BACKGROUNDER - Tax Policy Group March 4, 2021

BACKGROUNDER – Tax Policy Group
March 4, 2021

   1. Welcome / Introduction of Members & Online Portal (5 minutes: 3:00 p.m. – 3:05
      p.m.)

You have been selected by Board Chair ML Mackey and President Todd McCracken to serve on
the Taxation Policy Group this year based on your knowledge, expertise and your ability to take
appropriate policy positions regarding the issues in this jurisdiction on behalf of NSBA.

For 2021, your policy group is chaired by Malcolm Prouty
(malcolmprouty@systemsandmaterials.com) and Jody Milanese (jmilanese@nsba.biz) will be the
primary NSBA staff contact.

NSBA staff has developed a one-stop-shop Webpage for the Taxation Policy Group. Here, you
will find the agendas and background documents for each meeting as well as: supplemental
documents, Taxation issue briefs, meeting document archives, all Taxation Policy Group
members, the meeting schedule and video conferencing information and a variety of important
links to the NSBA website. This website is ONLY for this committee and is password protected.

   2. Policy Group Overview and Expectations (Role, Guidelines, Process, and
      Requirements) from Vice Chair for Advocacy Bob Treiber (5 minutes: 3:05 p.m. – 3:10
      p.m.)

   3. NSBA’s Top Priorities for the 117th Congress – Tax Purview (20 minutes: 3:10 p.m. –
      3:30 p.m.)
              No. 5 - Enact Tax Reform That Prioritizes Simplification
      The NSBA Tax Reform Brochure

President Joe Biden would like to see Congress make significant changes to the tax code,
including changes to the corporate tax rate and to the top tax rate for individuals. Further,
President Biden has indicated that he would like to see the reduction or elimination of the tax
cuts made by the TCJA. He believes that the tax system should be changed to ensure that large
corporations and high-net-worth individuals pay their "fair share” of taxes.

For individuals, President Biden has proposed increasing the top income tax rates and
expanding the Social Security tax base, as well as curtailing or eliminating various incentives
that are currently available to high income taxpayers. If these plans are implemented, roughly
$4 trillion would be raised over the next 10 years, as reflected in estimates obtainable through
the Tax Policy Center and the Tax Foundation. The additional tax revenue would be used to pay
for spending initiatives to improve the nation’s infrastructure, developing alternative energy
sources and building up the U.S. manufacturing sector.

To be successful in implementing proposed changes, the timing of any future tax increases will
need to be balanced against the need to keep the economy strong and resilient at a time when
the country is trying to address the economic slump that was brought about by the coronavirus
pandemic.

Individual Income Tax Rates

Current law provides for a progressive income tax rate system, which means that tax rates
increase as taxable income increases. Under the seven-bracket system, tax rates for ordinary
income start at 10 percent and increase to 37 percent for taxable income of $622,050 for
individuals filing joint income tax returns in 2020, and $518,400 for individuals filing as single
taxpayers. Under Biden’s plan, the TCJA tax cuts likely would be repealed and the top federal
income tax rate of 39.6 percent would be reinstated.

Business Income from Pass through Entities (Partnerships, S Corporations and Sole
Proprietorships)

Under current tax law, many businesses qualify for a qualified business income deduction of up
to 20 percent, which can lower the effective tax rate on the business income of individuals from
a high of 37 percent to as low as 29.6 percent for qualifying businesses.

President Biden would like to phase out the tax benefits associated with the qualified business
income deduction for individuals making more than $400,000 a year, thus effectively raising the
business income tax rate from 29.6 percent to 39.6 percent.

Corporate Tax

The Tax Cuts and Jobs Act (TCJA) reduced the corporate income tax rate to a flat 21 percent rate
from a progressive rate of up to 35 percent before 2018 and abolished the corporate alternative
minimum tax.

