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October 7, 2021

Tax proposals of bill approved by the House Ways and Means Committee would impact many higher-income families, individuals and privately held corporate groups

Recently proposed tax provisions in the Build Back Better Act, which were approved by the House Ways & Means Committee (the HW&M Bill), would increase the overall US tax burden on privately held international businesses and investments, whether those are in corporate or pass-through form, as well as the individuals and families owning them.

Taxpayers should consider the HW&M Bill a key part of a process but not necessarily a final product that will be enacted into law. Significant changes may be made to the provisions described in this Alert as part of the legislative process. To date, a Senate version of a reconciliation tax bill has not been released.

For other discussions of the tax proposals in the HW&M Bill, please see the following EY Tax Alerts:

  • Tax Alert 2021-9021(provides overview of tax proposals in HW&M Bill)
  • Tax Alert 2021-9019 (provides high-level discussion of international provisions)
  • Tax Alert 2021-9022 (summarizes provisions affecting state and local taxation)
  • Tax Alert 2021-9023 (provides in-depth discussion of international provisions)
  • Tax: Tax Alert 2021-1677 (summarizes provisions on credits and incentives)
  • Tax Alert 2021-1681 (summarizes provisions affecting partnerships)
  • Tax Alert 2021-1696 (summarizes provisions affecting individuals)
  • Tax Alert 2021-1697 (summarizes provisions affecting financial transactions and digital assets)

Proposed income tax rules affecting US tax resident individuals and families — domestic provisions

Proposed changes of interest for individual taxpayers would:

  • Increase the long-term net capital gains rate from 20% to 25%
  • Return the top individual income tax rate from 37% to 39.6%
  • Expand the net investment income tax (NIIT) to apply to net income derived in the ordinary course of a trade or business for taxpayers with taxable income greater than $400k (single filer) or $500k (joint filer)
  • Impose a 3% surtax on an individual's modified adjusted gross income (AGI) in excess of $5m
  • Increase the three-year carried interest holding period enacted under the Tax Cuts and Jobs Act of 2017 (TCJA) to five years
  • Allow the TCJA-doubled estate tax exemption to expire after 2021, rather than after 2025
  • Change how and when grantor trusts are taxed for gift and estate tax purposes and treat sales to grantor trusts as income-taxable events.

Proposed income tax rules affecting privately owned businesses — domestic provisions

Proposed tax provisions in the House Ways & Means Committee reconciliation bill would significantly affect privately owned businesses. The following provisions would likely have the broadest effects.

Corporate - General

The HW&M Bill would replace the flat corporate income tax with the following graduated rate structure:

  • 18% on the first $400,000 of income
  • 21% on income above $400,000 and up to $5 million
  • 26.5% on income above $5 million

The graduated rates would phase out for corporations making more than $10m. Personal services corporations would not eligible for graduated rates.


1. Business interest limitation

The HW&M Bill would amend IRC Section 163(j)(4) to apply IRC Section 163(j) at the partner level and allow carryforwards of disallowed business interest expense to expire after five years. For a partner with a carryforward excess business interest expense (EBIE) under the current rules, a transition rule would treat the EBIE as paid or accrued by the partner in the first tax year after the one described in existing IRC Section 163(j)(4)(B)(ii)(II).

Implications: This provision could potentially change an interest disallowance from a timing difference to a complete disallowance. For many debt-financed start-up businesses, five years may not be long enough to achieve positive adjusted taxable income (a/k/a profitability), especially when adjusted taxable income, which is currently determined by earnings before interest, tax, depreciation and amortization (EBITDA), shifts to earnings before interest and tax (EBIT), beginning in 2022. For some, the effect of adding a carryover limit to a more restrictive computation in 2022 would be an increase in taxable income subject to higher statutory rates; the combination would exponentially increase the US effective tax rate when compared to economic net income.

2. Worthless partnership interests

The HW&M Bill would add new IRC Section 165(m), providing that if any interest in a partnership becomes worthless, the loss would be treated as arising from the sale or exchange of a partnership interest under IRC Section 741. The proposal also would extend the IRC Section 165(g) rules applicable to worthless securities to securities issued by partnerships.

Implications: This provision would effectively eliminate the holding in Revenue Ruling 93-80 and turn all worthless interests into capital losses.

3. Carried interest

The HW&M Bill would replace the existing mechanism under IRC Section 1061(a) for calculating the long-term-to-short-term recharacterization amount. Under the proposal, a partner's "net applicable partnership gain" with respect to an applicable partnership interest could be recast as short-term capital gain unless an exception applied. Among other provisions, the proposal would extend the long-term capital gain holding period for gain attributable an applicable partnership interest from three to five years.

