REVENUE PROPOSALS
In the Fiscal Year 2022 Budget, the President proposes a number of reforms to the Internal Revenue Code (Code) that would modernize our tax system to respond to today's challenges. These changes would raise revenue, improve tax administration, and make the tax system more equitable and efficient.
The American Jobs Plan includes revenue proposals that reform corporate taxation, support housing and infrastructure, and prioritize clean energy. Reforms to the corporate income tax aim to collect sufficient revenue, build a fairer tax system, and reduce tax incentives that encourage profit shifting and offshoring. Housing and infrastructure tax credits would support low-income housing, economic development, and public school and transportation infrastructure. The American Jobs Plan would eliminate all fossil fuel subsidies that linger in the Code, while substantially expanding tax incentives that encourage clean energy sources, energy efficiency, carbon sequestration, and electric vehicle adoption.
The American Families Plan includes revenue proposals that strengthen the taxation of high-income taxpayers, expand tax credits for low- and middle-income workers and families, and invest in improved taxpayer compliance and service. Income tax rates for those with the highest incomes would increase, and loopholes, such as the carried interest preference and the like-kind real estate preference, would be eliminated for those with the highest incomes. Reformed taxation of capital income would even the tax treatment of labor and capital income and eliminate a loophole that lets substantial capital gains income escape taxation forever. The economic security of families and workers would be supported through more generous child tax credits, an expanded earned income tax credit, expanded child and dependent care tax credits, and more generous premium tax credits. Finally, transformative investments in taxpayer compliance would provide the Internal Revenue Service with the resources and information that it needs to build a fairer and more efficient tax administration system.
REFORM CORPORATE TAXATION
RAISE THE CORPORATE INCOME TAX RATE TO 28 PERCENT
Current Law
Income of a business entity can be subject to federal income tax in a manner that varies depending upon the classification of the entity for federal income tax purposes. Most small businesses are owned by individuals and taxed as "pass-through" entities, meaning that their income is passed through to their owners who are taxed under the individual income tax system. Most large businesses, including substantially all publicly traded businesses, are classified as "C corporations" because these corporations are subject to the rules of subchapter C of chapter 1 of the Internal Revenue Code (Code) and pay an entity-level income tax. Additionally, taxable shareholders of such corporations generally pay federal income tax on most distributions attributable to their ownership in the corporation. Some mid-sized businesses choose a pass-through form of entity classification (under subchapter K or subchapter S of chapter 1 of the Code) while others choose the C corporation form of entity classification.
C corporations determine their taxable income, credits, and tax liability according to the Code and regulations promulgated thereunder. The Tax Cuts and Jobs Act of 2017 replaced a graduated tax schedule (with most corporate income taxed at a marginal and average rate of 35 percent) with a flat tax of 21 percent applied to all C corporations.
Reasons for Change
Raising the corporate income tax rate is an administratively simple way to raise revenue in order to pay for the Administration's infrastructure proposals and other long-run drivers of spending growth. Furthermore, a corporate tax rate increase can increase the progressivity of the tax system and help reduce income inequality. Additionally, a significant share of the effects of the corporate tax increase would be borne by foreign investors. Therefore, some of the revenue raised by this proposal would result in no additional federal income tax burden to U.S. persons. Also, the majority of U.S. equity income is untaxed by the U.S. government at the individual level, so the corporate tax is a primary mechanism for taxing such capital income.
Proposal
The proposal would increase the income tax rate for C corporations from 21 percent to 28 percent.
The proposal would be effective for taxable years beginning after December 31, 2021. For taxable years beginning after January 1, 2021 and before January 1, 2022, the tax rate would be equal to 21 percent plus 7 percent times the portion of the taxable year that occurs in 2022.
REVISE THE GLOBAL MINIMUM TAX REGIME, DISALLOW DEDUCTIONS ATTRIBUTABLE TO EXEMPT INCOME, AND LIMIT INVERSIONS
Current Law
Global minimum tax regime with respect to controlled foreign corporation earnings
Any U.S. shareholder of a controlled foreign corporation (CFC) is taxed annually in the United States under the global minimum tax in section 951A of the Internal Revenue Code with respect to all of its CFCs. A U.S. shareholder's global minimum tax inclusion is determined by combining its pro rata share of the tested income (or tested loss) of all its CFCs. A CFC's tested income is the excess of certain gross income of the CFC over the deductions of the CFC that are properly allocable to the CFC gross tested income. A CFC's tested loss is the excess of the CFC's properly allocable deductions over the CFC's gross tested income. The U.S. shareholder's actual global minimum tax inclusion reflects a reduction for a 10 percent return on certain foreign tangible property (referred to as qualified business asset income, or QBAI). QBAI is generally tangible property eligible for depreciation, such as buildings or machinery, but does not include assets that are not depreciable (such as land) nor intangible assets.
Under section 250, subject to a taxable income limitation, a corporate U.S. shareholder is generally allowed 50-percent deduction against its global minimum tax inclusion. The section 250 deduction generally results in a 10.5-percent U.S. effective tax rate on a corporate U.S. shareholder's global minimum tax inclusion under the current U.S. corporate tax rate of 21 percent. The 50-percent deduction is scheduled to be reduced to 37.5 percent starting in 2026.
