Disposing of Assets Under The Ways and Means Committee’s Proposals

September 21, 2021 | Louis Vlahos | Tax

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 is not modified in any material respect thereafter.

Individual Ordinary Income Rate

Under current law, married individuals filing jointly, with taxable income of between $400,000 and $600,000, are subject to income tax at a top rate of 35 percent, while those with taxable income in excess of $600,000 are subject to a top rate of 37%.[xiv]

Ways and Means proposes to replace these two rate brackets as follows: a top rate of 35 percent rate would apply to married individuals with taxable income of between $400,000 and $450,000, while a top rate of 39.6 percent would apply to individuals with taxable income over $450,000.[xv]

What’s more, in the case of taxable years beginning after December 31, 2025, the 39.6 percent rate bracket threshold would be adjusted for post-2021 inflation.

The foregoing amendments would apply to ordinary income recognized in taxable years beginning after December 31, 2021.

This would include compensation for services (including services rendered as a consultant), payment for a non-compete, ordinary business income, payment for inventory or receivables, rent, interest (including imputed interest), depreciation recapture, and other items.

In the event a partnership interest was disposed of by an individual partner, the gain attributable to “hot assets” would be subject to tax at the increased rate.[xvi]

Capital Gains

The bill proposes to increase the individual income tax rate on long-term capital gains from 20 percent to 25 percent,[xvii] effective for taxable years ending after September 13, 2021 – in other words, gain recognized in the current year may be covered. Gain recognized after 2021, including gain in respect of payments made on an installment obligation after 2021, would be subject to the increased rate.[xviii]

This rate would apply, for example, to the gain realized by an individual taxpayer on the sale of shares of stock or of interests in a partnership, including liquidating distributions. It would also apply to the gain recognized by an S corporation or partnership on the disposition of assets that passes through to its individual owners.

The bill provides a transitional rule for the current year, ending December 31, 2021, that seeks to apportion the gain and the increased tax rate. Its application may be illustrated with a simplistic example:

Assume the only LT cap gain recognized by an individual for 2021 is a sale which occurs after Sept. 13, 2021.

The tax on the capital gain for the 2021 tax year [the year of the sale] would be the sum of:

  • 20% of (1) or (2) below, whichever is lower:
  • adjusted net capital gain for the full year, [including the gain from the sale after September 13, 2021]


(2) the amount of the net capital gain, computed only with dividends and gains (ignoring collectibles, unrecaptured depreciation, and sec. 1202 gains) for the portion of the 2021 tax year ending on September 13, 2021 [we’re assuming this is zero; thus, the 20% is applied to $0]


  • 25% of the excess of:
  • adjusted net capital gain for the full year, [including the gain from the sale after Sept. 13, 2021]


(2) the amount of the net capital gain, computed only with dividends and gains (ignoring collectibles, unrecaptured depreciation, and sec. 1202 gains) for the portion of the 2021 tax year ending on September 13, 2021 [this is zero].

Thus, the gain (which may be attributable to the sale of a business later in the year) will be subject to tax at the rate of 25 percent.

The Committee also included a grandfathering rule pursuant to which gain recognized in 2021 will be allocated (for purposes of applying the above transition rule) to the portion of the year ending on September 13, if the gain arose from a transaction that occurred pursuant to a written binding contract entered into on or before September 13, 2021 (provided the agreement is not modified in any material respect).[xix]

Net Investment Income Surtax

Since 2013, the annual “net investment income” (“NII”) of certain higher-income taxpayers has been subject to a 3.8 percent surtax. In determining a taxpayer’s NII for a taxable year to which the surtax applies, certain items of income are excluded.

Specifically, NII does not include ordinary income derived in the ordinary course of a trade or business in which the taxpayer materially participates. Nor does it include the gain realized from the disposition of property held in such a trade or business. Gain realized by an S corporation or partnership on a sale of assets is passed through and taxed to its owners. An owner’s NII includes their share of the gain attributable to the entity’s sale of property held in a trade or business that is a passive activity as to the owner.  The determination of whether the property sold was held in a trade or business that is a passive activity is made at the level of the individual owner, not at the entity level.[xx]

Thus, the determination of whether the surtax applies to a shareholder’s allocable share of the gain from an S corporation’s sale of assets depends upon whether the corporation held the assets for use in its business and whether that business was a passive activity as to the shareholder; i.e., whether the shareholder “materially participated” in the business.

Likewise, gain from the disposition of an interest in a partnership or S corporation is generally excluded if the entity is engaged in a trade or business in which the taxpayer materially participated.

The bill would amend the application of the foregoing rules.

Under the bill, in the case of any individual whose modified adjusted gross income for the taxable year exceeds the “high income threshold amount” – $400,000 in the case of a single individual, $500,000 in the case of an individual making a joint return with a spouse – net investment income will include the above-described items of income and gain from a business notwithstanding the taxpayer’s material participation in the underlying business.

If enacted, this change will have a significant impact upon the income and gain recognized by many closely held businesses and their owners, who are typically very active in the business.