4. IRC Section 199A

The HW&M Bill would limit the IRC Section 199A deduction overall to $500,000 (or $10,000 for estates and trusts), while keeping all of the complexity associated with the calculation.

Implications: The policy justification for enacting IRC Section 199A was to provide some parity between businesses operating in pass-through versus corporate form. The HW&M Bill would reduce the parity between pass-through entities and corporations.

The effects of the provision could vary depending on how many people own the business. An S corporation engaged in manufacturing started by Generation 1 could run into this limitation because the ownership would likely still be concentrated in a few individuals. Conversely, the limitation would not apply once the business were passed down through generations and had a wide diversification of family owners. Thus, the provision would reward broad ownership of family businesses versus concentration among a few individuals or trusts.

5. Closely held corporations

The increase in the long-term net capital gains rate to 25% would also increase the personal holding tax rate and accumulated earning tax rate to 25%.


1. Wash sales

The HW&M Bill would expand the wash sale rules to include commodities, currencies, and digital assets, which would prevent taxpayers from claiming tax losses on assets while retaining an interest in the loss asset. Digital assets are defined as any representation whose value is recorded on a cryptographically secured distribution ledger or any similar technology specified by the Treasury.

The HW&M Bill would also extend the wash sale rule to apply to purchases of replacement property by certain persons related to the taxpayer, in which case the loss would be permanently disallowed, not merely deferred.

2. Constructive sales

The HW&M Bill would include digital assets in the constructive sale rules previously applicable to other financial assets.

3. Adjusted basis limitation for divisive reorganization

Under the HW&M Bill, a distributing corporation in a divisive reorganization would apparently recognize gain to the extent that the controlled corporation debt securities transferred to the creditors of the distributing corporation exceeded the net basis in assets transferred from the distributing corporation to the controlled corporation in the transaction.

4. Small-business stock exclusion

The HW&M Bill would limit the benefit from the small-business stock exclusion under IRC Section 1202 by providing that the 75% and 100% exclusions will not apply to taxpayers with AGI equal to or greater than $400,000 (which includes the full amount of the gain before exclusion).

5. Converting from an S corporation to a partnership

Section 138509 of the HW&M Bill would allow an eligible S corporation to reorganize as a domestic partnership on a tax-free basis so long as the reorganization were completed after December 31, 2021 through December 31, 2023. Based on the proposed statutory text, the transaction would be treated as an IRC Section 332 liquidation, effectively reinstating General Utilities & Operating Co. V. Helvering, 296 U.S. 200 (1935) for two years. To be eligible, the corporation must have made its initial subchapter S election before May 13, 1996 (i.e., the effective date of the US entity classification election, or "check-the-box" regulations) and must have remained an S corporation through the date of the reorganization.

The proposal raises considerations in both the domestic and cross-border contexts, such as:

  • The impact to IRC Section 1366 losses or IRC Section 163(j) excess business interest expense that are suspended at the time of conversion
  • Whether the conversion is a triggering event for purposes of elections made under IRC Section 965(h) and (i)
  • The impact on passive and at-risk losses for deemed owners of qualified subchapter S trusts
  • The impact on S corporations of C corporation earnings and profits (E&P) and accumulated adjustments accounts, including those S corporations that elected under Notice 2020-69 to be treated as corporations for purposes of global intangible low-taxed income (GILTI)
  • The impact on S corporation shareholders that have made IRC Section 962 elections for underlying CFCs

Implications: Potentially eligible S corporations should pay close attention to how this proposal evolves as the legislative process continues through the end of the 2021 calendar year (and beyond). A House Committee Report released on September 28, 2021, with explanations of the provisions in the HW&M Bill includes a restriction that is not in the legislative text. According to the report, "An eligible S corporation does not, however, include an S corporation that, during the period beginning on September 13, 2021, and ending with the date the qualified liquidation is completed, holds, acquires, or transfers any asset for which the S corporation's basis is determined (in whole or part) by reference to the basis of such asset (or other property) in the hands of a C corporation. Thus, for example, if there is a merger or other transaction between a C corporation and an otherwise eligible S corporation that results in the S corporation holding carryover-basis property of the C corporation, then the S corporation is not treated as an eligible S corporation under this provision." The report acknowledges that a technical correction may be necessary to reflect this intent.

