On September 13, the House Ways & Means Committee released its first draft of the proposed tax changes to be incorporated into the Build Back Better Act budget reconciliation bill to fund President Biden’s $3.5 trillion in spending priorities.
While the draft — referred to as “Subtitle I - Responsibly Funding Our Priorities” — provides some insight on where negotiations currently stand, this is only the first step in creating the final legislation that will eventually be voted upon by Congress and sent to President Biden for signature. Given the current political environment, the final tax law changes will likely look very different than this draft.
The following is a summary of key business tax revenue provisions included in the draft.
Corporate tax rate
- Replace the flat corporate income tax with a graduated rate structure
- 18% on the first $400,000 of taxable income
- 21% on taxable income up to $5 million
- 26.5% on taxable income above $5 million
- The benefit of the graduated rates would be phased out for corporations with more than $10 million of taxable income, by requiring an increase in the tax determined using those rates by the lesser of 1) 3% of such excess or 2) $287,000
- Personal services corporations would not be eligible for these graduated rates and would thus be subject to a flat tax rate of 26.5%
- To reflect the above changes, the dividends received deduction would be adjusted
- From 50% to 60% for qualifying dividends received from a corporation in which it owns less than 20%
- From 65% to 72.5% for qualifying dividends received from a corporation in which it owns 20% or more
Enhancement of the Work Opportunity Tax Credit (WOTC)
- Increase the WOTC to 50% for the first $10,000 in wages for all WOTC targeted groups except for summer youth employees, through December 31, 2023
- This increase would be available for qualified wages earned by a WOTC target group employee in both their first and second year of employment (current law allows WOTC to be claimed only on first-year wages)
Research and experimentation expenses
- Delay the effective date of the requirement that research and experimentation expenses be capitalized and amortized, rather than immediately expensed, from tax years beginning after December 31, 2021 to tax years beginning after December 31, 2025
Conversion of S corporations to partnerships
- Allow qualified S corporations to convert into partnerships on a tax-free basis
- Qualified S corporations must have been in existence on or before May 13, 1996 and, presumably, have been taxed as an S corporation at all times since then
- The conversion must occur in the two-year period beginning on December 31, 2021, with the S corporation completely liquidating and transferring substantially all of its assets and liabilities to a domestic partnership or LLC taxed as a partnership during that time
- This is a pro-taxpayer provision that came as a surprise, not having been included in the Biden Green Book or discussed publicly
- Potential beneficiaries:
- S corporations that would otherwise need to engage in complicated (costly) restructuring to become a more viable target for a private equity acquiror
- S corporations holding substantially appreciated assets, such as real estate
- S corporations approaching the current 100 investor limit, which is imposed on S corporations but not partnerships
- Deny deduction for contributions of conservation easements by partnerships and other pass-through entities if the amount of the deduction exceeds 2.5 times the sum of each partner’s share of the tax basis in the contributed property
- An exception applies to donations of property that meet the requirements of a three-year holding period rule and contributions by family partnerships (as opposed to syndicated partnerships)
- This section generally applies to contributions made after December 23, 2016, but in the case of easement contributions related to the preservation of certified historic structures, this section applies to contributions made after December 31, 2018
- Various accuracy-related penalties, including the gross valuation misstatement penalty, apply to any deduction disallowed under this provision
- Adjustments are made to the statute of limitations on assessment and collection by the IRS, in the case of any deduction disallowed under this provision
- The IRS really dislikes what they perceive to be abusive conservation easements, and this is the latest tool being added to their toolbox to proactively pursue such arrangements and punish all parties involved
Unless noted, changes would be effective for tax years beginning after December 31, 2021, allowing taxpayers minimal time to implement planning opportunities to minimize their impact.
Wipfli will continue to monitor progress with respect to the Build Back Better Act and issue guidance as further details are provided on provisions that could impact businesses and their owners. But don’t wait until these proposals have become law to start thinking about how they will impact you, your business, and your future deals. If you have questions or would like additional information, please contact us. We are here to help.
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