President Biden recommends raising the corporate tax rate from 21 percent to 28 percent, a
middle ground between the top rate of 35 percent under the Obama administration and the
current 21 percent rate. He also would put in place a new form of corporate alternative
minimum tax that essentially would require corporations to pay the greater of their regular
corporate income tax or a new 15 percent minimum tax on worldwide book income.

Payroll Taxes

A 6.2 percent Social Security tax and a 1.45 percent Medicare tax currently are imposed on both
the employer and the employee. While the wage base for the Medicare tax is unlimited, there is
a cap on the Social Security tax base equal to the first $137,700 of employee wages (increasing to
$142,800 for 2021).

In addition to the Medicare tax rate, which totals 2.9 percent for the employer and the
employee, an additional 0.9 percent Medicare tax is levied on employees with wage and self-
employment income above the same thresholds that are applicable in the case of the net
investment income tax ($250,000 or more for joint returns or a surviving spouse, $125,000 or
more for a married taxpayer filing a separate return and $200,000 in all other cases). This
effectively increases the collective employer/employee rate or self-employed rate to 3.8 percent
(1.45% twice + 0.9%), which would raise the Social Security and Medicare tax rate for self-
employed individuals to 16.2 percent (12.4% + 3.8%).

President Biden has indicated that he would remove the cap on the wage base for the Social
Security tax for high earners, defined as those making more than $400,000. These changes to the
Social Security and Medicare taxes would apply to employees and self-employed individuals
that have sole proprietorships or are partners in a partnership.

It is uncertain whether wages between $142,800 and $400,000 would be subject to the additional
income tax, or whether there would be a so-called “donut hole” before the higher rate kicks in
for individuals with taxable earnings in excess of $400,000. This would raise the overall income
tax rate on some businesses to as high as 55.8 percent (39.6% + 16.2%) before taking into account
state income taxes.

Estate Tax

The estate tax rate currently is subject to a progressive rate scale up to 40 percent. The estate tax
is imposed upon the death of a taxpayer after an exemption allowance of up to $10 million per
taxpayer, as indexed for inflation (currently $11,580,000 per taxpayer ($23,160,000 per married
couple for 2020)). In addition, beneficiaries are entitled to a step-up in the tax basis of all
inherited assets based on the date of death valuation or the alternative valuation date.

President Biden would reduce the exemption amount to pre-Obama levels of $3.5 million per
taxpayer, while increasing the top estate tax rate to 45 percent. He has also suggested
eliminating the regime that allows for a step-up in tax basis on the date of death or alternative
valuation date.

Investments into Distressed Areas

The TCJA introduced significant incentives for investments in qualified opportunity zones
(QOZs). These rules allow taxpayers to defer recognition of capital gains where the proceeds are
reinvested in a property directly or a QOZ fund property within 180 days.

The capital gains deferral exists until the earlier of the time the QOZ property is sold or
December 31, 2026. In addition to the deferral, there is a 10 percent tax reduction if the fund is
held for five or more years, a 15 percent reduction in tax if the property is held for seven or
more years, and if the investment is held for 10 or more years, the appreciation of the QOZ fund
investment (not the original gain but the post-acquisition gain) qualifies for a step-up in tax

basis, essentially excluding the appreciation from gross income.

In addition to QOZs, a new markets tax credit is available to investors that inject capital into
community development entities. The credits are progressive and vest with each year of
expenditures and can equal up to 39 percent of the cost of the new markets tax credit project.

President Biden has indicated that he would like to continue both programs and may be willing
to expand and make the new markets tax credit program permanent.

Manufacturing and Business Incentives

Tax incentives currently are available for low-income housing, reducing fossil fuels and using
alternative energy, as well as employer incentives for hiring individuals that qualify for the
work opportunity tax credit and for hiring individuals with disabilities. Tax credits also are
available to employers for providing child-care facilities on their premises so that working
parents can continue working.

President Biden supports these programs but would like to add a tax credit for manufacturing
goods in the U.S. He also has proposed imposing a tax penalty on corporations that ship jobs
overseas in order to sell products back to the United States.