Methods and credits

The HW&M Bill would delay the requirement to amortize certain research and experimentation expenses. The requirement, which will be effective in 2022, requires taxpayers to capitalize and amortize R&E expenses for research conducted in the US over five 5 years; R&E expenses for research conducted outside the US must be capitalized and amortized over 15 years. The HW&M Bill would delay the capitalization and amortization requirements until 2026.

HW&M Bill would also accelerate termination of the employer credit for wages paid to employees during family and medical leave. The credit, which was scheduled to terminate for tax years beginning after 2025, would terminate for tax years beginning after 2023.

For all targeted groups (except summer youth employees) under the Work Opportunity Tax Credit (WOTC), the HW&M Bill would increase the WOTC to 50% for the first $10,000 in wages, through December 31, 2023.

Other provisions in the HW&M Bill would expand some of the more popular and successful tax credit programs. For details, see Tax Alert 2021-1677.

Proposed tax rules affecting international private businesses and cross-border investments

Controlled foreign corporations (CFCs)

1. Changes to GILTI and subpart F income rules

The rules for subpart F income and GILTI aim to include undistributed foreign corporate income in a US shareholder's current taxable income. These provisions specifically apply to US-resident shareholders owning at least 10% of the vote or value of a controlled foreign corporation (CFC).

Currently, a domestic corporation's effective US federal income tax rate on GILTI is 10.5%, after applying a 50% deduction under IRC Section 250. The corporation may claim a foreign tax credit equal to 80% of the foreign taxes paid or accrued with respect to a CFC's GILTI income (subject to limitations under IRC Section 904). Conversely, ordinary income tax rates apply to any subpart F income or GILTI recognized by an individual or domestic non-grantor trust that is a US shareholder of a CFC. The 50% GILTI deduction or the foreign tax credit are only available to an individual or trust if they make an IRC Section 962 election.

The HW&M Bill would require US shareholders to compute their GILTI inclusion on a country-by-country basis by aggregating the items (e.g., CFC tested income/loss, qualified business asset investment (QBAI), etc.) of taxable units within a single foreign country and computing a separate GILTI amount for each country. Consequently, tested losses and QBAI in one country could not reduce the GILTI inclusion attributable to taxable units in another country, as current law permits. The HW&M Bill would, however, introduce a GILTI-loss-carryforward rule so that tested losses could be carried forward to the succeeding tax year and reduce that year's tested income, if any.

Other notable changes to the GILTI regime include adding foreign oil and gas extraction income (FOGEI) into tested income and reducing a US shareholder's net deemed tangible return from 10% to 5% of QBAI. The net deemed tangible income return for QBAI located in US possessions, like Puerto Rico, would remain 10%.

The HW&M Bill would lower the IRC Section 250 deduction percentage for GILTI from 50% to 37.5% for domestic corporations and individuals or trusts that make IRC Section 962 elections. Domestic corporations also could claim credit for 95% (rather than 80%) of CFC-level foreign income taxes attributable to GILTI tested income.

These changes generally would apply to tax years beginning after December 31, 2021, with special transition rules for fiscal-year taxpayers.

The HW&M Bill also would change the taxation of foreign base company sales and services income as subpart F income to GILTI income unless the CFC transaction involves a US resident, directly or by way of a branch or pass-through entity. Other changes to the pro rata share rules of IRC Section 951 would potentially result in a pro rata share inclusion of subpart F and GILTI for US shareholders who own CFC shares during a tax year but do not own CFC shares on the last day of the CFC's tax year.

Under current law, controlling domestic shareholders of CFCs (as defined in Treas. Reg. 1.964-1(c)(5)) may elect to exclude, from subpart F income and GILTI, any CFC income that is subject to an effective rate of foreign tax that exceeds 90% of the tax rate applicable to domestic corporations (i.e., CFC income subject to an effective foreign tax rate of 18.9%).

Implications: For individuals and trusts making IRC Section 962 elections, the HW&M Bill would increase the applicable corporate income tax rate to 26.5% and require GILTI inclusions to be computed on a country-by-country basis. This would increase the potential minimum current effective tax rate on GILTI income from 10.5% to at least 16.5625%, before foreign tax credits. The country-by-country calculation would also eliminate the opportunity to obtain a blended US effective tax rate by mixing high-taxed and low-taxed GILTI income. The ability to claim 95%, rather than 80%, of CFC-level foreign income taxes as credits against GILTI income, however, would benefit these taxpayers.

