Biden Administration's FY 2023 Budget Plan Calls for Corporate Tax Hikes

5/19/2022 - By Saltmarsh, Cleaveland & Gund

The fiscal year 2023 budget blueprint, released by the Biden administration on March 28, reflects the President’s policy objectives. It consists of a mix of familiar proposals and brand-new initiatives. The proposals are described in more detail in the General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals, better known as the “Green Book,” that was released with the budget, and include the President’s now-familiar calls for increasing the top corporate tax rate to 28%.

These proposals, as well as others that have not been closely scrutinized, are described in more detail below.

Corporate Tax Proposals

Raise Corporate Income Tax Rate to 28%

C corporations, unlike an S corporation, the income of which passes through to its shareholders for a single level of tax, pay an entity-level income tax, and their shareholders pay a second level of tax on distributions that come out of either current or accumulated (past) earnings and profits of the corporation.

Before the Tax Cuts and Jobs Act of 2017 (TCJA), a C corporation’s tax was computed on taxable income in the U within a progressive tax system, with the highest rate reaching 35% (before offsetting any available tax credits). The TCJA replaced a graduated tax schedule with a flat tax of 21%, which is applied to all C corporations, before offsetting eligible credits.

The administration’s proposal would increase the tax rate for C corporations from 21% to 28%, roughly halfway between the pre-TCJA and post-TCJA rates. The purpose of the corporate income tax rate increase is intended to raise revenue to help pay for the Biden administration initiatives.

Many multinational corporations pay effective tax rates on worldwide income that are far below the statutory rate, due in part to low-taxed foreign income, as discussed below. The proposal would keep the global intangible low-taxed income (GILTI) deduction constant, raising the GILTI rate in proportion to the increase in the corporate rate through the application of the higher rate on the portion not excluded from the deduction. This takes away the incentive to shift profits and activity offshore as the domestic rate is increased with respect to that foreign-source income of foreign subsidiaries owned by U.S. corporations. Thus, the 28% corporate income tax rate would consequently increase the GILTI rate in tandem. The new GILTI effective rate would be 20%, applied on a jurisdiction-by-jurisdiction basis.

This proposal would be effective for taxable years beginning after December 31, 2022. The rate increase would therefore impact calendar year corporate taxpayers for the 2023 calendar year. However, for fiscal year taxpayers with taxable years beginning before January 1, 2023, and ending after December 31, 2022, the corporate income tax rate would be equal to 21% plus 7% times the portion of the taxable year that occurs in 2023.

This proposal may discourage investments in C corporations and might work to provide an increased incentive to fund these corporations through debt rather than equity, since the rate of return on equity investments available to shareholders decreases by 7%, or the amount of cash that is spent on taxes before excess after-tax earnings are reinvested into the business or are distributed to shareholders.

If enacted, the proposal would also encourage tax planning to manage taxable income between years, that is, to defer deductions to higher-taxed years (e.g., 2023), while accelerating income to lower-taxed years (e.g., 2022).

Change Definition of “Control” for Corporate Transaction Testing

Most large businesses, including substantially all publicly traded corporate businesses and certain closely held corporate businesses that do not elect to be an S corporation, have separate legal subsidiary corporate entities that are owned directly or indirectly by a common parent.

Under current law, most large businesses in the U.S are comprised of corporate affiliates connected to the common parent company through direct and indirect stock ownership. In order for these large businesses to file a single consolidated return, each related corporation must be a member of an “affiliated group.” The benefit of filing a consolidated return is that an affiliate’s losses can offset the income of other affiliates.

A related company is considered “affiliated” to another company when there is direct and indirect ownership of stock possessing at least 80% of the total voting power of the stock of the corporation and that has a value of at least 80% of the total value of the stock of the corporation.

While the definition for affiliation contains 80% tests relating to both vote and value, which appears to constitute control for consolidated return filing purposes, the definition of control for purposes of other corporate transactions is notably different. These other transactions include tax-free contributions to capital under Section 351, certain reorganization transactions under Section 368 and divisive reorganizations under Section 355.

For purposes of these other corporate tax provisions, “control” is defined under Section 368(c) as ownership of stock possessing at least 80% of the total combined voting power of all classes of voting stock and at least 80% of the total number of shares of each other class of outstanding stock. This includes both voting and nonvoting stock of the corporation. It does not, however, contain a value component, as is contained in the definition of an “affiliated group.”

