Treasury's Green Book, Part 1: Tax Rates, High Income Earners, and Capital Gains

HOST: Welcome to the Cherry Bekaert Tax Beat, a conversation about tax that matters.

Today is June 8, 2021, and our main topic of discussion will be the recently released Greenbook and its implications on domestic income tax rates for both individuals and corporations. This is the first in a two-part series on the Greenbook.

First, let's introduce my colleagues. Sarah?

SARAH MCGREGOR: Hello, this is Sarah McGregor calling in from Greenville, South Carolina.

BARRY WINES: This is Barry Wines. I am sitting in Tampa, Florida, today.

MIKE KIRKMAN: I am Mike Kirkman, and I am also sitting in Tampa, Florida.

HOST: Are you going to root for the Bolts while you are down there in Tampa?

MIKE KIRKMAN: I am going to cheer on the Hurricanes avidly.

HOST: I am a closet Montreal fan, I have to confess. My name is Brooks Nelson. I am a tax partner, and I am sitting in Richmond, Virginia, today.

Sarah McGregor, how is life treating you?

SARAH MCGREGOR: Life is good. It is nice to have the Greenbook out. We do not often get these from the Treasury.

"Greenbook" is a tax term for the information produced by the Treasury on proposed revenue raisers and tax law changes that the administration is proposing. Being a tax nerd, it is always good to have new things to talk about.

BROOKS NELSON: Let me set the table on the Greenbook. On March 31, the White House released the American Jobs Plan, or at least a fact sheet on it.

On April 28, the White House released a fact sheet on the American Families Plan. On May 28, President Biden proposed a federal budget that encompasses many of the concepts introduced in these two previously released plans.

In conjunction with this budget, the Treasury released what it calls "General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals," also known as the Greenbook. It is over 100 pages.

I thought the American Jobs Plan was well-written, but the American Families Plan was a little confusing. We have now gotten more clarity on a lot of these concepts, so I would like to give kudos to the authors.

In the Greenbook, we are looking at revenue raisers scored at a net of $2.4 trillion. Today, we are going to spend a lot of time talking primarily about corporate and individual rates, and some of the estate and gift tax implications.

We will not spend much time talking today about the legislative process, International Tax (ITX) proposals, energy credits, or infrastructure spending proposals. We will save those for our part two podcast.

Let's move forward and start with corporate tax rates. Barry, why don't you talk to us about what we now know regarding the corporate tax rate proposal and its implications?

BARRY WINES: In prior announcements, they said they were going to raise the corporate tax rate to 28%. They have done that, and we have a little more detail.

The effective date they are looking at is January 1, 2022. The rate increase was not a big surprise, and the effective date is where we would have expected it.

BROOKS NELSON: For the corporate rate, that is the effective date.

BARRY WINES: Correct. It is the same thing for the individual rates. They propose increasing those to a top rate of 39.6% for those above $509,300 for married filing jointly and $452,700 for unmarried individuals.

Those are all effective starting next tax year. Another corporate change is the proposed 15% minimum tax.

This would not apply to taxable income, but to financial statement book income. If you report financial statements to the public, they are proposing a minimum 15% tax on that.

The proposal only applies to companies with over $2 billion in book income. Really, only about 120 to 150 large worldwide corporations are going to have that apply to them.

BROOKS NELSON: Assuming that proposal went through, can you refresh our memories on the implications for entity structures and corporate planning?

BARRY WINES: Currently, money inside of a C Corporation that is not distributed is taxed less than an individual. That will continue to apply, although the rate differential will be much less.

Entity selection will still matter. Deciding whether to distribute operating cash flow or reinvest it in the company will require planning exercises.

The big key is going to be the capital gains rate, because that is going to apply to capital gains and to dividends. Section 199A, which is the 20% deduction for pass-through entities, has not been touched here.

There are some provisions to deal with the 3.8% net investment income tax (NIIT) and self-employment tax for certain taxpayers. Those all need to be worked out and considered.

BROOKS NELSON: Not to box you into a corner, but if you had to make a general statement, it seems pass-through entities will generally come out ahead of the corporate structure if we are at a 28% rate.

BARRY WINES: I think that is safe in most cases. The long-term benefit, even with an increased capital gains rate, is still going to be pass-through entities.

