At a Glance
Many business owners, chief financial officers, investors, and other business professionals are concerned that tax rates may change due to recent legislation. With the prospect of tax increases on the horizon, many companies have decided to go ahead with sales, mergers and acquisitions, or liquidity plans to get ahead of possible rate increases.
Businesses face uncertainty while tax-related legislation is still being determined; however, recent drafts indicate that there are still options and strategies companies can employ to reduce their tax burden.
Find out how federal legislation may impact your company, what to expect, what to prioritize, and how to prepare your business for potential tax law changes to minimize your tax liability.
Look at the Bigger Picture
Take a step back and look at your business operations overall. It is equally important to have a strong business and investing strategy to increase revenue, as it is to prioritize your tax considerations. Investors and business owners should examine their financial health and use tax modeling or projections of their finances for more clarity, weighing appreciation expectations against uncertain tax hikes.
Changes from the Build Back Better Act
The Build Back Better Act (BBBA) is federal legislation first introduced in 2021. While this bill passed the US House of Representatives, it stalled out in the US Senate.
The legislation aims to tackle many issues, including healthcare, climate change, clean energy, and changes to tax laws and rates. Businesses and investors may face higher capital gains taxes, corporate tax rates, and more tax accountability if the BBBA becomes law.
No Impact on Capital Gain Taxes
The BBBA proposed raising the long-term capital gains tax affecting individuals. An increased maximum rate of 43.4% on capital gains, whether long-term or short-term, was introduced, but pushback from legislators led to its removal. A surtax on all income, including capital gains, took its place.
Surtax on Multi-Millionaires
The bill includes a surtax on all forms of income, including wages, capital gains, and dividends, for taxpayers who meet certain income thresholds. Those making $10 million or more will see a 5% surtax, while those earning over $25 million will have an additional 3% on top of the first surtax. This rate is on top of their regular income tax rate.
High-income individuals, trusts, and estates are subject to this new surtax. Trusts and estates have lower thresholds than individuals. A 5% surtax applies to estates and trusts over $200,000, with an additional 3% for those valued at $500,000 or more. The BBBA’s framework also shuts existing loopholes that previously allowed some high-income earners to avoid paying Medicare taxes from their earnings.
Minimum Tax on Corporate Profits
The BBBA’s plan for increased tax equity includes a 15% minimum tax on corporate profits of $1 billion or more reported to shareholders. It also has a 1% surcharge for all corporate buybacks of stock.
Increase in Enforcement of Tax Laws
Investing more money into IRS tax investigators is another proposal in the BBBA. Wealthier taxpayers may face more scrutiny from the IRS in the future or be at an increased risk for audits.
Biden’s Fiscal Year 2023 Budget Proposal
Earlier this spring, President Biden released his budget proposal for fiscal year (FY) 2023. Some of the budget’s revenue proposals rely on the enactment of the (BBBA) provisions. It is unclear whether the bill will pass under its current state or a narrower version, which could affect some of Biden’s budget proposals.
While Biden’s budget proposal partially relied on the enactment of BBBA, other revenue plans in the FY 2023 budget are not tied to the BBBA, nor were they included in the FY 2022 budget. These new revenue proposals could significantly impact your real estate and corporate taxes.
Expanding Recapture Under Section 1250
Biden’s FY 2023 budget proposal includes the expansion of recaptured depreciation deductions on Section 1250 properties. Common Section 1250 real estate types include residential rental property, commercial real estate, and warehouses. It can also include the property’s structural components.
Under Section 1250, a portion of the gain from the sale of depreciated real estate can be taxed at a higher rate (versus a 20% long-term capital gain rate) due to the depreciation deduction claimed in the prior years on the property. Under the current law, the amount of gain to the extent of depreciation deductions taken before the date of this budget proposal is subject to current recapture rules, with the tax rate capped at 25% for noncorporate taxpayers.
The FY 2023 budget expands recapture to require 100% of all depreciation deductions of Section 1250 to be taxed as ordinary income. This expansion only affects depreciation and sales of Section 1250 properties after December 31, 2022. It does not impact noncorporate individuals with adjusted gross incomes of $400,000 or less.
This proposal could negatively impact individual real estate investors and corporations. The gain from the sale of real estate can be subject to a higher ordinary income tax rate than long-term capital gain from the sale of stock, but only if there is no change to the long-term capital gain tax rate.
