News & Insights

Build Back Better Act includes tax provisions impacting top earners

On Oct. 28, the Biden administration released the text of the $1.75 trillion Build Back Better Act — also referred to as the human infrastructure bill. Designed to expand the nation’s social safety net and also help fight climate change, about $1 trillion of the act would be financed by higher taxes on wealthy Americans. As a result, the new legislation includes a number of important corporate and individual tax provisions. These provisions primarily impact the top 80% of earners.

Corporate Alternative Minimum Tax: Consistent with recent Organization for Economic Cooperation and Development pronouncements, the Biden administration is proposing a minimum 15% tax on adjusted financial statement income rather than applying an income tax to taxable income. In general, this provision applies to a corporation that has average annual adjusted financial statement income of more than one hundred million dollars during a three-year period.

Tax on a Corporate Share Buybacks: The act includes a tax equal to 1% of the fair market value of any stock that a corporation repurchases during the taxable year. It applies to corporations whose stock is traded on an established securities market.

Limitations on Interest Deductions and Limitations on Worthless Partnership Losses: Also included is a limitation on the deduction of interest expense among members of an international financial reporting group as well as a limitation on losses from worthless partnerships. The act would provide that a worthless partnership interest is treated as a sale or exchange which would typically result in capital loss instead of ordinary loss.

Modifications to Portfolio Interest: The act would change the definition of “related persons” for purposes of the portfolio interest rules. Persons who cannot make loans that would qualify for the portfolio interest exemption would include any person who owns 10% or more of the combined voting power of all classes of stock or owns 10% or more of the total value of the stock of the corporation.

Limitation on Section 1202 Gains: Section 1202 allows an exemption of up to the greater of $10 million or 10 times the investor’s tax basis on the sale of qualified small business stock. The shares must be held for at least five years. Importantly, for many local businesses, a sale or exchange after September 13, 2021, would only be able to use a 50% exclusion rather than the current 100% exclusion under Section 1202 if the taxpayers’ adjusted gross income is greater than $400,000. This new limitation wouldn’t apply to sales made pursuant to a binding contract in effect on September 13, 2021. The taxable portion would be taxed at a 28% rate instead of the normal 20% maximum capital gains rate. Investors could still defer or roll-over gains into other qualified small business stock within 60 days of sale.

Increase in Investment Income Tax: Certain high-income individuals would have an increase in the 3.8% Medicare tax on net investment income if the taxpayer’s joint return showed taxable income in excess of $500,000 or if single return showed taxable income in excess of $400,000.

Limitations on Excess Business Losses: The act would reinstate a limitation on excess business losses for noncorporate taxpayers beginning as of January 1, 2021.

Surcharge for High-Income Individuals: The act would impose a 5% surcharge on modified adjusted gross income of a taxpayer which exceeds $10 million for single and individual and married taxpayers filing a joint return and additional 3% to the extent that modified adjusted gross income exceeds $25 million.

SALT Limitations: The state and local tax deduction allows people to avoid double-paying on taxes when they’ve paid for the services provided by states and localities, such as education, health care and transportation.

Under current law, the state and local income tax deduction is limited to $10,000 per year. The act would increase this limit to $80,000 ($40,000 for married filing separately) per year through 2030. The cap reverts back to $10,000 for 2031, the final year it would be in effect. This is generally the most controversial provision of the act.

Conclusion

Many of the provisions target large corporations and wealthy taxpayers and are still being negotiated. However, the proposed changes to Section 1202 could impact many California investors and start-up businesses. Start-ups may find that investor capital will become more expensive as the tax benefits of investing are diminished by Congress.

Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson — a San Diego-based commercial real estate law firm. He is recognized as a leading joint venture and tax attorney with a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning. The article can also be read in the Daily Journal and in the Daily Transcript (subscription required).