🚩 Red Flag | Federal Budget Tax Proposal Edition | TaxGPT's Newsletter

Salutations!

Welcome to the latest installment of TaxGPT’s Red Flag: just like that first date, you don’t want to ignore this one!

In this bi-weekly newsletter, we deliver a mix of burning tax updates, industry trends, insights into tax and accounting laws, or how AI is changing this landscape. Also, a deep dive into a trending tax subject.

Strap on your green eyeshade and get that next pot of coffee ready. Here we go!

Is this news Section 751? Because it is hot!

🔥IRS final reminder: Time to claim $1 billion in tax refunds from 2020:

The IRS has issued a final reminder to file 2020 tax returns by the May 17th deadline. While the statute of limitations typically expires in April, the filing deadline for 2020 returns was pushed to May 17th due to COVID. In the event taxpayers were not required to file, various refundable credits, such as the Earned Income Tax Credit and Recovery Rebate Credits, would love to find their forever home!

Trending faster than Kim K and Touchdown Tom

💲The Biden Administration’s FY2025 Budget is… a thing*:

‍Hitting a 100 on Google Trends during the last full week of April. I read these things so you don’t have to. Much like Sisyphus, the task is never-ending but at least it gives me a purpose.

A few highlights:

• Revenue from individual income, Social Security, and Medicare taxes make up for a whopping 82% of projected receipts. Corporate income tax accounts for just 12%. Estate and gift taxes come in at a why-do-we-even-bother figure of .6%.
• Proposed tax reform to increase overall taxes by somewhere between $3.4 and $5.5 trillion, depending on MODELLING methods, through 2029.
• Increased social security deficit to $259 billion dollars.
• 5-year net overall deficit increase of nearly $8 trillion.

*I, nor TaxGPT, choose a political side. This is purely bi-partisan and informational.

Better have your wetsuit handy, we’re going deep!

💵Biden Administration’s Proposed Tax Reform and Economic Effect

“Delivering on a Commitment to Fiscal Responsibility.” That’s what they wrote, right there on page 44. The self-aggrandizing of literally every administration I can remember is beyond incredible.

The proposal was delivered to Congress on March 11th, 2024. Now that we aren’t working 40 hours per day, let’s have a looksee at the details of it! We’ll have a one-sided fireside chat at the end to summarize and opine.

What’s on my radar as a tax professional?

Individual Provisions:

• Increase top ordinary income tax rate from 37% to 39.6%.
• Increase Net Investment Income Tax from 3.8% to 5% on income above $400,000 and it applies to pass-through business income.
• A very spooky “25% minimum income tax on the wealthiest taxpayers”. Applicable to taxpayers with a net wealth greater than $100 million, including unrealized capital gain “income”.
• Section 1031 reform to limit aggregate deferrals per taxpayer, per year, to $500,000 ($1,000,000 married filing joint). Any gains in excess are taxable in the year of transfer.
• Long-term capital gains taxed at ordinary income rates for taxable income above $1 million.
• Limitations on retirement account contributions if taxpayers have “large individual retirement account” balances and are “high-income”.
• Make permanent the full refundability of the Child Tax Credit & permanently extend the Earned Income Tax Credit (both under American Rescue Plan Act).

Business Provisions:

• Increase the corporate income tax and alternative minimum tax from 21% to 28% and 15% to 21%, respectively.
• Excess business loss limitation for pass-through businesses made permanent.
• Quadrupling the excise tax on corporate stock buybacks from 1% to 4%.
• Denying deductions for any employee’s compensation above $1 million.
• Increasing Global Intangible Low-Taxed Income (GILTI) tax rate from 10.5% to 21%.
• Repealing the Foreign-Derived Intangible Income (FDII) deduction.
• Replacing Base Erosion and Anti-abuse Tax (BEAT) with an “undertaxed profits rule”.

Discussion:

First off, this is the budget proposal and has not been marked up by the House or Senate yet. There will absolutely be material modifications (please, please, please) to this as it makes the rounds. Once the House & Senate resolve the budget, spending bills are passed along with reconciliation and authorizations. The new fiscal year begins October 1st.

On the individual side of things, I’m growing uncomfortable with the punishment “high income” taxpayers receive. The demonization of financial success in this country is troubling at best, and if this continues, the risk of capital flight is going to become more relevant than it already is.

The increase to top marginal rates and NIIT is particularly damaging. If you live in California or happen to reside in Portland, OR, your overall income tax burden could be as high as 57.9% or 58.5% (plus the $35 Arts Tax!) respectively. And this is just income tax!

The real head-turner comes from the limitations on Section 1031 deferrals. Section 1031 exchanges are an incredible tool that have stood in existence since 1921. At a time when the commercial real estate industry is in literal tatters, reducing the benefits of 1031 exchanges will further stifle investment by increasing capital costs, discouraging reinvestment and transactions, and have a measurable contractionary effect on the economy. With interest rates where they are, there’s already little incentive to trade a low-rate holding to a high-rate, and the ceiling on gain deferrals is a nail in the coffin.

And of course, the buy-votes-with-refundable-credits strategy we all know and love.

For business, there are dozens more changes that you can read up on at your leisure. The bottom line is, unlike the federal government which perpetuates deficits, businesses will not operate at a loss forever. Any tax increases will absolutely be passed through to taxpayers.

These proposed changes mostly target large business, particularly multinationals. The corporate buyback tax is amusing and I’m not exactly sure why people are so hellbent on punishing corporates for performing them. It’s a nondeductible transaction and you’re punishing them for having nothing better to do with capital? The claim is that rather than invest and grow, they’re enriching shareholders. These companies are getting hit left and right by anti-trust cases and blocked mergers. Complete catch-22.

One change in particular will be noticeable at the gas pump: in a “makes-sense-because-government” proposal, GILTI will be applied to Foreign Oil & Gas Extraction Income (FOGEI). This is among over a dozen other tax changes specifically and intentionally targeting domestic producers. The net effect will increase taxes, and end-user prices. This will also shift demand (and capital) from domestic production to foreign producers such as OPEC.

How much of a chance does any of this stand? More than we’d like, unfortunately. With many provisions of the Tax Cuts and Jobs Acts sunsetting in 2025, the Administration has a tremendous amount of leverage in quid-pro-quo dealings with Republicans who would otherwise place the proposal violently into the paper shredder.

Now, for a holistic look at what this means for our economy as a whole: interest rates. Everyone wants lower interest rates. Unfortunately, the Fed hasn’t seen enough negative economic data to give a reason to lower rates. Tax policy could finally be the nudge they need to do this, albeit the effects from tax changes will have some lag. In an environment where there are enough tax hikes to dampen profits, stifle GDP growth, and increase unemployment - this policy might actually be a long-term boon for prospective first-time home buyers and startups looking for capital (wink wink).

Amalgamation from these sources:

White House: Fact Sheet and Budget.

Tax Foundation: Details & Analysis and Oil & Gas Policies.

Until next time, keep on taxin' and relaxin', fellow tax pros!

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Tax insights should be viewed as informative guidance, not definitive advice.

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With Gratitude,
Andrew Sedlacek
Founding CPA
TaxGPT, Inc.
www.taxgpt.com

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