The proposal introduces a new tax. In the case of a taxpayer other than a corporation, a tax equal to 3 percent would be imposed on so much of the taxpayer’s modified adjusted gross income for the year as exceeds $5 million in the case of any taxpayer filing a joint return.

The surcharge would apply to an individual taxpayer’s gain from the sale of property, including their share of such gain from an S corporation or partnership.

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


Let’s pause for a second to take stock of what the foregoing changes would mean to an individual seller selling their business: a 25% tax on long-term capital gain arising from the sale, a 3.8% surtax on the same gain, plus a 3% surcharge for good measure. That comes out to 31.8%.

If you’re fortunate enough to live in New York State, add another 9.65-to-10.9 percent; New York City, another 3.876 percent. (Deep breaths.)

S Corp Liquidation

The Committee surprised me with this one. But, first, to set the stage. The “conversion” of a corporation (S or C) into a tax partnership (including an LLC with at least two members) – regardless of how effected – is treated as a liquidation of the corporation: a taxable event.

Under the bill, an electing S corporation may be converted to a partnership without the recognition of gain, if the corporation (including any predecessor corporation) was an S corporation on May 13, 1996 – the date on which the check-the-box regulations were proposed – (and at all times thereafter) and if, during the 2-year period beginning on December 31, 2021, the corporation is completely liquidated and substantially all of its assets and liabilities are, as a result of such liquidation, transferred to a domestic partnership.[xxi]

Presumably, the partnership would take the S corporation’s assets with the same adjusted basis and holding period they had in the hands of the corporation.

The domestic partnership that succeeds to the liquidating S corporation would not be allowed to make an S election during the five-year period following the year of the liquidation.

Estate and Gift Tax Exemption

The Ways and Means Committee’s proposal would eliminate the increased basic exclusion amount that was enacted in 2017. You will recall that the Tax Cuts and Jobs Act doubled the basic exclusion from $5 million to $10 million. As adjusted to date for inflation, the exemption amount for gifts made and decedents dying in 2021 is $11.7 million.

You may also recall that the basic exclusion was scheduled to revert to $5 million in 2026. In other words, the bill would accelerate the reduction, effective for decedents dying and gifts made after December 31, 2021. It would leave the portability rule intact.

Thus, if an individual taxpayer is interested in using what remains of their increased exemption amount – including any amount carried over to them from a pre-deceasing spouse under the portability rule – now is the time to make some gifts and to leverage the grantor trust rules and valuation discounts before their use is also restricted (see below).[xxii]

Grantor Trusts

Grantor trusts – i.e., trusts the income and assets of which are treated, for purposes of the income tax, as “owned” by the individual who created and funded the trust – have played a significant part in gift and estate planning. Their utility is based primarily upon the inconsistent treatment accorded the trusts for income tax purposes, on the one hand, and gift tax purposes, on the other.

For example, a grantor may transfer appreciated property to a grantor trust in exchange for other property or a note; the grantor is treated as having received sufficient consideration for gift tax purposes – no taxable gift has occurred – without incurring any income tax; at the same time, the grantor has preserved their exemption amount.[xxiii]

The bill would turn the use of the grantor trust topsy turvy.

Assume a grantor is treated as the owner of all or a portion of a trust under the grantor trust rules and assume further that the trust is not otherwise includible in the grantor’s gross estate. Under the proposal, upon the grantor’s death, their gross estate would include the assets the grantor was treated as owning under the grantor trust rules at the time of their death. Any distribution (other than to the grantor or their spouse) from that portion of the trust deemed to be owned by the grantor would be treated as a taxable gift.

If the grantor ceased to be treated as the owner of the trust during their lifetime, the grantor would be treated as having made a gift of the trust assets that the grantor was previously treated as owning.

In determining whether the transfer of property between an irrevocable grantor trust and the deemed owner of the trust constitutes a sale for purposes of the income tax, the grantor’s status as the deemed owner will be disregarded. The grantor would be treated as having sold the property for income tax purposes – the grantor would have to recognize the gain realized.[xxiv]

These changes to the grantor trust rules would apply to trusts created on or after the date of the enactment, and to any portion of a trust established before the date of the enactment which is attributable to a contribution made on or after such date.

Valuation Discounts

Finally, Ways and Means has one more item in the bill of which taxpayers should be aware – a change which, if enacted, will be effective for transfers after the date of enactment.

Combined with the proposed reduction in the exclusion amount, and the proposed limitations on the use of grantor trusts, this last piece may be the coup de grâce (or was it the foie gras?) for certain gift and estate tax planning techniques.

In determining the FMV of an equity interest in a closely held business entity, one will typically consider the nature of the underlying assets in setting the lack of marketability (“LOM”) discount; the more liquid or marketable such assets, the lower the LOM discount for the equity interest gifted or bequeathed.

Taking its cue from this principle, the Committee has proposed that the value of “nonbusiness assets” held by a closely held entity – an interest in which entity is being transferred by the taxpayer – is to be determined as if the taxpayer had transferred such assets directly to the recipient of the gift or bequest; in other words, no valuation discount is to be applied with respect to such nonbusiness assets.

