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Articles From Lumsden McCormick

Corporate and Business Tax Provisions under the Federal Budget

The Biden administration has released its budget proposal for fiscal year 2024. The proposal aims to decrease the federal deficit by roughly $3 trillion within the next decade. To achieve this, taxes will be raised on high-net-worth individuals and large corporations.

The proposed budget entails a 7% increase in the U.S. corporate income tax rate, from 21% to 28%. The ordinary tax rate for top individuals will also increase from 37% to 39.6%. Changes in international tax rules will be implemented, which will increase the tax rate on foreign earnings of U.S. multinational corporations. Furthermore, the corporate stock repurchase excise tax will move up from 1% to 4%, which was part of the Inflation Reduction Act of 2022.

The White House has also released the "Green Book," or General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposal. It provides an in-depth analysis and detailed estimates from the Treasury Department for the administration’s revenue proposals.

In this article we cover the Corporate and Business Tax Provisions under the 2024 Federal Budget.

Raise Corporate Income Tax Rate to 28%

C corporations pay an entity-level income tax at a flat rate of 21%, and their shareholders pay a second level of tax on distributions that are made from either current or accumulated (past) earnings and profits of the corporation.

The proposal would increase the tax rate for C corporations from 21% to 28%, thus restoring one-half of the tax-rate reduction that became effective after December 31, 2017 (from 35% to 21%).

This proposal would be effective for taxable years beginning after December 31, 2022. 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.

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. The proposal would keep the global intangible low-taxed income (GILTI) deduction constant, raising the effective 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, or 14%. Separate proposals applicable to GILTI would further increase the effective rate of tax on such income (see discussion below).

Increase the Excise Tax Rate on Repurchases of Corporate Stock

The Inflation Reduction Act imposed a 1% excise tax on stock repurchases by domestic corporations whose stock is publicly traded. Among other provisions, the amount subject to the tax is subject to a de minimis exception, is offset by certain issuances of stock by the corporation and includes some transactions that are considered to be economically similar to a redemption by a corporation of its own stock. The tax also applies to acquisitions of the corporation’s stock by certain specified affiliates, to certain subsidiaries of foreign corporations, and to certain non-U.S. corporations subject to the inversion rules.

The proposal would quadruple the excise tax rate to 4%, applicable to repurchases of stock after December 31, 2022, the original effective date of the tax.

Tax Corporate Distributions as Dividends

Distributions made by a corporation with respect to its stock are generally subject to a three-tier treatment, consisting of (1) taxable dividends to the extent of the corporation’s current or accumulated earnings and profits, (2) recovery of basis to the extent the distribution exceeds the amount taxable as a dividend, and (3) gain from the exchange of stock to the extent the distribution exceeds the amount subject to the first two categories.

The proposals are intended to limit or prevent the use of some transactions that have been used by taxpayers to reduce the portion of their distributions treated as a taxable dividend. If enacted, they would apply to (1) distributions of certain high-basis stock owned by the distributing corporation, (2) certain leveraged distributions, (3) purchases of “hook stock” by a subsidiary of the issuing corporation, and (4) the use of the “boot-within-gain” limitation applicable to reorganization transactions.

Most of the proposals would become effective for transactions occurring after December 31, 2023. The first of the four changes described above would be effective as of the date of enactment.

Limit Tax Avoidance Through Leveraging of Parties to Divisive Reorganizations

The divisive reorganization provisions of Sections 368(a)(1)(D) and 355 (commonly referred to as “spin-offs,” “split-offs” or “split-ups”) represent one of the few exceptions in the Code that permit a corporation to distribute appreciated property without the recognition of gain. In the most straightforward transaction, the distributing corporation (“Distributing”) transfers property to a controlled corporation (“Controlled”) and then distributes all the stock of Controlled to its shareholders. Provided that all the applicable statutory and regulatory requirements are satisfied, none of Distributing, Controlled or the shareholders of Distributing will recognize any gain or loss from the transactions.

