically file their information reporting forms and tax returns. In addition, the Administration proposes to:
(a) Increase the statute of limitations for assessment for returns reporting benefits from listed transactions from three to six years under I.R.C. § 6501(a) and to also increase the limitations period under I.R.C. § 6501(c)(10) from one to three years after a taxpayer files Form 8886, Reportable Transaction Disclosure Statement, to report a listed transaction. In addition to these statute of limitations increases, the Administration seeks to add a new tax code provision that would impose liability on shareholders to collect unpaid income taxes on the sale of stock of “applicable C corporations.”
(b) Modify the centralized partnership audit regime to allow for a carryover of net negative changes in tax that exceed a partner’s income tax liability in the reporting year as well as amend the 2015 Bipartisan Budget Act’s definition of partnership-related items to “include items that affect a person’s Chapter 2/2A taxes and would apply the highest rate of tax in effect for the reviewed year under section 1401 or 1411.”
(c) Give the Bureau of Economic Analysis and Bureau of Labor Statistics access to certain federal tax information of those sole proprietorships with receipts greater than $250,000 and of all partnerships.
(d) Require taxpayers to affirmatively disclose tax positions contrary to the Treasury Regulations. If enacted, failure to affirmatively disclose tax positions taken contrary to the Treasury Regulations will result in significant penalties—“Except to the extent provided in regulations for failures due to reasonable cause and not willful neglect, a taxpayer who fails to make the required disclosure would be subject to an assessable penalty that is 75% of the decrease in tax shown on the return as a result of the position. Such penalty shall not be less than $10,000 or more than $200,000, adjusted for inflation.”
(e) Require employers to withhold the 20% additional tax and interest related to failed nonqualified deferred compensation arrangements.
(f) Extend the statute of limitations period from three to six years for certain tax assessments where the taxpayer omits more than $100 million from its reported gross income.
(g) Expand and increase the amount of tax penalties that apply to paid tax return preparers for “willful, reckless, or unreasonable understatements, as well as for forms of noncompliance that do not involve an understatement of tax” and grant the IRS authority to oversee and “regulate all paid preparers of federal tax returns, including by establishing mandatory minimum competency standards.”
(h) Toll the 3-year statute of limitations for assessment of tax until three years after the date on which a required Form 8854, Initial and Annual Expatriation Statement, is filed with the IRS.
(i) Simplify foreign exchange gain or loss rules and exchange rate rules for individuals, as well as increase thresholds for simplified foreign tax credit rules and reporting.
Baker Botts Notes:
- Listed Transactions Statute of Limitations. This suggests that the IRS is overwhelmed and unable to effectively audit listed transactions within the prescribed statute of limitations.
- Extension of 3-Year Statute of Limitations for $100M omissions. This proposal is noteworthy because it suggests that the IRS is seeing enough audits in which a $100 million omission of income would be less than the 25% substantial omission that would trigger a 6-year statute of limitations under I.R.C. § 6501(e)(1). The Greenbook also suggests that this proposal is directed at audits involving transfer pricing issues.
(3) Modernize Rules, Including those for Digital Assets (Cryptocurrency)
Given the prevalence of digital assets in today’s society, it is not surprising that the Administration intends to modernize the tax rules related to digital assets, including crypto. Specifically, the Administration proposes to:
(a) Amend the securities loan nonrecognition rules to apply to loans of actively traded digital assets recorded on cryptographically secured distributed ledgers, while granting the Secretary the authority necessary to determine when a digital asset is actively traded.
(b) Require certain financial institutions and digital asset brokers to report all financial accounts and assets held by foreign persons within the United States in order to allow for information sharing among partner jurisdictions in exchange for U.S. taxpayer information and U.S. taxpayer-involved foreign transactions.
(c) Amend I.R.C. § 6038D(b) to require certain taxpayers to report any accounts that hold digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider.
(d) Amend the mark-to-market rules for dealers and traders to encompass digital asset trading.
Baker Botts Notes:
- Digital Asset Accounts. Similar to rationale for the FATCA and FBAR reporting requirements, the IRS hopes to reign in potential tax evasion related to digital asset accounts and further expand financial reporting of crypto. Another potential goal related to these provisions is the desire to make crypto trading look more like stock trading (i.e., amending mark-to-market rules to include digital assets).
