On March 28, 2022, the U.S. Department of the Treasury released its General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals (here), also known as the “Greenbook.” The Greenbook provides detail regarding the Biden Administration’s proposals to increase taxes and reduce tax benefits applicable to sponsors of and investors in private equity funds and to portfolio companies owned by private equity funds.

It remains to be seen whether these proposals will be enacted into law. If they are enacted, they could have significant effects on private equity funds and their sponsors, investors and portfolio companies.

Proposed Revenue Raisers Potentially Affecting Private Equity Funds and Portfolio Companies

Proposed revenue raisers detailed in the Greenbook of particular interest to private equity funds and portfolio companies include:

• Treating as ordinary income a partner’s share of income and gain from, and such partner’s gain from the disposition of, “carried interests” in an investment partnership for which such partner provides services, if the partner’s taxable income (from all sources) exceeds $400,000.


• Increasing the federal income tax rate for portfolio companies taxed as C corporations to 28%, effective for taxable years beginning after December 31, 2022 (with blended rates for fiscal year taxpayers whose tax year begins before January 1, 2023 and ends after December 31, 2022).


• Increasing the top federal income tax rate on ordinary income to 39.6% for single taxpayers with taxable incomes greater than $400,000 and for married taxpayers filing jointly with taxable income greater than $450,000, effective for tax years beginning after December 21, 2022.


• Increasing the top federal income tax rate on capital gains and qualified dividends to the maximum tax rate applicable to ordinary income (proposed to be 39.6% plus 3.8% Medicare tax) for taxpayers with taxable income greater than $1 million ($500,000 for married taxpayers filing separate returns), effective for gain required to be recognized and dividends received on or after the date of enactment.


• 20% minimum tax on taxpayers with wealth (i.e., assets in excess of liabilities) greater than $100 million, the purpose of which is to ensure that the minimum tax is paid not only realized taxable income, but also on unrealized ordinary income and capital gains.


• Requiring that employers withhold and, thus, be responsible for collecting, the 20% excise tax that applies to nonqualified deferred compensation.

These items are discussed in more detail below.

The Biden Administration proposals detailed in the Greenbook also include:

• Increases in taxes and reductions of tax benefits applicable to investments in real estate, discussed in more detail here.


• Elimination of substantially all tax benefits applicable to investments in oil and gas and other fossil fuels, discussed in more detail here.


• Increased reporting and IRS enforcement, discussed in more detail here.

Taxation of Carried Interests

The Biden Administration proposals detailed in the Greenbook would generally treat as ordinary income, subject to both tax at ordinary income rates and self-employment tax, a partner’s share of income and gain from an investment partnership for which such partner provides services (an “ISPI”), if the partner’s taxable income (from all sources) exceeds $400,000. Gain recognized on the disposition of an ISPI also would be treated as ordinary income if the partner’s taxable income exceeds such threshold (although it isn’t clear whether it would be subject to self-employment tax). The proposal further provides as follows:

• A partnership is an investment partnership if substantially all of its assets are investment-type assets (certain securities, real estate, interests in partnerships, commodities, cash or cash equivalents, or derivative contracts with respect to those assets), but only if over 50% of the partnership’s contributed capital is from partners in whose hands the interests constitute property not held in connection with a trade or business (e.g., hedge funds and private equity funds).


• The proposal would not apply to income or gain from “qualified capital interests” for which the partner contributes “invested capital” to the partnership. Invested capital is generally money or other property, but would not include contributed capital that is attributable to the proceeds of any loan or advance made or guaranteed by any partner or the partnership (or any person related to such persons). A qualified capital interest is generally one where (a) the partnership allocations to the invested capital are made in the same manner as allocations to other capital interests held by partners who do not hold an ISPI and (b) the allocations to these non-ISPI holders are significant.


• Anti-abuse rules would be included to prevent avoidance of the proposal’s application through the use of compensatory arrangements other than partnership interests, including rules which would apply ordinary income recharacterization treatment to convertible or contingent debt, an option, or any derivative instrument held by a person in any entity for whom such person performs services.


• Mechanisms may be included “to assure the proper amount of income recharacterization where the business has goodwill or other assets unrelated to the services of the ISPI holder.”

The proposal would be effective for taxable years beginning after December 31, 2022 and would repeal Section 1061 for taxpayers with taxable income (from all sources) in excess of $400,000.

Choice of Entity: Tax Partnership vs. C Corporation

The proposed increase in the top corporate tax rate (to 28% from the current level of 21%) and the top dividend and capital gain tax rate (to 43.6% from the current level of 23.8%, taking into account the effect of the 3.8% Medicare tax) would substantially increase the tax benefits of owning businesses through a tax partnership rather than a C corporation, particularly in the case of businesses eligible for the 20% deduction under Section 199A that currently distribute their cash flows to their owners.