The administration believes taxpayers “can use the section 368(c) control test in highly structured transactions, which control voting rights and total shares are issued in a manner that qualifies the transaction as tax-free,” while effectively selling a large percentage of the “value” of a corporation, which would not otherwise qualify the transactions as tax-free. Moreover, the administration also believes that the definition could be used to structure into a taxable transaction, as opposed to a tax-free reorganization, when needed to recognize a loss that would otherwise be deferred through the mandatory tax-free transaction provisions.

These structured transactions allow for the allocation of voting power among the shares of a corporation, so that taxpayers can control the voting shares to qualify or not qualify a transaction, as desired, as tax-free, thereby allowing corporations to retain control of a corporation but to “sell” a significant amount of the value of the corporation tax-free.

The administration’s proposal would conform the control test under Section 368(c) with the affiliation test under Section 1504(a)(2). This would be done by changing the definition of “control” to ownership of at least 80% of the total voting power and at least 80% of the total value of the stock of a corporation.

It should be noted that the proposal is silent regarding how plain vanilla preferred stock under Section 1504(a)(4) would be treated for these purposes. There are four requirements to be considered plain vanilla preferred stock: the stock (1) is not entitled to vote, (2) is limited and preferred as to dividends and does not participate in corporate growth to any significant extent, (3) has redemption and liquidation rights that do not exceed the issue price of the stock (except for a reasonable redemption or liquidation premium), and (4) is not convertible into another class of stock.

While this type of stock would not be considered for “affiliated group” determinations, it could be considered for control purposes. The thought is that if a majority of the value is represented by this type of preferred stock, including it could make what would otherwise be a tax-free transaction taxable, and thus raise more revenue for the administration if this proposal is ultimately enacted into law. However, if the business objectives cannot be agreed to from an economic standpoint, rather than enter into a taxable transaction, many deals may not move forward.

The proposal would be effective for transactions occurring after December 31, 2022.

International Tax Proposals

GILTI and FDII

As a result of the proposed increase of the corporate income tax rate to 28%, the effective rate of GILTI and FDII would increase to 20% and 21%, respectively. These effective rates also assume that the Section 250 deduction for GILTI and FDII would be reduced to 28.5% and 24.8%, respectively, as a baseline from the Build Back Better Act. The baseline also assumes that GILTI would be calculated on a country-by-country basis.

Consequently, the threshold rate for determining whether a CFC’s earnings under GILTI or subpart F would be eligible for the high-tax exception would also increase to 25.2% (90% of the increased corporate income tax rate of 28%).

Tax Credit for Onshoring Jobs to the U.S.

Effective for expenses paid or incurred after the date of enactment, the administration’s proposal would incorporate a new business credit for onshoring a U.S. trade or business.

The onshoring tax incentive, which is substantially similar to the proposal included in the administration’s fiscal year 2022 budget proposal, would provide a new general business credit equal to 10% of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business (limited to expenses associated with the relocation of the trade or business and would not include capital expenditures, costs for severance pay or other assistance to displaced workers). Onshoring a U.S. trade or business is defined as reducing or eliminating a trade or business (or line of business) currently conducted outside the U.S. and moving the same trade or business to a location within the U.S., to the extent that this action results in an increase in U.S. jobs.

Tax Deduction Disallowance for Offshoring Jobs

Also effective for expenses paid or incurred after the date of enactment, the administration’s proposal would include a disallowance of deductions for offshoring a U.S. trade or business.

Specifically, to reduce the tax benefits associated with a U.S. company moving jobs outside of the U.S., the proposal would disallow deductions for expenses paid or incurred in connection with offshoring a U.S. trade or business. Offshoring a U.S. trade or business means reducing or eliminating a trade or business, or a line of business currently conducted inside the U.S. and starting up, expanding or otherwise moving the same trade or business outside of the U.S., to the extent the action results in a loss of U.S. jobs. Additionally, no deduction would be allowed against a U.S. shareholder’s GILTI or subpart F income inclusions for any expenses paid or incurred in connection with moving a U.S. trade or business outside of the U.S.

Questions?

For any questions regarding the 2023 budget plan and individuals, estates and gift taxes, reach out to our Tax team!