Increasing the corporate rate to 26.5% would also increase the tax burden on subpart F income for individuals making IRC 962 elections. Because these individuals pay tax on a CFC's dividend of previously taxed E&P (in excess of the US taxes previously paid on such amounts), increasing the rate of US tax on qualified dividend income would substantially increase the overall effective rate of tax on an individual US shareholder's portion of CFC E&P.

Given the possible effects of these changes, individuals and trusts may want to reevaluate whether IRC Section 962 elections continue to be an effective strategy for mitigating the current US tax impact of subpart F and GILTI. Individuals who have historically made IRC Section 962 elections should consider recomputing the benefit of doing so under the proposed changes and consider whether the costs and complexities arising from the elections continue to fit within their strategies for tax rate management and repatriation.

2. Reinstating IRC Section 958(b)(4)

Before the TCJA, IRC Section 958(b)(4) prevented downward attribution of stock owned by a foreign person to a US person. The TCJA modified IRC Section 958(b) to apply the constructive stock ownership rules of IRC Section 318(a), including the downward ownership attribution rules of IRC Section 318(a)(3).

If a shareholder owns (directly or indirectly) 50% or more of the shares of a corporation by value, IRC Section 318(a)(3)(C) treats the stock of another corporation owned (directly or indirectly) by the shareholder as owned by that corporation. Similarly, the downward attribution rules of IRC Section 318(a)(3)(A) treat stock owned (directly or indirectly) by a partner as owned by the partnership.

The HW&M Bill would reinstate IRC Section 958(b)(4) to prohibit downward attribution from a foreign corporation, retroactive to December 31, 2017. It would also add new IRC Section 951B to more narrowly allow downward attribution to foreign-controlled US corporations.

Implications: Reinstating IRC Section 958(b)(4) may relieve certain US shareholders from reporting obligations or tax liabilities related to holding shares in a CFC. This relief would be welcome news for most taxpayers.

For some taxpayers, however, the retroactive reinstatement of IRC Section 958(b)(4) could present challenges. For example, retroactively reinstating IRC Section 958(b)(4) could convert a CFC's non-taxable distribution of previously taxed E&P to a US shareholder into taxable dividends. The retroactivity would also require affected taxpayers to reconstruct their US tax attributes, beginning with the repeal of IRC 958(b)(4) through its reinstatement.

For calendar-year taxpayers affected by the repeal as early as January 1, 2017, IRC Section 958(b)(4)'s retroactive reinstatement could occur outside the statute of limitations for amending some returns. Absent a statutory extension of the limitations period or some other mechanism, these taxpayers could not claim refunds of prior-year tax payments resulting from IRC Section 958(b)(4)'s repeal.

Finally, for owners of a CFC that is also a passive foreign investment company (PFIC), retroactively reinstating IRC Section 958(b)(4) could mean continued reporting and income inclusions on US returns. As CFC/PFIC owners may not make qualified election fund (QEF) elections retroactively, they may be left applying the IRC Section 1291 excess distribution regime to stock of foreign corporations acquired while IRC Section 958(b)(4) was repealed. As a result, dividends and capital gains related to the stock of the foreign corporation would be taxed at the highest applicable US individual marginal rates. Such gains would also be subject to statutory interest for deemed underpayment of tax over the US owner's holding period with respect to the PFIC stock.

Passive foreign investment companies (PFICs)

US investors who make minority investments in foreign corporations are subject to the PFIC rules when the foreign company's passive assets or activities meet certain thresholds. The PFIC regime limits the ability of US persons to defer current US federal income tax on E&P accumulated in foreign corporations, thereby discouraging US taxpayers from investing in foreign corporations that primarily earn passive income and hold passive assets. Although US residents have historically enjoyed preferential long-term capital gains rates on dispositions of stock in a foreign corporation, the PFIC regime generally subjects capital gains and dividend distributions related to PFIC shares to US tax at the highest ordinary tax rate and to statutory interest on deferred taxes.

A QEF election, however, allows US shareholders to mitigate these consequences by requiring the electing shareholder to include a share of PFIC earnings in gross income annually. In exchange for current taxation, shareholders of a QEF are taxed at the preferential tax rates for long-term capital gains and qualified dividends from their PFIC stock.

The QEF election also allows the PFIC's income that passes through to the US shareholder to retain its character, so lower capital gains tax rates apply to income that was characterized as capital when held by the foreign corporation. Despite the pass-through of annual earnings, non-corporate US shareholders cannot claim credit for foreign taxes paid by a QEF.

Implications: The proposed increases to the US long-term capital gains and ordinary income tax rates would reduce some of the advantages of the QEF election by increasing the current US tax liability associated with shareholder-level inclusions of QEF earnings.