Under current law, the effective tax rate advantage of tax partnerships fully eligible for the 20% Section 199A deduction is 6.4% – this is the excess of a 39.80% effective tax rate on income earned and distributed by a C corporation over a 33.40% effective tax rate on income earned and distributed by a tax partnership, in both cases taking into account the effect of the 3.8% Medicare tax.

Under the Biden Administration proposals, the effective tax rate advantage for taxpayers with income over $1 million would rise to 15.85% even before taking into account any additional benefits available under Section 199A – this is the excess of a 59.25% effective rate on income earned and distributed by a C corporation over a 43.40% effective tax rate on income earned and distributed by a tax partnership, in both cases taking into account the effect of the 3.8% Medicare tax.

Simplified illustration of effective tax rate calculation for a C corporation. Assume a corporation earns $100, pays tax of $28 (28% of $100) and pays a taxable dividend of $72 ($100 minus $28). Assume the shareholder pays income tax of $28.51 (39.6% of $72) and Medicare tax of $2.74 (3.8% of $72) on the dividend. The total tax payments with respect to the original $100 would be $59.25 ($28 paid by the corporation and $31.25 paid by the shareholder), for an effective tax rate of roughly 59.25%.

In cases where the relevant entity is a foreign entity or operates in foreign jurisdictions, the choice of entity (tax partnership v. corporation) will be further impacted (and complicated) by the international tax proposals included in the Biden Administration proposals detailed in the Greenbook, including the proposals to (i) increase the minimum rate, and make certain other modifications to the rules, applicable to global intangible low-taxed income (GILTI), (ii) deny deductions for expenses related to “offshoring” jobs and provide a credit for expenses related to “onshoring” jobs and (iii) replace the base erosion anti-abuse tax with the OECD’s Pillar Two proposal. These international tax proposals are discussed in more detail here.

Minimum Tax on Unrealized Gains of Taxpayers with Net Worth Exceeding $100 Million

Under the Biden Administration proposals detailed in the Greenbook, taxpayers with wealth (i.e., assets in excess of liabilities) greater than $100 million would be subject to a 20% minimum tax, the purpose of which is to ensure that the minimum tax is paid not only on realized taxable income, but also on unrealized ordinary income and capital gains. The 20% minimum tax rate would be phased in for taxpayers with wealth greater than $100 million but less than $200 million. The proposal further provides as follows:

• Payments of this minimum tax would be treated as a prepayment available to be credited against subsequent taxes on realized capital gains to avoid taxing the same amount of gain more than once.


• Taxpayers could choose to pay the first year of minimum tax liability in nine equal, annual installments. For subsequent years, taxpayers could choose to pay the minimum tax imposed for those years in five equal, annual installments.


• Taxpayers whose tradeable assets (held directly or indirectly) make up less than 20 percent of their wealth (i.e., illiquid taxpayers) may elect to include only unrealized gain in tradeable assets in the calculation of their minimum tax liability. However, taxpayers making this election would be subject to a deferral charge on the tax incurred when gain is actually realized on non-tradeable assets. The proposal indicates that this deferral charge would not exceed 10% of unrealized gains. The proposals detailed in the Greenbook do not define “tradeable” or “non-tradeable” assets, but provide publicly traded stock as an example of a tradeable asset.


• Taxpayers with wealth greater than the threshold would be subject to detailed annual reporting requirements and valuation requirements regarding their assets and liabilities. However, taxpayers would not have to obtain annual, market valuations of non-tradeable assets. Instead, non-tradeable assets would be valued using the greater of the original or adjusted cost basis, the last valuation event from investment, borrowing, or financial statements, or other methods approved by the IRS, and such valuations would be deemed to increase by a “conservative” floating annual return (the five-year Treasury rate plus two percentage points) in between valuations.

This proposal would be effective for tax years beginning after December 31, 2022.

Employer Withholding of Excise Tax on Nonqualified Deferred Compensation

Section 409A of the Code currently imposes on employees and other service providers a 20% excise tax (and, under certain circumstances, additional interest penalties) on the value of vested nonqualified deferred compensation for failure to comply with the requirements of Section 409A. Employers are not currently required to withhold the 20% excise tax or additional interest penalties. By amending Section 3402(a) of the Code, the Biden Administration proposals detailed in the Greenbook would require employers to withhold the 20% excise tax and the additional interest penalties on nonqualified deferred compensation included in the employee’s income due to Section 409A compliance failures. If adopted, this change would allow the Treasury to recover such excise taxes and penalties from the employer, leaving the employer to prove whether the employee has, in fact, remitted such excise tax or penalties, which would largely shift the risk of Section 409A non-compliance from employees to employers.

This proposal would be effective after December 31, 2022.

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We will continue to monitor developments and will provide further updates as more details are released. In the meantime, Baker Botts would be pleased to assist you in your analysis of these proposals.

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