02.29.2012 White House Proposal for Business Tax Reform
On February 22, 2012, the Obama administration issued The President’s Framework for Business Tax Reform (the “Proposal”), an outline for what would be the first major overhaul of the U.S. Tax Code since 1986. In broad form, the Proposal would reduce the top income tax rate for corporations from 35% to 28%, increase revenues by eliminating dozens of perceived tax loopholes and deductions to broaden the overall tax base and create new disincentives for U.S. businesses to shift operations overseas, including, for the first time ever, a minimum tax on foreign earnings.
Corporate tax reform undoubtedly will become a major issue during the 2012 presidential campaign, but significant changes are probably years away. Individual taxes will be addressed first, as the Bush tax cuts are scheduled to expire at the end of the year. Then, as with all significant legislation, corporate tax reform will be subject to intense lobbying in Congress.
Nevertheless, we believe that some version of corporate tax reform is coming within the next few years. The U.S. will soon have the highest statutory corporate tax rate among all advanced countries, and most Democrats and Republicans agree that the current system is uncompetitive, inefficient and overly complicated.
The following discussion summarizes the key aspects of the Proposal in further detail. Although corporate tax reform will look markedly different when enacted, it is important to consider the reforms President Obama proposes and what they could mean for your business.
- Reduction of the Corporate Tax Rate: The President believes that reducing the top corporate tax rate from 35% to 28% is necessary to put the U.S. in line with other advanced countries, help encourage greater investment in the U.S. and reduce tax-related economic distortions. The leading Republican presidential candidates generally agree: Mitt Romney would reduce the top rate to 25%; Rick Santorum argues for a 17.5% general corporate tax rate; Ron Paul proposes 15%; and Newt Gingrich 12.5%. Accordingly, depending on the outcome of the November presidential elections, some commentators believe that the eventual tax rate could be lower than the proposed 28%.
- Broaden the Tax Base: The Proposal finds that the U.S. has a relatively narrow tax base compared to other countries. The Proposal would broaden that base by eliminating dozens of deductions and expenditures, preferences for oil and gas companies, the favorable 15% capital gains rate on “carried interest” paid by managers of private equity and hedge funds and certain deductions allocable to life insurance polices. The Proposal would also eliminate the “last-in, first-out” (LIFO) method of accounting and limit the deductibility of interest for corporations. This latter effort would serve to reduce incentives to over-leverage. Thus, while some business would pay less in taxes as a result of the overall rate reduction, other business would likely pay more in taxes under the Proposal due to lost subsidies and deductions.
- Strengthen American Manufacturing and Innovation: The Proposal recognizes that manufacturing plays a critical role in U.S. job creation, innovation and economic growth. The Proposal would cut the top corporate tax rate on manufacturing to no more than 25% and expand the current domestic activities deduction to 10.7%. This would lead to additional savings for U.S. businesses with advanced manufacturing. The Proposal would also expand and simplify the tax credits for research and experimentation, such as by increasing the simpler credit from 14% to 17% and by making the credits permanent to increase tax certainty and effectiveness. Another aspect of the Proposal would make the tax credit for the production of renewable electricity permanent and refundable to encourage investment in clean energy.
It should be noted that other aspects of the Proposal call for revising the accelerated depreciation schedules, which allow companies to deduct their investments in machinery and equipment more quickly, as well as eliminating LIFO accounting in order to increase revenue. By losing these tax benefits, some manufacturers may actually pay a higher effective tax rate, something the White House promised it would not do. Accordingly, U.S. manufacturers will need to stay informed as details of the Proposal emerge.
- Strengthen the International Tax System: The Proposal intends to implement new rules to limit the ability of U.S. corporations operating abroad to defer the recognition of gain by (1) requiring U.S. companies operating overseas to pay, for the first time ever, a minimum tax on their foreign earnings; (2) currently taxing excess profits associated with shifting intangibles to low-tax jurisdictions; (3) eliminating tax deductions for moving productions overseas; (4) providing a tax credit for moving production back to the U.S.; (5) eliminating the interest deduction for businesses that borrow money to invest overseas; and (6) reforming transfer pricing laws to discourage taxpayers from selling goods and services in low-tax jurisdictions. The Proposal neither suggests what the minimum tax rate would be on foreign earnings nor provides important details on pertinent issues, such as the interplay with the existing anti-deferral regimes and the impact on foreign tax credits that prevent the double taxation of income. Thus, as details emerge, U.S. businesses with overseas operations and foreign holding company structures will need to consult with tax professionals to minimize their U.S. tax consequences.
- Improve Transparency and Reduce Accounting Gimmicks: The proposal intends to increase transparency and reduce the gap between book income (reported to shareholders) and taxable income (reported to the IRS). These reforms could include greater disclosure of annual corporate income tax payments.
- Simplify and Cut Taxes for Small Businesses: The Proposal is not limited to corporate tax reform. It would also make tax filing simpler and less expensive for small businesses and entrepreneurs. To offset any of the base-broadening reforms described above, the Proposal would allow small businesses to permanently expense up to $1 million in investments and permit businesses with up to $10 million in gross receipts to use the cash method of accounting. This latter change represents a significant benefit. Taxpayers on the accrual method must immediately recognize future cash receipts and costs for income tax purposes, while taxpayers on the cash method may defer recognition until cash is received. In addition, in his current budget, President Obama proposes to double the deduction for start-up costs from $5,000 to $10,000 and calls for a tax credit to help small businesses afford the cost of health insurance.
For further details regarding the Proposal, please contact a member of Williams Mullen’s Tax Group.
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