               No. 11 – Support Fair and Simple Capital Gains Taxes

Under current law, capital gains are taxed as income. A capital gain is a profit from the sale of a
capital asset—such as a house, stock, bond, or jewelry— from the time that asset is acquired
until the time it is sold. The price at which an asset is purchased is called the asset’s “basis,” and
taxpayers pay tax on the difference between an asset’s basis and its sales price when they sell, or
realize, that capital gain.

For capital gains realized on assets held for less than one year (short-term capital gains),
taxpayers pay taxes according to their ordinary individual income tax rate, ranging from 10
percent to 37 percent. For assets held longer than one year (long-term capital gains), taxpayers
pay a reduced tax rate, ranging from 0 percent to 20 percent, depending upon a taxpayer’s
income. Individuals with Modified Adjusted Gross Income surpassing $200,000 ($250,000 for
married couples) pay an additional 3.8 percent tax on net investment income.

Currently, when a person dies and leaves property to an heir, the basis of that property is
increased to its fair market value. This “step-up in basis” means that any capital gains that
occurred during the decedent’s life go untaxed. When the heir sells that property, any capital
gains taxation will be assessed based on the heir’s new basis. Step-up in basis reduces the tax
burden on transferred property, as the total value of transferred property is already taxed by
the estate tax.

Senate Finance Committee Chairman Ron Wyden (D-Oregon) Proposal

Senate Finance Committee Chairman Ron Wyden (D-Oregon) has proposed a plan that would
tax the capital gains of the highest-earning taxpayers annually, at ordinary income tax rates.
Known as “mark-to-market” taxation, this plan would eliminate the “lock in effect” by
eliminating deferral, but it would also increase the tax burden on saving and make the tax code
more complex.

Wyden has previously proposed taxing some investment income under mark-to-market
taxation. He introduced a bill in the 115th Congress focused on transitioning the treatment of
financial derivatives to mark-to-market. Specifically, his 2017 bill would have required
derivatives traders to value their swaps, options, and forwards contracts at their market rate
and report them to the IRS annually for taxation.

While the details of Wyden’s newest plan are not fully fleshed out, there are a few things about
mark-to-market taxation of capital gains to consider.

This would be a noticeable tax increase for some taxpayers and raise additional revenue. Under
Wyden’s plan, all capital gains owned by the top 0.3 percent of taxpayers would be taxed
annually at ordinary income tax rates (ranging from 10 percent to 37 percent), excluding
primary residences and 401(k) plans. Currently, long-term capital gains—or those held for
longer than a year— are taxed at a lower rate, ranging from 0-23.8 percent (short-term capital
gains held for less than a year are taxed as ordinary income tax rates).

By removing deferral, Wyden’s plan would eliminate the lock-in effect for some taxpayers.
Individuals subject to Wyden’s proposal would no longer have a choice over when they paid
taxes on capital gains. As a result, there would no longer be an incentive to hold on to these
assets. Even so, the proposal would also increase the tax burden on savings by accelerating
taxes on capital gains and could have an impact on the incentive to save.

President Joe Biden’s Proposal

President Joe Biden’s plan would first raise taxes on capital gains by treating them as ordinary
income for those earning more than $1 million. Further, he has said he would also raise the top
rate on ordinary income back up to 39.6 percent from the 37 percent rate put in place by the Tax
Cuts and Jobs Act. As such, the top rate on long-term gains would nearly double from 23.8
percent to 43.4 percent. Biden cites a Joint Committee on Taxation report on tax expenditures
which estimates that the special lower rate on capital gains and dividends reduces federal
revenue by $127 billion each.