Minimum Tax on Net Wealth
Biden’s Billionaire Minimum Income Tax proposal introduces a 20% minimum tax on income, including unrealized capital gains, on those with a net worth of over $100 million. It is estimated that half of the revenue generated by this proposal would come from taxpayers worth more than $1 billion.
Under this minimum tax proposal, households paying 20% of their taxable income and unrealized income will pay no additional taxes. If they pay less than 20% due to formerly tax-free tradable assets, they will need to increase their tax payment to reach the minimum rate through top-up payments.
Wealthy taxpayers will be able to stretch out their initial top-up payments for unrealized gains through installments over nine years. The budget proposal includes installment plans of up to five years for new income.
Spreading out payments combats annual variations in investment income while ensuring minimum tax rates are met. Taxpayers without liquidity can also opt to defer payments but may be charged interest.
Boost for Low-Income Housing Tax Credit Basis
Biden’s budget proposal includes a $50 billion measure allowing state housing agencies to give non-geographic basis boosts to some low-income housing tax credit projects financed through passive activity bonds. The proposal aims to increase the supply of affordable housing and address real estate market gaps across the US.
The budget allocates $35 billion to the Department of Housing and Urban Development for distribution to state and local housing agencies. These agencies will provide grants, financing tools, and fund loans to reduce barriers to homeownership.
Another $5 billion will finance the renovation and construction of affordable housing units. It only affects building owners who are issued passive activity bonds after enacting this proposal.
Other Tax Increases Released in Biden’s Budget Proposal
- The tax rate for C corporations will increase from 21% to 28%.
- The top marginal tax rate will increase from 37% to 39.6% for taxable income over $450,000 for married individuals filing a joint return ($400,000 for unmarried individuals).
- There will be a limitation on gains deferred under section 1031 to $500,000 ($1 million in the case of married individuals filing a joint return) per taxpayer per year.
- Long-term capital gains and qualified dividends will be taxed at the ordinary income tax rate for taxpayers with taxable income exceeding $1 million.
- Income recognized by partners from their profit interests in investment partnerships (i.e., carried interest) will be taxed at the ordinary income tax rate and subject to self-employment tax regardless of the character of the income at the partnership level for partners with taxable income (from all sources) exceeding $400,000.
- Transfers of appreciated assets by gift or death will be treated as realization events subject to capital gains tax, subject to a $5 million per donor lifetime exclusion.
Steps Businesses Can Take
Businesses can take action to reduce their tax burden while legislation and potential tax increases are pending.
Qualified Small Business Stock Gain Exclusion
You or your company may be eligible for qualified small business stock gain exclusions, a tax incentive for certain C corporations. This option, also known as Section 1202, allows taxpayers to exclude capital gains earned from small business stocks if they meet strict criteria, including how they purchased the stock and the length they have owned it.
While this option is framed as a small business incentive, many larger companies can also qualify. Up to $10 million or ten times the basis of the qualified small business stock when it was issued can be excluded per corporation or shareholder. Small business owners who are considering selling their companies in the near term should review the requirements and make sure that they meet all criteria before finalizing the sale. For example, this provision calls for a minimum five-year holding period. If the holding period is getting close to five years, the shareholders may consider holding the shares longer to meet the holding period requirement.
Revisit Succession Planning and Gifting
A succession plan allows you to divest from your business in a tax-efficient method. Consider estate planning and gifting as routes to lower your taxable earnings.
Strengthen Your Tax and Accounting Strategy
With expected tax law changes on the horizon, Windes can work with you to implement a solid tax and accounting strategy to minimize both your short-term and long-term tax liabilities. We will work with you to develop a customized plan that meets your specific needs and help you reach your financial goals.
As your tax and accounting partner, Windes will help your business find ways to maximize your cash flow and help you take advantage of tax deductions.
Minimize Your Tax Exposure
Although tax rates are still unknown, it is unlikely that they will decrease. With this in mind, business owners should focus on their company’s success and find ways to take advantage of available programs and tax credits. Working with an experienced accounting team, like Windes, can help your business lower your tax exposure and benefit your bottom line.
At Windes, we focus on strengthening your tax strategy. Our skilled accountants provide the guidance needed to minimize your tax liability through tax credits and incentives, cost segregations, and more.
Contact our Los Angeles, Long Beach, or Orange County offices to learn more about our full range of tax strategies and accounting services.