Overview and critique
In February 2012, the White House and Treasury Department released The President’s Framework for Business Tax Reform (the report), which presents five “elements” of business tax reform. For each element, the report provides background information to explain why reform is needed and describes the suggested reforms. Some of the reforms are specific, such as repealing LIFO, while others are more general, such as reducing “accounting gimmicks.” In addition, one element offers a few suggestions as a “menu of options” to consider in reform.
Following are the five elements and their proposals with observations on what is missing from the plan as well as possible challenges to achieving the reform.
I. “Eliminate dozens of tax loopholes and subsidies, broaden the base and cut the corporate tax rate to spur growth in America”
- Reduce the corporate tax rate to 28%.
- Eliminate many tax expenditures and “loopholes,” including most of the ones for specific industries. Specifically mentioned are elimination of LIFO, oil and gas preferences, interest deductions related to life insurance, except for policies on employees who own at least 20% of the business, and special depreciation for corporate aircraft. Carried interests would be taxed as ordinary income.
- Broaden the corporate tax base to allow for a lower rate and remove “harmful distortions.” Accelerated depreciation would be modified to better match economic depreciation. The current bias for debt over equity would be addressed by reducing interest deductions for corporations.
- Improve parity among all large businesses regardless of organizational form without affecting small businesses. The framework suggests consideration of reforms suggested in the 2005 final report of President George W. Bush’s Advisory Panel on Federal Tax Reform and options analyzed by President Barack Obama’s Economic Recovery Advisory Board in 2010.
- “Improve transparency and reduce accounting gimmicks.” The proposal suggests reducing the gap between book and taxable incomes and allowing for “greater disclosure of annual corporate income tax payments.”
- An October 2011 report by the Joint Committee on Taxation (JCT) observed that reaching a revenue-neutral rate of 28% for corporations would require eliminating many tax deductions for corporations. No transitional rules were included in the estimate, which used a 10-year time frame. Most of the revenue generated to cover the reduced rate was from timing changes: eliminating R&D expensing, repealing LIFO, and moving from MACRS to the alternative depreciation system (ADS). With so much of the revenue to pay for the rate reduction generated from timing changes, will the rate reduction be revenue neutral in the long term? Does the administration have an alternative way to pay for a lower corporate rate that does not include capitalizing R&D expenditures and an immediate switch from MACRS to ADS? If not, how would such changes affect economic growth and international competitiveness? (For more on the JCT report and a lower rate, see Nellen, “The Rough Road to a 28% Corporate Tax Rate,” Corporate Taxation Insider (11/10/11).)
- What transitional rules would be allowed for tax expenditures that are repealed, such as LIFO? How do the transitional rules affect the rate reduction? Should the rate gradually decrease during the transitional period rather than all at once?
- Will the corporate alternative minimum tax be repealed?
- Treasury’s General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals (Green Book) calls for continuing tax cuts only for individuals with income below $200,000 ($250,000 if married filing jointly). Also, qualified dividends would be taxed as ordinary income for these high-income individuals. What changes, if any, are needed to personal holding company and accumulated earnings tax rules in a system where the corporate tax rate is lower than the top individual rate and some individuals would have a higher tax rate on dividends than do corporations and most individuals?
- Would economic lives of assets be reviewed to determine their appropriate tax depreciation life, or would ADS be implemented across the board?
- How should elimination of interest deductions affect taxation of interest income? What might be the effect on interest rates and financial markets? Imputed interest rules will become more important.
- How will tax parity among all large forms of business be achieved? Will large partnerships and S corporations be subject to double taxation, or will the corporate tax be integrated? What transition rules will be provided? How will “large” be defined?
- For improved book conformity, why not postpone repeal of LIFO until IFRS is fully adopted in the United States (IFRS does not allow LIFO)? Why not also repeal the uniform capitalization rules of Sec. 263A for inventory, which create book-tax differences and are complex?
II. “Strengthen American manufacturing and innovation”
- Through reform of the Sec. 199 domestic production activities deduction, the top tax rate for manufacturers would be 25% and lower for “advanced manufacturing.” This would be achieved via use of a 10.7% deduction (rather than the current 9%) with a higher percentage for “advanced manufacturing.” Sec. 199 would be modified to “focus … more on manufacturing activity.”
- The alternative simplified research credit would be increased to 17% (from 14%) and made permanent. It appears that the general credit using 1984 through 1988 base years, which the report describes as complex and outdated, would not be continued.