While the expenditure estimate implies that the government loses a lot of revenue from the
lower rate on capital gains, it is highly unlikely that the federal government could get this much
revenue from just raising the rate. Research from the Congressional Budget Office (CBO) and
the Joint Committee on Taxation (JCT) shows that capital gains realizations are very sensitive to
taxation. This is because taxpayers can time when they want to realize their capital gains in
order to minimize their tax bills. Specifically, the CBO and JCT estimate that the elasticity of

realizations to the tax rate is -1.2 in the short run and -0.79 in the long run. Specifically, a 1
percent increase in the capital gains tax rate would result in a 0.79 to 1.2 percent drop in capital
gains realizations.

In practice, this means that proposals to significantly raise capital gains tax rates, with no other
changes, can lose federal revenue. Using CBO data on capital gains realizations and these
elasticities, the Tax Foundation estimate that raising the top rate to 43.4 percent (39.6 percent
statutory rate plus the 3.8 percent Net Investment Income Tax) could lose about $2 billion each
year. However, Biden is not simply proposing to raise the top rate on capital gains. He also
proposes eliminating step-up basis in capital gains. According to the JCT, not taxing gains at
death results in a loss of about $40 billion each year.

Again, this is a tax expenditure estimate and not a revenue estimate, and the amount of revenue
Biden’s proposal would ultimately raise would depend on how he structures the elimination of
step-up in basis. He could require heirs to take on the decedent’s basis when they receive an
asset, known as carryover basis, but still allow heirs to defer realization of that inherited asset’s
capital gain. This would raise much less than making death a taxable event—and even then,
proposals to tax capital gains at death can have many exemptions.
It is also worth noting that these two proposals interact in two important ways. Since Biden is
raising the tax rate on capital gains, the value of the tax expenditure for step-up in basis will
mechanically increase. This is because the rate at which these gains would otherwise be taxed at
would be higher.

In addition, eliminating step-up in basis at death reduces a taxpayers’ incentive to defer
realizing gains. Part of the reason why there is such a strong incentive to defer the tax on capital
gains is that if an individual defers long enough, the tax on the asset will eventually be forgiven.
Without step-up in basis, a taxpayer has a greater incentive to realize during their lifetime. As
such, eliminating step-up in basis can indirectly boost revenue from capital gains.

    4. New Item – Legislation (10 minutes: 3:30 p.m. – 3:40 p.m.)
             a. Carried Interest Fairness Act of 2021 (H.R. 1068)
This is an actionable item for this Policy Group. Using the four issue filters, the Policy Group will need to
decide whether NSBA should weigh-in on this bill, and provide a letter to the sponsors.

House Ways and Means Committee member Bill Pascrell (D-N.J.) and Democratic Reps. Andy
Levin of Michigan, and Katie Porter of California introduced legislation on February 16 that
generally would end capital gain treatment for income from carried interests.

According to a news release from Pascrell, Levin, and Porter, the Carried Interest Fairness Act
of 2021 would tax certain carried interest income at ordinary income tax rates and subject it to
employment taxes. Capital gain treatment would continue to apply for individuals “who truly
put money at risk, such as private-equity partners who invest their own money in their funds,”
but “all income from managing a firm’s assets would be taxed at ordinary rates,” the release
said.

Under current law, gains on certain carried interests that have been held for more than three
years generally are taxed at long-term capital gain rates.

An official revenue estimate for the proposal is not available yet, but the bill’s sponsors note in
their news release that a December 2018 report from the Congressional Budget Office on
options for reducing the deficit estimates that taxing carried interest income as ordinary would
increase federal receipts by $14 billion over 10 years.

Co-sponsors of the measure include House Democratic taxwriters Don Beyer of Virginia, Tom
Suozzi of New York, Earl Blumenauer of Oregon, and Judy Chu of California. A companion
proposal has not been introduced in the Senate.

Rep. Pascrell sponsored similar legislation in 2019. His bill is generally based on a proposal
introduced in the 115th Congress by then-Ways and Means Committee Chairman Sander Levin
(D-Mich.).

President Biden campaigned for office in part on a promise to tax carried interests at ordinary
income tax rates.