The only thing that would make a difference is if you have a corporation that qualifies for the Section 1202 Qualified Small Business Stock (QSBS) exclusion. That exclusion is not being touched in these proposals.

BROOKS NELSON: There are always situations where you have to be a C Corporation for business reasons. You have business decisions and you have tax decisions.

President Biden has signaled willingness to compromise on the 28% flat rate and substitute a 15% minimum tax on all corporations, not just the very large ones. Does that change your thinking?

BARRY WINES: Not really, because it is still going to be based on book income. Financial statement decisions are now going to come into play, which will be interesting.

It appears the G7 has agreed that a 15% minimum tax is a good idea. I can certainly see that $2 billion threshold coming down significantly to get a deal done.

I would also submit that if we do not see a corporate tax rate increase in this proposal, it is very likely to come back before the end of the year in another proposal. These are the targets.

BROOKS NELSON: Let's switch to you, Mike. We have individual rates and capital gains rates. What are your thoughts on the proposals for high-net-worth individuals?

MIKE KIRKMAN: They have determined that high income earners will go from a top rate of 37% to 39.6%. These are based on the 2017 index threshold amounts.

For married filing jointly, the threshold is $509,300, and for a single person, it is $452,700. Dollars over that are going to be taxed at 39.6%.

Depending on the type of income, you could add another 3.8% to that, effectively making the tax rate 43.4%. Those rates would become effective for tax years beginning after December 31, 2021.

SARAH MCGREGOR: By going back to those 2017 rates, the marriage penalty comes back into play. The unmarried threshold is roughly $450,000, and the married threshold is only a bit over $500,000. That puts more income into those top rates for married couples.

BROOKS NELSON: Let's talk about the shocking part of the proposal: the effective date for capital gains and qualified dividends.

MIKE KIRKMAN: This is where it gets interesting. For a married filing joint couple with AGI that exceeds $1 million, long-term capital gains and qualified dividends would be taxed at 37%.

When you add the net investment income tax, you are looking at 40.8%. When individual rates go up in January 2022, those gains could effectively be taxed at 43.4%.

The proposed effective date for this change is after the date of announcement, which would be April 28, 2021. I do not know if it is going to get much traction in Congress, but that is the proposal.

BROOKS NELSON: Mike, in our previous podcast we talked about planning around a perceived increase in capital gains rates. What are the high-level thoughts on that now?

MIKE KIRKMAN: If the "date of announcement" becomes the effective date, there is not much we can do at this point. However, there is still a lot of activity around selling companies to get deals executed in 2021.

We still do not know if the date of enactment or announcement will be the final choice. Potentially, installment sales could benefit a taxpayer depending on the size of the deal and the appetite for it.

BROOKS NELSON: It is unfortunate they used the date of announcement instead of the date of enactment. It creates unnecessary confusion.

BARRY WINES: There is still a 2.6% rate difference between 37% in 2021 and 39.6% in 2022. There is still a small opportunity to save taxes before the top bracket changes in January.

MIKE KIRKMAN: If you have an installment sale, a planning technique may be to elect out of installment treatment if you can work the cash flow. You could trigger the gain in 2021 at a potentially lower rate.

BROOKS NELSON: Let's talk about the estate and gift tax implications of this capital gain rate. Mike, try to recap what they are proposing for capital gains in these scenarios.

MIKE KIRKMAN: This is part of the income tax section. While we are dealing with transfers and date of death, it is not a transfer tax per se.

If an individual transfers appreciated assets by gift, they will have a realized capital gain at the time of transfer. For an estate, the deceased owner of appreciated assets will realize capital gains as of the date of death.

It is a deemed recognition event. It is no different than if you sold securities, but in this case, you have just moved the asset to an heir or donor.

BROOKS NELSON: What is upsetting is that it is a non-cash transaction. Moving valuable property will frequently force a second transaction just to fund the taxes. It is not in keeping with normal concepts in taxation.

MIKE KIRKMAN: There are some carve-outs. Family-owned businesses and farms get some special treatment. They are focusing on assets that are more liquid, like marketable securities, where you might be forced to sell a chunk to pay the tax.

Transfers to spouses and charities are excluded. Tangible personal property, except for collectibles, would not be subject to this. Section 1202 stock is also excluded.

They are providing a $1 million exclusion per person, which is $2 million for a married couple. There is also a $250,000 per person exclusion for a personal residence.