(4) General Increases to Tax Rates, Capital Gains, and Minimum Taxes
As with many tax proposals, the Administration intends to make certain adjustments to tax rates, capital gains provisions, and minimum tax requirements. To fund the Budget, the Administration proposes to:
(a) Increase the corporate income tax rate from 21% to 28%, thereby indirectly increasing the Global Intangible Low-Taxed Income (“GILTI”) rate.
(b) Replace the Base Erosion Anti-Abuse Tax (“BEAT”) provisions with an Undertaxed Profits Rule (“UTPR”) based on the OECD’s Pillar Two Model Rules.
(c) Establish a new business credit equal to 10% of the eligible expenses paid or incurred in connection with “onshoring” a U.S. trade or business while disallowing deductions for expenses paid or incurred in connection with “offshoring” a U.S. trade or business.
(d) Prevent related parties from frequently using partnerships to shift partnership basis among themselves. For instance, “[i]n the case of a distribution of partnership property that results in a step-up of the basis of the partnership’s non-distributed property, the proposal would apply a matching rule that would prohibit any partner in the distributing partnership that is related to the distributee-partner from benefitting from the partnership’s step-up until the distributee-partner disposes of the distributed property in a fully taxable transaction.”
(e) Modify the I.R.C. § 368(c) control test to conform with the I.R.C. § 1504(a)(2) affiliation test, resulting in a consistent definition of “control” to mean ownership of at least 80% of the total voting power and at least 80% of the total value of stock of a corporation.
(f) Modify I.R.C. § 1295(b)(2) to permit taxpayers to make qualified electing fund (“QEF”) elections, including retroactive elections that do not prejudice the U.S. government.
(g) Expand the definition of “foreign business entity” for purposes of I.R.C. § 6038, requiring information to be reported separately with respect to each taxable unit in a foreign jurisdiction and applying separate penalties for each failure to report each taxable unit.
Baker Botts Notes:
- Increase in Tax Saving Structures.Such increases in tax rates, taxes on capital gains, and minimum taxes tend to increase the prevalence of planning in reducing or avoiding taxes in transactions that the IRS may view as abusive. This, in turn, could increase the workload for the IRS at a time when it has reported historically low staffing levels and is already asking Congress for additional time on the statute of limitations on listed transactions.
(5) Modify Estate and Gift Taxation
In addition to some of the other significant proposals, the Administration proposes considerable modifications to the estate and gift tax regime under the Internal Revenue Code. The Administration proposes to:
(a) Overhaul the income, estate, and gift tax rules for certain grantor trusts.
The Administration is continuing to target certain grantor trust planning techniques that allow taxpayers to shift value out of their estate while avoiding income and gift tax consequences. The various techniques that the Administration intends to use in closing this tax “loophole” for Grantor Retained Annuity Trusts (“GRATs”) include the following: (1) requiring the remainder interest in a GRAT to have a minimum gift tax value equal to the greater of 25% of the value of the assets transferred to the GRAT or $500,000 (but not more than the value of the assets transferred); (2) precluding any decrease in the annuity during the GRAT term and the grantor’s acquisition of an asset held in the trust without recognizing gain or loss; and (3) requiring that GRATs have a minimum of 10-year term and a maximum term of the life expectancy of the annuitant plus ten years. Notably, the Administration would not prohibit the use of GRATs, but rather “impose some downside risk on the use of GRATs so they are less likely to be used purely for tax avoidance purposes.” These provisions would apply to trusts created “on or after the date of enactment,” meaning that they would not be retroactive.
Consistent with legislative and other proposals that arose at the end of 2021, the Administration proposes treating transactions (other than securitization transactions) between an irrevocable grantor trust and a deemed owner as “regarded for income tax purposes, which would result in the seller recognizing gain on any appreciation in the transferred asset and the basis of the transferred asset in the hands of the buyer being the value of the asset at the time of the transfer.” The proposal generally would apply to all transactions between a grantor trust and a deemed owner occurring on or after the date of enactment, meaning that it would not be retroactive. The proposal, however, would apply to transactions between a grantor trust and a deemed owner occurring after the effect date in satisfaction of obligations created before the effective date (such as in-kind payments to satisfy a GRAT annuity or a promissory note due to the grantor).
