These difficulties increased this year as the political parties position themselves for the upcoming November 4 midterm Congressional elections.
While enactment of comprehensive tax reform is unlikely in 2014, business taxpayers should consider how recent reform proposals in the House and Senate may shape future efforts to overhaul U.S. tax laws. As was true under the 1986 Tax Reform Act, sweeping changes to our domestic and international tax rules could have markedly different effects on various sectors of the economy and particular businesses within a sector — effects that financial executives will want to monitor and measure.
The release of a comprehensive tax reform discussion draft in late February by House Ways and Means Committee Chairman Dave Camp (R-MI) was a significant development that could influence future Congressional action on tax reform. In late 2013, former Senate Finance Committee Chairman Max Baucus (D-MT) also offered a series of tax reform discussion drafts, before he became U.S. ambassador to China earlier this year. Senator Ron Wyden (D-OR), the new Finance Committee Chairman, has a long-standing interest in tax reform, having introduced bipartisan tax reform bills with Republican senators in previous sessions of Congress.
While tax reform efforts will continue beyond 2014, the specific reform proposals discussed below warrant close attention because of their potential to significantly affect how businesses are taxed.
Pending Deadlines
In advance of the November elections, the House and Senate are facing a few “must-pass” deadlines for legislative action. By the end of September, Congress will need to enact appropriations legislation to fund government programs for Fiscal Year (FY) 2015, which begins on October 1. A two-year highway and transit authorization is also scheduled to expire on September 30, 2014, and the Obama Administration projects the highway trust fund may run out of money before then. While the House and Senate tax committees will be called on to provide funding options, it will be difficult for Congress to agree on any legislation that includes significant tax increases for federal highway programs.
Another deadline to note is the November 1 expiration of the current federal moratorium on new state and local taxes on Internet access. Business taxpayers also could be affected by other state and local tax issues before Congress this year. For example, legislators in the House are considering a Senate-passed bill (S. 743, the Marketplace Fairness Act) that would provide standards for collecting taxes on “remote” sales to customers within a state. Another state and local tax issue of interest to many employers is legislation introduced in the
House and Senate (H.R. 1129; S. 1645) to simplify state income tax withholding rules for employees working in more than one state.
Both the House and Senate have begun the process of considering legislation to renew certain tax provisions that expired at the end of 2013, as discussed below. At this writing it appears Congress will attempt to pass an extenders package during the summer, but if that effort fails, final Congressional action on expired tax provisions will be delayed until after the November 4, 2014 election, when Congress is expected to return for a “lame-duck” session. Finance Chairman Wyden has called for action to extend expired business and individual tax provisions a “bridge” to tax reform in 2015.
Tax Extenders
The Senate and House tax-writing committees each have taken action to extend certain expired tax provisions. More than 50 temporary business and individual tax provisions expired at the end of 2013. Additional provisions are set to expire at the end of 2014.
Senate Finance Committee
The Senate Finance Committee on April 3 approved the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act, which retroactively extends for two years — from January 1, 2014 through December 31, 2015 — nearly all of the business and individual tax provisions that expired at the end of 2013. The EXPIRE Act also extends for one year several provisions that are scheduled to expire at the end of 2014.
In his opening statement at the committee markup, Chairman Wyden said many expired provisions are “well-intentioned and ought to be permanent,” and the fact that the committee is again marking up a temporary tax extenders bill “shows the urgency of tax reform.” Chairman Wyden expressed his hope that “this will be the last tax extenders bill the committee takes up as long as I’m chairman.”
Significant expired business provisions that would be extended through the end of 2015 under the Finance Committee-approved bill include the research credit, look-through treatment of payments between related controlled foreign corporations (CFCs), and the Subpart F active financing exception. The EXPIRE Act also would renew 50 percent ‘bonus’ depreciation for qualified property and would continue to allow an election to accelerate AMT credits in lieu of bonus depreciation. In addition, the bill would extend 15-year straight-line cost recovery rules for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
Additional business tax provisions that would be extended through 2015 include the Section 179 small business expensing limits, the Work Opportunity Tax Credit, and tax rules governing the treatment of S corporation built-in gains and basis adjustments to stock of S corporations making charitable contributions of property.
The bill includes a two-year extension of the renewable electricity production tax credit (PTC) and the election to claim the energy credit in lieu of the PTC. Additional energy tax provisions that would be extended through 2015 include the credit for construction of energy-efficient homes and the energy-efficient commercial building deduction, with modifications.
The Finance Committee approved several amendments to the EXPIRE Act as initially proposed by Chairman Wyden, including a proposal to modify the research credit to allow qualifying start-up businesses to claim the credit against payroll taxes. The Joint Committee on Taxation staff estimates the EXPIRE ACT as proposed by Chairman Wyden would reduce net tax revenues by $85.3 billion from 2014 through 2024.
As a signal of bipartisan interest in advancing tax reform, the Finance Committee extenders bill includes a ‘Sense of the Committee’ statement calling for action on comprehensive tax reform in the next Congress before the proposed tax extenders would expire, and with a major focus on “fostering economic growth and lowering tax rates by broadening the tax base.”