But what constitutes a nonbusiness asset?

The term “nonbusiness asset” means any “passive asset” which is held for the “production or collection of income” and is not used in the “active conduct of a trade or business.”[xxv]

In general, the term “passive asset” means any cash or cash equivalents, stock in a corporation or any other equity, profits, or capital interest in a partnership, evidence of indebtedness, an option, forward or futures contract, notional principal contract, or derivative, RICs, REITs, precious metals, an annuity, real property, an asset (other than a patent, trademark, or copyright) which produces royalty income, commodity, collectible, and certain other personal property.

A passive asset will not be treated as used in the active conduct of a trade or business unless the asset is (1) inventory or other property held for sale to customers in the ordinary course of business, receivables generated in the ordinary course, or a hedge with respect to such property, or (2) real property used in the active conduct of a real property trade or business in which the transferor materially participates and with respect to which the transferor meets certain other requirements.

Any passive asset which is held as a part of the “reasonably required working capital needs” of a trade or business will be treated as used in the active conduct of a trade or business.

Thus, the value of liquid assets in excess of the working capital requirements of a business will not be discounted in determining the value of an interest in the business for purposes of the estate tax or gift tax. This is the proper result.

What’s Next?

There is much to be grateful for; for example, the stepped-up basis rule survived the Committee’s mark-up; the estate and gift tax rate was not increased; the deemed-sale-at-death-sale (or mark-to-market) rule was not adopted by the Committee; the nonrecognition rule for like-kind exchanges of real property also made it through.

But the heavy-set individual hasn’t sung yet. The Senate has not yet released its tax proposals, the President appears eager to restore some of the proposals that Ways and Means omitted, and there’s a whole lot of pork to be shared.

Stay tuned.

[i] Representative Stephanie Murphy of Florida.

[ii] Which cannot make any substantive changes.

[iii] Remember “Schoolhouse Rock!”? “I’m just a bill.”

[iv] Of course, I am assuming the Representative from Florida will not be swayed or coerced into changing her vote. I am also assuming that the SALT caucus, or whatever they call themselves, will secure some relaxation of the $10,000 cap in exchange for their votes in favor of the bill.

[v] As previously mentioned, Sen. Wyden, who chairs the Senate Finance Committee, recently proposed an overhaul of the partnership tax rules. https://www.rivkinradler.com/publications/tax-hikes-effective-dates-and-selling-a-business/#_ednref3 .

[vi] Presidential “gravitas” you might say? Or was it more like horse-trading? My money is on the horses.

[vii] https://www.whitehouse.gov/briefing-room/speeches-remarks/2021/09/16/remarks-by-president-biden-on-the-economy-4/ .

The President continued: “we’re not going to raise taxes on anyone making under $400,000.  That’s a lot of money.  Some of my liberal friends are saying it should be lower than that.  But only corporations and people making over $400,000 a year are going to pay any additional tax.”

[viii] Follow this word to one of Monty Python’s most hysterical sketches, from “Life of Brian.”

[ix] IRC Sec. 311(b) and Sec. 336.

[x] IRC Sec. 1374.

[xi] Thus, IRC Sec. 332 does not apply.

[xii] IRC Sec. 267(f).

[xiii] IRC Sec. 1202.

[xiv] IRC Sec. 1(j).

[xv] Trusts and estates would face the 39.6% rate if their taxable income exceeds $12,500.

[xvi] IRC Sec. 741 and Sec. 751.

[xvii] As proposed by the President, this increased rate would apply to the long-term capital gain of individuals with gross income for the taxable year in excess of $1 million. Ways and Means did not include such an income threshold.

[xviii] Query whether a taxpayer who received an installment obligation during 2021 should accelerate recognition of the gain inherent therein; for example, by electing out of installment reporting or by pledging the obligation as collateral. IRC Sec. 453A.

[xix] Fortunate is the taxpayer who had a crystal ball, or who had a “friend” whispering in their ear. https://www.rivkinradler.com/publications/tax-hikes-effective-dates-and-selling-a-business/ .

[xx] IRC Sec. 1411(c).

[xxi] This is something worthy of consideration.

[xxii] The IRS previously confirmed, by regulation, that taxpayers who make gifts that take advantage of the increased exemption amount will not be adversely affected when the lower exemption amount is later restored – this outcome should continue to hold.

[xxiii] Rev. Rul. 85-13.

[xxiv] The implications cannot be understated. The exchange may still be treated as having been made for full and adequate consideration for purposes of the gift tax. However, (a) an insured’s sale of a life insurance policy to an ILIT would be treated as an actual sale, and may implicate the transfer for value rule, exposing the receipt of the insurance proceeds to the income tax; (b) what about a GRAT – a GRAT is really just a sale of property to a grantor trust in exchange for a note; a zeroed-out GRAT may avoid gift tax, but the gain realized on the transfer would be subject to income tax.

[xxv] Congressional clarity at its finest – define something with a number of terms which must themselves be defined. A Russian nesting doll.

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