BROOKS NELSON: What about the installment plan?

MIKE KIRKMAN: If an individual transfers a family-owned business during life, it will not trigger a gain event until the business ceases to be family-owned or they sell it.

However, if a patriarch dies with that appreciated business, the Greenbook says we would have a 15-year payment plan at a fixed rate of interest for that tax.

BROOKS NELSON: This is far from a done deal, but it is unsettling. Mike, what is your takeaway on what people should be considering regarding gifting?

MIKE KIRKMAN: The proposed effective date for capital gains related to estate and gift transfers would be after December 31, 2021. This gives people time to do what they are already doing.

People are making transfers, doing planning, and obtaining valuations. This proposal only exacerbates the need for people with highly appreciated assets to do planning.

BROOKS NELSON: Any concern that this $1 million exclusion translates into a move to lower the overall estate and gift tax exemption to that level?

MIKE KIRKMAN: It clearly could. The Greenbook emphasizes that you would get a deduction on the estate tax return for the income tax paid on the appreciation. However, it would be a huge revenue generator if they reduced the overall exclusions as low as a million dollars.

BROOKS NELSON: Sarah, you want to talk about the proposal for realizing capital gains in non-corporate entities?

SARAH MCGREGOR: They seem to be after dynasty trusts that hold family wealth. If a trust holds assets for 90 years without a recognition event, it will have to pay tax on the built-in gain.

The start date would be around 1940, so the first time this would come into play would be at the end of 2030. That gives everyone about nine years to plan.

MIKE KIRKMAN: They are targeting grantor trusts. People have made irrevocable transfers to trusts where the income is taxed to the donor so the trust never incurs the burden. At some point, the appreciation will be triggered.

BROOKS NELSON: Sarah, what are they saying about the net investment income tax and self-employment tax?

SARAH MCGREGOR: They are trying to bring all pass-through entities—partnerships, LLCs, and S Corporations—under the same roof regarding tax on earnings.

The idea is to level the playing field so all that income is subject to self-employment taxes if you are actively involved in the business.

BARRY WINES: If these provisions are equalized, it will have a big impact on entity selection. Currently, a main advantage for an S Corporation is the avoidance of some of these taxes.

If they are taxed the same, why put up with S Corporation restrictions? I could see a move away from S Corporations if these provisions are equalized.

BROOKS NELSON: Let's hit a few items quickly. Sarah, offshore expense disallowance?

SARAH MCGREGOR: This would disallow deductions for companies that are offshoring business or moving production outside of the U.S.

On the flip side, they are offering a 10% tax credit for the expenses of "onshoring" or bringing activity back to the U.S. This is one of the few items with an effective date of "date of enactment."

BROOKS NELSON: Carried interest?

SARAH MCGREGOR: The proposal is to completely eliminate Section 1061. This means those receiving partnership interests for services will be taxed on that income as ordinary income, no matter its character.

BROOKS NELSON: 1031 exchanges?

SARAH MCGREGOR: This would eliminate 1031 exchanges for high-income individuals. It would still allow gains to be deferred up to $500,000, but any gain above that would have to be recognized.

BROOKS NELSON: Barry, excess business losses?

BARRY WINES: The 2017 Act introduced the concept of limiting excess business losses to $500,000. That was slated to lapse in 2026, but this provision would make that limitation permanent.

SARAH MCGREGOR: One bit of bright news is the intent to extend tax credits for families. This includes child tax credits and earned income tax credits, which were expanded under the American Rescue Plan. This proposal wants to make some of those permanent.

BROOKS NELSON: My takeaway is that the "date of announcement" effective date for capital gains is concerning. It makes me want to think hard about corporate restructuring or triggering certain transactions like 1031 exchanges now.

If you have gifting that needs to be done, you really need to accelerate that plan. Sarah, any other wrap-up comments?

SARAH MCGREGOR: Only that all of this is up for negotiation. We will have to see what actually gets passed in the coming months.

BROOKS NELSON: We have a Greenbook part two podcast coming up to discuss the legislative process. A quick disclaimer that we are not providing personal tax advice. Please consult with your personal tax advisor at Cherry Bekaert with your specific issues.

Check out our website, cbh.com, for the latest guidance. That concludes today’s podcast. Thank you, Sarah, Barry, and Mike.