The Administration also proposes treating the deemed owner’s payment of the income tax that is attributable to the grantor trust as a gift to the beneficiaries of that trust. This proposal would apply to all trusts that are created on or after the date of enactment, meaning that it would not be retroactive.
(b) Require consistent valuations of promissory notes. Under the proposal, “if a taxpayer treats any promissory note as having a sufficient rate of interest to avoid the treatment of any foregone interest on the loan as income or any part of the transaction as a gift, that note subsequently must be valued for Federal gift and estate tax purposes by limiting the discount rate to the greater of the actual rate of interest of the note, or the applicable minimum interest rate for the remaining term of the note on the date of death.” The proposal would apply to valuation dates on or after the date of introduction, which mean that the proposal is retroactive.
(c) Improve the tax administration for trusts and decedents’ estates by expanding the definition of “executor,” increasing the limit on the maximum valuation decrease for qualified real property elected to be treated as special use property to $11.7 million, extending the 10-year period for estate and gift tax liens, and requiring annual information reporting by certain trusts.
(d) Limit the duration of the generation-skipping transfer tax exemption.
Baker Botts Notes:
- Installment Sales to Grantor Trusts and Overriding Revenue Ruling 85-13. For decades, taxpayers have relied on well settled authorities, including Revenue Ruling 85-13, to not recognize the gain or loss on the sale of property (often in exchange for a mid- or long-term note with interest at the applicable federal rate) between a grantor trust and a deemed owner under Subchapter J. Likewise, under current law, the deemed owner’s payment of the income tax attributable to trust assets is not considered an additional gift. As a result of the larger unified credit under the Tax Cuts and Jobs Act of 2017, a deemed owner who anticipates having a “nontaxable” estate (i.e., one that is below the amount of the unified credit) might also repurchase the asset sold to the grantor trust before his or her death (again without gain/loss recognition) with the goal of obtaining a step-up in the asset’s basis pursuant to I.R.C. § 1014 upon death. The Administration describes this planning as a “tax avoidance strategy facilitated by grantor trusts.”
- Promissory Notes. There has been an uptick in the IRS asserting that promissory notes must be valued consistently at and after issuance (e.g., in a later transfer or at death) by either using the below-market loan rules under I.R.C. § 7872 or the traditional fair market value standard (i.e., the willing-buyer/willing-seller test) for gift and estate tax purposes. The Administration now seeks to enact new legislation to enact the IRS’s positions. The Administration argues that doing so prevents a taxpayer from “tak[ing] inconsistent positions regarding the valuation of a loan and thereby achiev[ing] a tax savings.”
- Additional Reporting. Because there is a lack of statistical data on the nature and value of assets held in trusts, the Administration complains about difficulties in developing administrative and legal structures for compliance and tax policies, and it now seeks to remedy that deficiency by “identifying an applicable range of estimated total value on the trust’s income tax return” for trusts with an estimated total value at year’s end in excess of $300,000 or gross income in excess of $10,000. This additional reporting will increase tax compliance costs for trusts, especially when such trusts hold non-financial assets (e.g., art, real estate, and business interests).
- Extension of the Automatic Liens. Current law provides for an automatic 10-year lien on gifts made by a donor and on property included in a decedent’s estate. This lien, however, cannot be extended, even if a taxpayer enters into an agreement with the IRS to defer tax payments or to pay taxes in installments. Even though the Internal Revenue Code and Treasury Regulations have procedures for establishing special liens to address some deferrals (e.g., the I.R.C. § 6324A special lien for estate tax deferred under I.R.C. §§ 6166 or 6166A), the proposal appears to simplify the IRS’s ability to recover unpaid taxes from property that was transferred by a donor or included in a decedent’s gross estate during any applicable deferral or installment period.
We will continue to monitor developments and will provide further updates as more details are released. In the meantime, Baker Botts would be pleased to assist you in your analysis of these proposals.
1GREENBOOK at 50-69.
2Id. at 70-92.
3Id. at 93-102.
4Id. at 1-17, 29-36.
5Id. at 40-49.
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