Flow-through entity owners affected by proposed changes to federal tax law
If you have your head buried in the sand or have just decided that you are not going to follow all of the potential changes in federal tax law, you have made a wise choice. Between Biden’s Green Paper proposal, the House Ways and Means Committee’s proposal, and the latest budget reconciliation bill released by House Democrats last week, potential tax law changes have been ubiquitous. The discrepancies between the proposals seem to indicate that there is still enough discontent within the Democratic Party in Washington to demand significant changes. Unfortunately, when you follow the money, the picture begins to reveal that the taxpayers who bear the burden of income are disproportionately the owners of flow-through entities, and not the large multinational corporations and estates as many believed. The best way to understand the most recent tax proposals is to review the progress of the changes and follow the money train.
A sigh of relief was felt by investors as the increase in capital gains from 20% to 25% does not appear in the most recent proposal for married filing spouses earning taxable income above $ 450,000. , or $ 400,000 in taxable income for single tax filers. However, there will still be an increase to 25% and 28% for individual taxpayers with an AGI greater than $ 10,000,000 and $ 25,000,000 respectively due to the surtax.
Some of you may be wondering where the billionaire’s tax proposal was included. It was never included in the proposals of Biden or the House Ways and Means Committee. The billionaire tax has reportedly targeted around 700 people with over $ 100 million in annual revenue or over $ 1 billion in assets for three consecutive years. The calculation would include the taxation of unrealized gains (or losses) incurred by this select group of people on the basis of a mark-to-market approach. It was all the media buzz over the past week, but it didn’t show up anywhere in the proposals. For me, the main reason was the difficulty of its implementation. First, those targeted have the most resources to challenge the very constitutionality of the tax. Second, it could have led to economic turmoil, as it is possible that those targeted would reduce their investments in publicly traded companies. After all, the only way to tax marketable assets is to have clear, verifiable value. If the assets are transferred to the private sector, the billionaire tax no longer applies. Finally, the target audience has access to some of the most talented accountants and lawyers in the world. There were already planning discussions to find tax avoidance opportunities, including the use of trusts to reduce asset valuation below the $ 1 billion threshold.
Other important proposals concerning inheritance and gift tax seem to have been dropped all together in the most recent proposal. House Democrats’ Budget Reconciliation Bill says nothing about significant inheritance tax changes, including reducing the lifetime inheritance and gift exemption by $ 11,700,000 to $ 5,000,000 (which would be indexed for inflation) and significant changes to ceditor trusts which were both introduced in House Ways. and proposal of the Means Committee. Even Biden had made estate planning professionals nervous with his proposal to create additional taxes that would apply when assets were transferred to trusts and on certain unrealized gains on death. The professionals were then amazed to see no modification relating to the regime of inheritance and gift taxes in the last bill. After all, the platforms of many Democratic campaigns included the giveaway reduction and the lifetime exemption. There seemed to be consensus that a change in the inheritance tax arena might be one of the most systematic ways to increase revenue.
Looking at the list of what’s left in the Tax Proposals versus what’s been deleted, some may conclude that the above highlights are fair for corporations, flow-through entities, and individuals. Everyone has a bit of “compromise”. But to understand the weight of some of these proposals, and the type of taxpayers involved, we have to follow the money. The effects on preliminary estimated revenues of certain provisions provided by the White House and the University of Pennsylvania in the Penn Wharton Budget Model (PWBM) can be found below.
If you add in the creation of federal revenue from both the expansion of the net investment income tax and the permanent establishment of the excess business loss limit, both of which have a direct impact on homeowners. of intermediary entities, the revenue generated under the White House estimate is $ 420 billion or $ 400 billion, respectively, under the PWBM estimate. The total Build Back America proposal is now estimated at $ 1.75 trillion, so 23% were born on the backs of the owners of flow-through entities. Examining the same PWBM revenue estimates for the corporate minimum tax and the changes to GILTI, which typically impact large multinational C corporations, will only create $ 447 billion, or roughly 25% of the proposal. .
Do you think that the differences between the sources of income between the flow-through entities and the C companies are negligible? As flow-through entity owners and C corporations see their taxes rise, keep in mind the type of businesses that are affected. For corporate minimum tax to apply, accounting profits must exceed $ 1 billion over a three-year period and the provisions of GILTI generally apply to large multinational corporations. On the other hand, the proposal to extend the net investment income tax will affect shareholders of S corporations and some partners with adjusted gross income above $ 500,000 and the permanence of the limitation rule. Excess business losses can apply to individuals who operate businesses or businesses, regardless of their GI. Even though the proposals from Company C and the flow-through entity will create similar revenue streams, the burden of the proposals from the flow-through entity will have a much broader impact on a much larger base of small businesses with AGI as little as $ 500,000, while the impact of Company C primarily targets large multinationals. companies with more than $ 1 billion in accounting profits, estimated at less than 12o companies.
As long as the Internal Revenue Service is able to recoup $ 400 billion over the next ten years with increased funding, many tax practitioners are wary. It’s unclear how the White House estimates that number, and the PWBM estimates it could raise as little as $ 190 billion, less than half of what the White House is projecting.
Although it appears that negotiations have yet to take place, the most recent proposed legislation places a heavy burden on the owners of flow-through entities and is rated at a much lower income threshold than C companies. revenue for the federal government while focusing on middle-income owners makes sense. After all, before the COVID pandemic, more than 90% of businesses in the United States were transient businesses. However, for now, it looks like large multinational C corporations and wealthy estates have once again escaped higher tax rates and most likely are breathing a sigh of relief.