   5. Outstanding Issue / Ongoing Discussion (10 minutes: 3:40 p.m. – 3:50 p.m.)
         a. Small Business Economic Growth Package

As an outstanding issue from the 2020 Policy Group, Chairman Prouty and Vice Chair for
Advocacy Treiber will provide an update surrounding Reimagining the Post-Pandemic Economic
Future. As the COVID-19 crisis continues, policy makers are challenged to emerge from it in a
way that lays a foundation for a stronger, healthier economy in the long run. NSBA is working
to formulate a nonpartisan strategy to respond and reinvigorate our economy with a pro-jobs,
pro-growth and pro-business approach.

The COVID-19 pandemic has threatened not only our healthcare systems, but our livelihoods
and the stability of our economy. The U.S. has responded with unprecedented levels of both
fiscal and monetary stimulus to blunt the economic impact of the crisis. Yet, tremendous
uncertainty remains about what to do next. NSBA’s aim is to focus on how best to restart the
economy and outline a nonpartisan approach we can move forward—to secure the future
health, safety and prosperity of all Americans.

Please read and review all of the comments provided and be prepared to share what you
consider the top 3-4 themes, overarching ideas/concepts from the collected responses. These
topics will be discussed and a consensus will determine the Tax Policy Group’s starting
point for the creation of a White Paper.

On the microsite, please click on the Committee Comments on Post-COVID Economic Growth
Strategy. This links to the OneDrive document where you can input comments on a shared
document that the entire committee can see.

Directions for Commenting on OneDrive Documents:
   1) Click on the link to open the document in OneDrive
   2) Click on the “Edit” button toward the top-right (a new screen will open)
   3) Next, input your comments in one of two ways:
           a. Highlight the text relative to your comments and a pop-up will appear
                    i. Click on the “New Comment” button on the far right of that pop-up.
                   ii. A box on the right will appear.
                  iii. Enter your name here FIRST, then add your comments.
                  iv. Once finished, click on the blue arrow/airplane icon to make your
                       comment public.
           b. Click on the “Comments” button at the top and enter general comments if not
               related to a specific piece of text.
                    i. A right-hand sidebar will appear with everyone’s comments.
                   ii. Enter your name here FIRST, then add your comments.
                  iii. Once finished, click on the blue arrow/airplane icon to make your
                       comment public.
   4) You can also respond to comments you see in the right sidebar.
   5) Once you have entered your comments, you do NOT need to save – everything is
       automatically saved in the document.

    6. NSBA Coalition Letter to Hill / Policy Group Member Action (5 minutes: 3:50 p.m. –
        3:55 p.m.)
                a. Main Street Tax Certainty Act
        The letter can be found here: https://s-corp.org/draft-199a-trades-letter_main-street-tax-
certainty-act/

Reps. Jason Smith (R-Mo.) and Henry Cuellar (D-Texas), as well as Sen. Steve Daines (R-Mont.)
are planning to reintroduce their Main Street Tax Certainty Act. The Main Street Tax Certainty
Act prevents the 20 percent small business tax deduction from expiring after 2024. This bi-
partisan approach provides long-term certainty for small businesses and coincides with the
need for Congress to immediately provide COVID-19 liability protection and additional
financial aid for employers whose survival is on the line. According to Tax Foundation
estimates, the extension of lower small business rates will increase long-run GDP by 2.2 percent,
long-run wages by 0.9 percent, and will add 1.5 million jobs.

With the acknowledgement that Section 199A isn’t set to expire until another few years, NSBA
signed onto a coalition letter of support. We figure the issue is likely to come up between now
and 2025, and having a letter with broad backing to point to should be helpful. NSBA
encourages members of this Policy Group to craft a similar letter to your own lawmakers asking
them to cosponsor the measure upon introduction.

   7. Other Issues (2 minutes: 3:55p.m. – 3:57 p.m.)

   8. Adjourn (4:00 p.m.)