Foreign tax credit limitation

Under current law, US taxpayers may claim credit for foreign taxes paid, or that they are deemed to pay, on foreign-source income. The foreign tax credit is the primary US mechanism for alleviating the double taxation that can arise from US taxation of residents' worldwide income. US taxpayers may only claim credit for foreign tax in the current year to the extent of the US tax on the foreign-source income.

To claim a foreign tax credit under current law, the taxpayer segregates foreign-source income into the following categories: (1) GILTI; (2) passive income; (3) general category income; (4) foreign branch income; and (5) income resourced by treaty. After segregating their income, taxpayers allocate foreign tax paid to the appropriate category and may only claim a credit based on the amount of US tax imposed on the income in each category.

In addition to the current limitations based on the categorization of a taxpayer's foreign-source income, the HW&M Bill would introduce a "per country" limitation that would apply to a taxpayer's ability to claim foreign tax credits. Within these categories, the HW&M Bill would eliminate a taxpayer's ability to "cross-credit" or reduce its US tax burden on income sourced from low-taxed jurisdictions by claiming credit for taxes paid on similar income sourced from a high-tax jurisdiction. It also would repeal the separate limitation category for foreign branch income, and introduce a separate limitation on foreign tax credits for taxes paid or deemed paid on FOGEI and foreign oil-related income

The HW&M Bill would also decrease the current 20% haircut under IRC Section 960(d) for foreign taxes attributable to GILTI inclusions to 5%. When combined with the changes to the US corporate rate and the reduced IRC Section 250 deduction percentage, taxpayers would need to pay an effective foreign tax rate of 17.43% in any given country to avoid paying residual US tax on GILTI inclusions from that country. Any excess FTCs, including excess GILTI-category foreign tax credits, would be carried forward five years, with no carryback. This contrasts with current law, which prohibits any carryover for GILTI-category foreign tax credits, while allowing a 10-year carryforward and 1-year carryback for non-GILTI FTCs.

The House Report indicates that the foreign tax credit carryback would be repealed for foreign taxes arising in tax years beginning after December 31, 2021; in contrast, the five-year limitation on carryfowards would apply to foreign taxes that may be carried to any tax year beginning after December 31, 2021. The Report indicates that a technical correction may be required to reflect this intent.

For purposes of determining foreign-source taxable income, only the IRC Section 250 deduction would be allocable to GILTI inclusions; none of the taxpayer's other expenses (such as interest and stewardship) would be allocable to the GILTI category or reduce the GILTI-category foreign tax credit limitation.

Implications: These proposals would dramatically increase the cost of US information reporting, as well as the complexity of the foreign tax credit rules. They would also increase the effective tax rate on many taxpayer's multinational business investments. By imposing a per-country limitation on the foreign tax credit, the HW&M Bill would eliminate a taxpayer's ability to blend credits for taxes paid in high- and low-tax-rate jurisdictions, whether income is earned directly or through CFCs. Some relief would be provided by the ability to carry over excess GILTI foreign tax credits and to credit a higher percentage of foreign taxes each year.        

Concluding observations

For individuals, estates and trusts that own operating businesses in pass-through form, the proposed tax rate changes, NIIT changes, and surtax would increase taxes on business income by over 50%. A taxpayer that was paying 29.6% federal tax on business income could now pay as high as approximately 46.4% (a 56% increase), in addition to state income tax. Combined with the limitation on the state and local tax deduction, taxpayers in high-tax states could face annual cash tax costs well above 55%. As a result, cash distributions to cover owners' taxes would likely increase, leaving less available cash for business reinvestment.

While a 46.4.% rate may appear modest compared to the highest marginal rates of the 1950s and 1960s, the current, comparatively broader, tax base makes these changes more likely to increase cash outlays for taxes than in prior years.

The changes to foreign provisions, which were largely designed around large multi-national corporations rather than closely held pass-through businesses, could further increase the cash tax burden. The combination of the individual rate changes, when combined with the business and international changes, will likely reinvigorate the debate of whether pass-through entities are more advantageous than corporations for new and existing businesses.


Contact Information
For additional information concerning this Alert, please contact:
International Tax and Transaction Services – Private Company
   • Zsuzsanna Kádár (
   • Mitchell Kops (
   • Rolando J. Acosta (
Private Client Services
   • David Kirk (
   • Anna Skvortsova (
   • Marianne Kayan (
   • Dianne Mehany (
   • Caryn Friedman (