Taxpayers have devised a number of transactions in connection with a divisive reorganization that are collectively referred to as “monetization transactions.” These transactions have the effect of extracting value from Controlled prior to the distribution of the Controlled stock. Such transactions include (1) the distribution of Controlled debt to Distributing, (2) the transfer of money or other property by Controlled to Distributing, and (c) the assumption by Controlled of liabilities of Distributing. If properly structured within applicable guidelines and safe harbors, Distributing will not recognize any gain from these monetization transactions.

The proposal would further restrict (but not eliminate) the ability of taxpayers to use monetization transactions to reduce or eliminate gain realized by Distributing. The proposal would be effective for transactions occurring after the date of enactment, with an exception for transactions described in ruling requests submitted to the Internal Revenue Service on or before the date of enactment.

Limit Losses Recognized in Liquidation Transactions

In general, when a corporation distributes its property in complete liquidation, gain or loss is recognized to both the distributing corporation and its shareholders. The corporation recognizes gain or loss as if its property had been sold to the shareholders for its fair market value. The shareholders recognize gain or loss based on the difference between the amount realized and their tax basis in the stock. The Section 267 rules that would disallow or defer the recognition of losses from the sale of property between related persons do not apply to losses arising out of the complete liquidation of corporations.

One important exception to this rule applies to “subsidiary liquidations,” in which a corporate shareholder owns at least 80% of the subsidiary’s stock (by vote and value). In this case, the corporate shareholder does not recognize gain or loss on the liquidation, and the liquidating corporation does not recognize gain or loss to the extent that property is distributed to the corporate shareholder.

Because neither gains nor losses are recognized under this exception to the general rule, taxpayers with a built-in loss have structured pre-liquidation transactions in an effort to claim a deductible loss upon liquidation. Stated differently, taxpayers seek to avoid the non-recognition rules applicable to subsidiary liquidations to use the rules for taxable liquidations of corporations. Such transactions frequently involve the transfer of more than 20% of the subsidiary’s stock to a related party, such that the parent does not directly own at least 80% of the subsidiary’s stock at the time of liquidation.

The proposal would expand the scope of the loss-disallowance provisions so that they would apply to losses from the complete liquidation of a corporation when the assets of the liquidating corporation remain in the “controlled group” after the liquidation. The term “controlled group” generally includes corporations under common control using a 50% stock ownership level. Although the proposal would not change the requirements for a tax-free subsidiary liquidation, it would effectively defer the recognition of losses in those cases.

The proposal would apply to liquidating distributions after the date of enactment.

Conform Definition of “Control” for Corporate Transaction Testing

Most large businesses operate through parent-subsidiary structures in which separate legal entities are owned, directly or indirectly, by a common parent. Domestic parent-subsidiary groups may file a single consolidated return federal income tax return if each lower-tier corporation is a member of an “affiliated group” under the common parent. One benefit of filing a consolidated return, among others, is that an affiliate’s losses can offset the income of other affiliates.

A related corporation is considered to be a member of an “affiliated group” when there is direct and indirect ownership of stock by a common parent possessing at least 80% of the total voting power of the stock of the corporation and at least 80% of the total value of the stock of the corporation. Certain “plain vanilla” preferred stock is not taken into account in determining the existence of an affiliated group.

However, the definition of control for purposes of other corporate provisions 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 requirement thus includes both voting and nonvoting stock of the corporation. Importantly, it does not contain a value component, in contrast to the definition of an “affiliated group.”

The proposal would conform the control test under Section 368(c) with the affiliation test under Section 1504(a)(2) by uniformly applying the “affiliated group” definition to most corporate transactions. Thus, the Section 368(c) definition of “control” would also require ownership of at least 80% of the total voting power and at least 80% of the total value of the stock of a corporation. The exception for “plain vanilla” preferred stock would continue to apply.

The proposal would be effective for transactions occurring after December 31, 2023.

Strengthen Limitation on Losses for Noncorporate Taxpayers

Section 461(l) imposes a limitation on the ability of noncorporate taxpayers to use business losses to offset other sources of income. Indexed annually for inflation, the annual limitation for 2023 is $578,000 for married individuals filing a joint return and $289,000 for all other taxpayers. Any net business losses in excess of this limitation constitute an excess business loss that is carried forward to subsequent taxable years subject to the rules applicable to net operating losses. These limitations are applied after basis limitations (for pass-through entities), at-risk limitations and limitations on losses from passive activities.

