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Disposing Of Assets Under The Ways and Means Committee’s Proposals | Rivkin Radler LLP

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First Step

Last Wednesday, the House Ways and Means Committee approved that portion of the 2022 budget legislation with which it was tasked by the Congressional Budget resolution of August 24. The text of the bill prepared by the Committee – almost nine hundred pages long – was passed along party lines, except for one Democrat who joined her Republican colleagues to oppose the measure.[i]

The bill, which includes several provisions from the Administration’s tax plan (announced in April), as well as several that were not included in the plan, has now been sent to the House Budget Committee[ii] where it will be assembled into an omnibus bill (together with the legislative recommendations drafted by other committees) that will be reported to the House floor for consideration by the full Chamber.[iii]

Assuming the House passes the bill – no small matter considering Speaker Pelosi can afford to lose only two more votes from among the members of her Party[iv] – the next stop will be the Senate.

Ah, the evenly divided Senate. Thus far, none of the Senate committees charged with writing portions of the reconciliation bill – including the all-important Finance Committee – have presented their recommendations.[v]

The President Isn’t Done

However, the same day that Ways and Means released its bill, President Biden met separately with Democratic Senators Sinema and Manchin, presumably to convince them to support the budget legislation of which they have, thus far, been critical.[vi]

The next day, at the White House, the President stepped back into the legislative fray.

In remarks regarding the economy, Mr. Biden intimated that Ways and Means did not go far enough in its recommendations. He then repeated his favorite lines:[vii]

“Big corporations and the super wealthy have to start paying their fair share of taxes. It’s long overdue. I’m not out to punish anyone.  I’m a capitalist.  If you can make a million or a billion dollars, that’s great.  God bless you.  All I’m asking is you pay your fair share.  Pay your fair share just like middle-class folks do.  But that isn’t happening now.”

The House on Taxes

Let’s assume for the moment that the President brings the two Senatorial rapscallions[viii] into line, while keeping the Party bloc intact in the House – because this is Washington, where everyone’s favorite gameshow is “The Price is Right,” the odds are pretty good.

If we accept the foregoing as a not improbable outcome, then it behooves those who advise closely held businesses and their owners to familiarize themselves with the tax provisions recommended by the Ways and Means Committee, and to start planning for their possible enactment.

What follows is a brief discussion of some of those provisions that may be of interest to a taxpayer thinking about disposing of some of their assets. We will first consider certain provisions that may impact upon business transactions; then we’ll review how some of the proposals may affect personal transfers by business owners.

Corporate Tax

The Committee’s proposal would eliminate the flat 21 percent rate imposed on taxable C corporations under current law.

In its place, it would provide a graduated rate structure under which the amount of the tax imposed on a C corporation will be the sum of ‘‘(A) 18 percent of so much of the taxable income as does not exceed $400,000, (B) 21 percent of so much of the taxable income as exceeds $400,000 but does not exceed $5,000,000, and (C) 26.5 percent of so much of the taxable income as exceeds $5,000,000.”

Of course, these rates would apply to any gain recognized by a C corporation on the sale of its assets, and to any gain recognized by the corporation on the in-kind distribution of assets to its shareholders, whether in liquidation or otherwise.[ix]

In the case of a C corporation which has taxable income in excess of $10 million for any taxable year, the amount of tax determined above will be increased by the lesser of 3 percent of such excess, or $287,000, which has the effect of eliminating the benefit of the lower rate brackets and causing all taxable income to be taxed at a rate of 26.5 percent.

The rate increase would also apply to an S corporation subject to the built-in gain rules that disposes of property in a taxable transaction during the so-called recognition period.[x]

The rate increase would apply to taxable years beginning after December 31, 2021.

Corporate Liquidations

Under current law, a corporation that owns less than 80 percent of the stock of a subsidiary corporation[xi] may recognize the loss realized with respect to such stock in a complete liquidation of the subsidiary.

The bill provides, in the case of two corporations that are members of a more-than-50 percent (but less than 80 percent) parent-subsidiary “controlled group,”[xii] no loss will be recognized with respect to the stock of the liquidating corporation in a complete liquidation until the shareholder-corporation receiving an in-kind distribution of property in such liquidation with respect to such stock has disposed of substantially all the property it received in the liquidation to one or more persons who are not “related” to the shareholder-corporation.

In this way, the recognition of the loss is deferred.

This amendment would apply to corporate liquidations occurring on or after the date of the enactment.

Section 1202 Stock

In 1993, Congress determined that it could encourage the flow of investment capital to new ventures and small businesses – many of which, Congress believed, had difficulty attracting equity financing – if it provided additional “relief” for non-corporate investors who risked their funds in such businesses. To accomplish this goal, it enacted Section 1202 of the Code.

Under this provision, a non-corporate taxpayer who holds “qualified small business stock” for more than five years may be able to exclude from their gross income 100 percent of the gain realized by the taxpayer from their sale or exchange of such stock.[xiii]

The bill seeks to deny the benefit of this 100-percent exclusion rule to certain otherwise qualifying taxpayers. Specifically, in the case of any sale or exchange of qualified small business stock after September 13, 2021, the amount that may be excluded under the rule by a taxpayer that is a trust or estate, or by any individual taxpayer whose adjusted gross income for the year of the sale or exchange equals or exceeds $400,000 (determined without regard to the rule), will be capped at 50 percent of the gain realized.

The remaining 50-percent of the gain from the sale of the stock would be taxable at the increased capital gain rate (see below).

However, this amendment would not apply to any sale or exchange made after the above effective date if such sale or exchange is made pursuant to written binding contract which was in effect on September 12, 2021 and which…

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