Certain foreign income taxes paid by a CFC can be credited against a corporate U.S. shareholder's U.S. tax liability attributable to its global minimum tax inclusion. The allowable credit is limited to 80 percent of the amount of the foreign income taxes properly allocable to a CFC's tested income taken into account as part of the global minimum tax inclusion. Under final Treasury regulations promulgated in 2020, if the foreign effective tax rate on the gross income of a CFC that would otherwise be part of a global minimum tax inclusion exceeds 90 percent of the U.S. corporate income tax rate, the U.S. shareholder of the CFC is generally permitted to exclude that gross income (and the associated deductions and foreign income taxes) from its global minimum tax inclusion. A similar statutory rule applies for purposes of certain subpart F income. Subpart F taxes certain foreign income earned indirectly by U.S. persons at full U.S. tax rates.
A single foreign tax credit limitation generally applies to a corporate U.S. shareholder's global minimum tax inclusion. Therefore, foreign income taxes paid to a high-tax foreign jurisdiction can be used to reduce the U.S. tax liability with respect to global minimum tax income earned in lower-tax jurisdictions. Thus, generally, a U.S. shareholder's aggregate U.S. tax (after accounting for the allocation of U.S. shareholder deductions) on its global minimum tax inclusion is reduced by reference to the average foreign effective tax rate on its aggregate global minimum tax income rather than the effective tax rates in each individual foreign jurisdiction where income is actually earned.
Treatment of deductions properly allocable to exempt income
Certain dividends received by a domestic corporation from foreign corporations are effectively exempt from U.S. tax by reason of the 100-percent deduction allowed with respect to such dividends under section 245A. Specifically, section 245A provides a domestic corporation a deduction equal to the foreign-source portion of a dividend received from a specified 10-percent owned foreign corporation, but only if the domestic corporation is a U.S. shareholder of the foreign corporation.
Section 265(a)(1) generally disallows a deduction for any amount that is allocable to certain classes of income that is wholly exempt from U.S. tax. For purposes of determining a taxpayer's foreign tax credit limitation, tax exempt assets and their associated income are disregarded under section 864(e)(3). Section 904(b)(4) applies to disregard (solely for purposes of the foreign tax credit limitation) deductions allocable to income from foreign stock other than global minimum tax or subpart F income inclusions, for determining a taxpayer's foreign tax credit limitation.
Limitations on the ability of domestic corporations to expatriate
Section 7874 applies to certain transactions (known as "inversion transactions") in which a U.S. corporation is acquired by a foreign corporation ("foreign acquiring corporation") in a transaction where (1) substantially all of the assets held directly or indirectly by the domestic corporation are acquired directly or indirectly by the foreign acquiring corporation; (2) the former shareholders of the domestic corporation hold at least a 60-percent ownership interest in the foreign acquiring corporation by reason of the acquisition; and (3) the foreign acquiring corporation, together with its expanded affiliated group, does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organized. Similar provisions apply to acquisitions of domestic partnerships.
The tax consequences of an inversion transaction depend on the level of continuing former shareholder ownership. If the continuing former shareholder ownership of the foreign acquiring corporation is at least 80 percent (by vote or value), the foreign acquiring corporation is treated as a domestic corporation for all U.S. tax purposes (the "80-percent test"). If the continuing former shareholder ownership is at least 60 percent but less than 80 percent (by vote or value), the foreign acquiring corporation is respected as foreign but full U.S. tax must generally be paid with respect to certain income or gain recognized by the expatriated U.S. entity and its affiliates in connection with the inversion or within the ten year period ending after the completion of the inversion (the "60-percent test"). Furthermore, the Tax Cuts and Jobs Act of 2017 (TCJA) adopted several anti-abuse provisions that apply to inversion transactions that satisfy the 60-percent test.
Reasons for Change
Global minimum tax regime
The reduction to global minimum tax inclusions for a percentage of certain foreign tangible assets incentivizes U.S. multinational companies to invest in tangible assets abroad rather than domestically. The elimination of QBAI would eliminate this perverse investment incentive while simplifying the taxation of CFCs.
The difference between the effective U.S. tax rate on global minimum tax inclusions versus the effective U.S. tax rate on income earned directly by U.S. companies that results from the section 250 deduction incentivizes U.S. companies to locate profits and operations offshore. Reducing the section 250 deduction for these foreign earnings would reduce this perverse incentive.
The determination of a U.S. company's global minimum tax inclusion and residual U.S. tax liability on such inclusions on a global blended basis incentivizes U.S. companies with operations in high-tax jurisdictions to invest in lower-tax jurisdictions, to take advantage of the automatic global averaging under the existing global minimum tax regime. In some cases, U.S. companies may have an incentive to locate operations in jurisdictions with corporate income tax rates higher than the United States, to average these high taxes against low-taxed income earned elsewhere. This automatic blending feature exacerbates the race to the bottom on corporate income tax rates and encourages U.S. companies to report profits (as well as the activities that give rise to those profits) in offshore jurisdictions rather than in the United States, creating a perverse "America last" tax policy. Similar global blending concerns arise with respect to high and low-taxed income earned through foreign branches.
In contrast, determining a taxpayer's global minimum tax inclusion and residual U.S. tax liability on such inclusions on a jurisdiction-by-jurisdiction basis would be a stronger deterrent to profit shifting and offshoring because residual U.S. tax would be due on every dollar earned in a low-tax jurisdiction at the minimum rate, with no ability to reduce that residual U.S. tax for excess foreign taxes paid to higher-tax jurisdictions.