After being extended twice, under current law, these limitations would cease to apply for taxable years beginning after December 31, 2028.

The proposal would make Section 461(l) permanent and would eliminate the provision that subjects excess business losses from a prior taxable year to the rules applicable to net operating losses in subsequent years. Thus, the Section 461(l) limitations would apply to the initial year of the excess business loss and to any subsequent taxable years to which such losses are carried.

Accelerate and Tighten Rules on Excess Employee Remuneration

Section 162(m) disallows a deduction for compensation paid by publicly held corporations in excess of $1 million to certain covered employees. Covered employees consist of the chief executive officer, the chief financial officer and the three highest-paid officers in addition to the two identified positions. For taxable years beginning after December 31, 2026, the term “covered employee” is expanded to include any employee who was among the five highest-paid employees of the corporation but who is not already included in either of the previous categories. Subject to certain exceptions and the $1 million allowance, the disallowance applies to “applicable employee remuneration” paid to the covered employees.

The proposal would expand the scope of the disallowance provisions in four ways:

  • Accelerate the effective date of the expanded definition of covered employees so that it applies three years earlier, that is, to taxable years beginning after December 31, 2023;
  • Treat all members of a controlled group (as generally defined for certain employee benefit purposes) as a single employer for purposes of identifying the covered employees and applying the $1 million deduction limitation;
  • Extend the application of Section 162(m) disallowance to all amounts paid to a covered employee, otherwise treated as applicable employee remuneration, whether or not paid directly by the publicly held corporation; and
  • Expand the regulatory authority of the Secretary of the Treasury to carry out the purposes of Section 162(m) and to prevent avoidance of the rule.

The proposal would be effective for taxable years beginning after December 31, 2023.

Prevent Prison Facility Rent Payments from Contributing to Qualification as a REIT

A real estate investment trust (REIT) is a modified pass-through entity whose status as such is achieved by permitting a deduction for dividends paid to its shareholders. To qualify as a REIT, in addition to several other strict requirements, a REIT must meet two separate income tests. In general, at least 95% of its gross income for the year must be derived from sources on one list, while at least 75% of its gross income for the year must be derived from sources on a second list. The second list is generally narrower than the first list.

The proposal is intended to further the purposes of a January 26, 2021, Executive Order that forbade the U.S. Department of Justice from entering into any new or renewed contracts with privately operated criminal detention facilities. To prevent the tax benefits of REIT status from being available for rents received from a prison or other detention facility, the proposal would exclude from both the 95% and the 75% income tests any of such rents. Even though the Executive Order applies only to federal facilities, the tax proposal would apply to non-federal facilities as well.

The proposal would be effective for taxable years beginning after December 31, 2023.

Additional Federal Administrations proposed budget plans are defined and detailed in these articles:

  1. Partnership Tax Provisions under the 2024 Federal Budget
  2. International Tax Proposals under the 2024 Federal Budget
  3. Individual, Estate and Gift Taxes under the 2024 Federal Budget
     

For more information, contact Cory Van Deusen or our tax team.

 

 

Corporate and Business Tax Provisions under the Federal Budget

for more information

Cory has over 20 years of experience providing tax and consulting services to commercial businesses and individuals. His expertise lies in the myriad of business development incentives offered by various federal, state, and local agencies to targeted industries such as Manufacturing, Software Development, Technology Companies and many other in order to encourage regional investment, spur job creation, and foster economic growth. The available incentives include refundable tax credits, tax abatements, grants, and forgivable loans. He has extensive knowledge of Start-Up NY, Opportunity Zones, the Excelsior Jobs Program, Qualified Emerging Technology Companies, and various local incentives such as Industrial Development Agency (IDA) benefits. Additionally, he spends his time providing services to Start-Up Companies ranging from a founder with an idea to multi-national tech companies that have raised hundreds of millions of dollars.  Cory has experience in all areas of U.S. federal and NY State taxation. He has been with Lumsden McCormick since 2001, was named partner on January 1, 2015. He is a member of the Firm’s Executive Committee and is head of the commercial services group.

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