House Ways and Means Committee
The House Ways and Means Committee held an April 8 hearing on several expired business tax provisions that would be made permanent or given long-term extensions in Chairman Camp’s tax reform discussion draft. In his opening statement, Chairman Camp said “making some tax policies permanent now will open the door to economic growth” in advance of comprehensive tax reform, adding that “this is just the beginning of the conversation we must have to overhaul the tax code.”
Following the April 8 hearing, several senior Ways and Means Committee Republicans introduced stand-alone bills that would permanently extend expired provisions that were examined by the Ways and Means Committee. Other committee members have introduced bills that would make permanent other expired provisions that are not addressed by Chairman Camp’s tax reform discussion draft.
The House Ways and Means Committee on April 29 approved six of the separate bills to permanently extend certain expired tax provisions. The bills address the research credit, look-through treatment for payments between CFCs, the Subpart F active financing exception, Section 179 small business expensing limits, and tax rules governing the treatment of S corporation built-in gains and basis adjustments to stock of S corporations making charitable contributions of property. The Joint Committee on Taxation staff estimates that the bills would reduce federal revenues by roughly $310 billion over 10 years.
It may take some time to resolve differences between the House Ways and Means Committee effort to make permanent only a limited number of expired provisions and the Senate Finance Committee effort to temporarily renew nearly all expired tax provisions through the end of 2015. The full House on May 9 passed the Ways and Means Committee bill to make the research credit permanent, but Senate action on the Finance Committee extenders bill was delayed by a May 14 procedural vote, which failed to secure the required 60 votes. If both chambers can pass bills on tax extenders, Congress could hold a summer conference on extenders. Other-wise, as noted above, a final decision on tax extenders could bedelayed until after the November elections. The revenue effects of renewing expired tax provisions are another reason why action may bedelayed until after the elections.
Tax Reform
While enactment of comprehensive tax reform is unlikely in 2014, business taxpayers should consider how recent tax reform proposals in the House and Senate may shape future efforts to overhaul U.S. tax laws. Chairman Camp’s discussion draft in particular is the most significant comprehensive tax reform proposal since enactment of the Tax Reform Act of 1986. Chairman Camp’s draft proposal would modify nearly 40 business-related deductions and exclusions, 30 separate business tax credits, more than 15 tax accounting methods, and nearly 40 provisions affecting pass-through entities such as S corporations and partnerships.
Financial executives will want to be aware of how these recent tax reform proposals could shape future tax law and affect their businesses.
Camp Tax Reform Discussion Draft
Chairman Camp in February released a 979-page tax reform discussion draft that would lower corporate and individual tax rates, reform U.S. international tax rules, and broaden the tax base by repealing or limiting business and individual tax deductions, credits, and income exclusions. Under Chairman Camp’s discussion draft, the current 35 percent top corporate rate would be reduced over five years to 25 percent. The proposed corporate rate reduction would be phased in by two percentage points each year from 2015 through 2019.
The proposal is designed to be revenue neutral, i.e., not resulting in a net revenue gain or loss over the 10-year budget measuring period. Some of the key proposals to broaden the tax base by limiting deductions, credits, and income exclusions affecting businesses would:
• Eliminate the modified accelerated cost recovery system (MACRS), resulting in longer deduction periods for the cost of certain property;
• Require, after a phase-in period, five-year amortization of research and experimental expenditures;
• Require, after a phase-in period, 10-year amortization for 50 percent of certain advertising expenses;
• Phase out and repeal the domestic manufacturing deduction (Section 199);
• Repeal the ‘last-in, first-out’ (LIFO) and lower-of-cost-or-market (LCM) inventory accounting methods;
• Limit use of the cash accounting method for certain large pass-through entities;
• Repeal special net operating loss (NOL) carryback rules;
• Repeal deferral of gain on like-kind exchanges; and
• Impose an excise tax on systemically important financial institutions (SIFI).
Building on a 2011 international tax reform discussion draft released by Chairman Camp, the new discussion draft would move from the current U.S. worldwide system of taxation to a “territorial” tax system in which 95 percent of qualified foreign-source dividends received by U.S. corporations from foreign subsidiaries would not be subject to U.S. tax (through a dividend received deduction).
Note: S corporations and U.S. partnerships (and their respective owners) would not be eligible for this territorial tax treatment under Chairman Camp’s draft. Chairman Camp proposes to address concerns about U.S. corporations shifting profits to low-tax jurisdictions
by providing for taxation of all intangible income of foreign subsidiaries when the income is earned, at a reduced rate of 15 percent. The same reduced rate would apply to foreign intangible income of U.S. parent companies. The draft proposal also would limit certain
interest deductions.
A one-time transition tax would apply to all previously untaxed earnings and profits of foreign subsidiaries of U.S. corporations. The cash portion of previously untaxed E&P would be subject to an 8.75 percent rate, and the reinvested portion would be subject to a 3.5 percent rate.