- The credit for production of renewable electricity (Sec. 45) would be made permanent and refundable.
- How does eliminating the Sec. 199 deduction for some taxpayers while increasing it for certain manufacturers affect a revenue-neutral rate reduction?
- The Sec. 199 deduction will increase in complexity with different percentages allowed for certain taxpayers and the need to define the type of manufacturers eligible for the higher deduction. In addition, transparency is weakened when rate reductions are achieved via changes to the tax base rather than to the rate structure.
- Why not consider a “patent box” approach to tax rate differentials (a reduced tax rate on income from patents) such as has been introduced in the United Kingdom?
- The JCT estimates for achieving a 28% corporate tax rate did not include a large number of business credits, such as the research credit, that expired at the end of 2011. What additional changes will be needed to cover the “cost” of a permanent research credit and refundable renewable energy credit?
- Would the research tax credit consist only of the simplified credit or would it also include the “university basic research credit” (Secs. 41(a)(2) and 41(e)) and the energy consortium credit (Secs. 41(a)(3) and 41(f)(6))? Why not also make this credit refundable for all or some taxpayers, such as startups?
III. “Strengthen the international tax system, including establishing a new minimum tax on foreign earnings to encourage domestic investment”
- Deferral would be changed by imposing a minimum tax rate (unspecified in the report) on income earned by subsidiaries of U.S. corporations operating outside of the United States. A foreign tax credit would be allowed.
- The costs of moving operations abroad would be disallowed.
- A 20% tax credit would be allowed for the expenses of moving operations to the United States from outside the United States.
- Additional international tax reforms would “reduce incentives to shift income and assets overseas.” Excess profits from moving intangibles to low-tax counties would be taxed currently. If attributable to investment abroad, interest expense deductions would be deferred until the related income is taxed in the United States.
- A proposal by Rep. Dave Camp, R-Mich., for a territorial system and a 25% corporate tax rate also includes a minimum tax on earnings of foreign subsidiaries. Can common ground be found between the administration and Camp for international tax reform and a rate reduction that would enhance the international competitiveness of U.S. firms?
- What is the proposed minimum tax rate on earnings of foreign subsidiaries?
- It will be complex to identify and measure the costs of moving operations into or outside of the United States.
- The report also refers to “aggressive transfer pricing to shift profit offshore.” Will any transfer pricing reforms be proposed?
- Why not also consider a value-added tax (VAT) to determine if it could improve international competitiveness in that a VAT is imposed on imports, but not on exports, and it is a source of revenue in all other industrialized countries?
IV. “Simplify and cut taxes for America’s small businesses”
- Allow annual expensing of “qualified investments” up to $1 million.
- Allow businesses with up to $10 million of gross receipts to use the cash method.
- Double the Sec. 195 startup expenditure expense from $5,000 to $10,000.
- Expand the Sec. 45R health insurance credit by increasing the business size from 25 to 50 employees. This would “provide a more generous phase-out schedule, and substantially simplify and streamline the tax credit’s rules.”
- Is the expensing election achieved via Sec. 179 or depreciation rules? Does “qualified investment” include intangibles and real property?
- Why not further simplify Sec. 45R by defining eligible employers based on gross receipts rather than complex definitions based on wages of full-time equivalent employees? (For additional suggestions, see AICPA testimony of Nov. 15, 2011.)
- Will additional simplifications be considered such as for the home office deduction?
V. “Restore fiscal responsibility and not add a dime to the deficit”
- As part of fiscal responsibility, the “wealthiest [will be asked] to contribute more” and the “business sector must also be asked to contribute to restoring fiscal sustainability.” To improve certainty and budget control, temporary business provisions would either be made permanent in a revenue-neutral manner or discontinued.
- If tax changes for upper-income individuals, defined in the fiscal year 2013 Green Book as individuals with over $200,000 of income ($250,000 for married filing jointly), will help pay for business tax reform, business and individual tax reforms should be merged to better ensure an efficient and logical tax system. This reform should consider all federal taxes. In addition, a complete review of the federal tax system can help identify inefficiencies that may harm the business environment. For example, tax preferences for home ownership may encourage over-investment in housing (President Bush’s Advisory Panel on Federal Tax Reform).
- Which temporary tax provisions will not be renewed?
The release of the administration’s business tax reform plan is a helpful step in moving toward tax reform so that Congress and the administration can more productively work on improving the tax system.
The author has compiled a chart
listing all of the Obama administration’s proposals—both specific and general, and the Green Books or other reports where they are mentioned.