Chairman Camp proposes to replace the current seven individual income tax brackets — ranging from 10 percent to 39.6 percent — with two tax brackets of 10 percent and 25 percent. A new 10 percent surtax would apply to broad range of ‘modified’ adjusted gross income above $450,000 for joint filers and above $400,000 for single filers. The standard deduction would be increased, but personal exemptions would be repealed. The discussion draft would repeal both the individual and corporate alternative minimum tax.
Chairman Camp has announced he intends to hold public hearings on his tax reform discussion draft this year after completing a series of briefings for other House members.
Senate Finance Committee Plans
Senate Finance Committee Chairman Wyden has said his initial focus is on tax extenders because he does not believe enacting tax reform is possible by the end of 2014. Chairman Wyden plans to discuss options for future action on tax reform with Finance Committee members, and those options could include reform proposals he has offered in the past.
Senator Wyden in 2010 and 2011 introduced comprehensive tax reform bills with Republican Senators. Although he has not introduced a tax reform bill in the current Congress, Senator Wyden has been a strong advocate of the need to reform both the domestic and international tax regimes.
At the same time, he has stated reservations about switching to a territorial tax system rather than the worldwide tax system currently in effect for U.S. multinationals.
Senator Wyden’s most recent 2011 tax reform bill proposed to lower the corporate tax rate to 24 percent and broaden the tax base. Major business base broadeners included current taxation of all foreign income without benefit of deferral and adoption of a per-country FTC limitation; repeal of the Section 199 domestic manufacturing deduction; replacing MACRS depreciation with the slower alternative depreciation system (ADS); and reducing corporate interest deductions.
Note: The earlier bills introduced by Senator Wyden include some proposals that are similar to those in Chairman Camp’s draft (e.g., repeal of the Section 199 domestic manufacturing deduction), while differing significantly on certain issues, including the taxation of foreign earnings.
Before leaving the Senate, former Finance Chairman Baucus in late 2013 released a series of tax reform discussion drafts prepared by his committee staff. These Baucus staff discussion drafts also are important, since they could influence future tax reform legislation:
• An international reform discussion draft proposes to repeal or modify the current deferral system. In its place, the discussion draft provides statutory language for two differing regimes that would generally impose current taxation on all CFC income at a minimum rate.
• A tax administration reform draft proposes to improve tax return filings, expand information reporting and IRS collection tools, and combat tax-related identity theft.
• A cost recovery and tax accounting discussion draft proposes to replace MACRS and ADS with a new system that approximates economic depreciation based on estimates provided by the Congressional Budget Office. This discussion draft also proposes to repeal LIFO and limit the use of cash accounting by large pass-through entities.
• An energy tax reform discussion draft focuses on simplifying approximately 40 current energy tax incentives into two basic categories of activity: clean electricity production and clean transportation fuel production.
Note: Former Chairman Baucus expressed support for reducing the corporate rate below 30 percent, but his Finance staff discussion drafts did not propose a specific corporate tax rate reduction.
White House Tax Reform Proposals
While the House and Senate tax committees are focusing on comprehensive individual and corporate tax reform, President Barack Obama continues to call for reducing the top corporate rate to 28 percent while his FY 2015 budget proposes $651 billion in tax increases on higher-income individuals for deficit reduction.
President Obama has not released a detailed tax reform plan, but a “framework for business tax reform” released in early 2012 identified some options for offsetting the cost of a lower corporate tax rate, such as limiting depreciation deductions. These options are similar to proposals included in Ways and Means Chairman Camp’s discussion draft and tax reform bills previously introduced by Finance Chairman Wyden.
President Obama’s FY 2015 budget proposes to reserve proceeds from certain revenue-raising proposals for “long-run revenue-neutral business tax reform,” with $150 billion in one-time revenue from tax reform to be used for infrastructure spending.
The budget includes several new revenue-raising proposals along with other previously proposed international and domestic business revenue raisers (e.g., repeal of LIFO) that could offset part of the cost of business tax reform, with adverse effects on some businesses. New provisions in the President’s FY 2015 budget include proposals that would:
• Restrict deductions for excessive interest of members of a financial reporting group;
• Prevent avoidance of foreign base company sales income through manufacturing services arrangements;
• Create a new category of Subpart F income for transactions involving digital goods or services;
• Limit the ability of domestic entities to expatriate; and
• Modify like-kind exchange rules for real property.
The President’s budget proposes to make certain provisions permanent as part of tax reform, including a modified research credit, certain renewable energy tax provisions, and several temporary individual and small business tax provisions.
What Happens Next
While Congress is expected to act on renewing expired business and individual tax provisions in 2014, recent tax reform proposals could have a far more significant long-term impact on how businesses are taxed.
There is bipartisan agreement that an overhaul of U.S. tax laws is long overdue since it has been nearly 30 years since the Tax Reform Act of 1986. Efforts in Congress to make U.S. tax laws more competitive will continue in 2015. Financial executives need to understand these tax reform proposals and be in a position to assess the impact of specific reform proposals on their businesses.
Ed McClellan is a principal in the Washington National Tax Services practice of PwC US. Thanks to Larry Campbell and Laurie Hoffman Colbert of PwC US for their contributions to this article.