On February 22, the Treasury Department released a document called “The President’s Framework for Business Tax Reform.” It carries a rough blueprint for the President’s plan to cut corporate tax rates, simplify corporate tax rules, and reform the international tax rules. It also carries some proposals for simplifying and reducing the tax burden for small businesses.
The “President’s Framework for Business Tax Reform” says a corporate tax overhaul is necessary because of the following flaws in the current tax system:
• Today’s system, which trades off a high corporate rate and a base that’s narrowed by tax breaks, is uncompetitive relative to other countries, distorts business decision making, and slows economic growth.
• The complexity of today’s tax rules increases compliance costs for businesses, increases enforcement costs for the IRS, and invariably leads to disputes between businesses and IRS, requiring significant expenses to adjudicate these disputes.
• Industry-specific tax preferences produce a wide disparity in average tax rates across industries, resulting in a tax system that distorts investment decisions.
• Current corporate rules encourage corporations to finance themselves with debt (because interest payments are deductible) instead of equity (because corporate dividends aren’t deductible). The resultant “outsize reliance” on debt financing can raise the risk of financial distress and thus raise the risk of bankruptcy.
• Large companies are increasingly avoiding corporate tax liability by organizing themselves as pass-through businesses. The ability of large pass-through entities to take advantage of preferential tax treatment has placed businesses organizing as C-corporations at a disadvantage. By allowing large pass-through entities preferential treatment, the tax code distorts choices of organizational form, which can lead to losses in economic efficiency.
• Current incentives to shift income abroad significantly erode the U.S. tax base, and lead to lower corporate tax receipts.
The President’s “Framework for Business Tax Reform” carries the following proposals to overhaul the corporate tax rules. Many of the proposals aren’t new and have been put forth before by the Administration, for example, in its budget proposals, as well as by the President’s Economic Recovery Advisory Board.
• Reduce the top corporate tax rate from 35% to 28%.
Republicans have objected that 28% is still too high. However, it’s not far off from the 25% top tax rate for business that was put forth in 2011 by Representative Paul Ryan (R-WI), chairman of the House Budget Committee, in his “Path to Prosperity” plan.
• Cut the top corporate tax rate on manufacturing income to 25% and to an even lower rate for income from advanced manufacturing activities. This would be accomplished by reforming the Code Section 199 domestic production activities deduction to: focus more on manufacturing activity; increase the credit to 10.7%; and increase it even more for advanced manufacturing.
• Eliminate tax breaks for specific industries “with the few exceptions that are critical to broader growth or fairness.” Tax breaks that would be targeted would include the following: last-in, first out (LIFO) accounting; tax breaks for the oil and gas industry; interest deductions allocable to life insurance policies (would be disallowed unless the contract is on an officer, director, or employee who is at least a 20% owner of the business); current rules allowing “carried interest” to be taxed at preferential capital gains rates (would be taxed as ordinary income); and special depreciation rules that allow owners of non-commercial planes to depreciate them more quickly (over five years) than commercial aircraft (over seven years).
• Revise current depreciation schedules that generally overstate the true economic depreciation of assets.
Presumably this would mean longer depreciation periods for tangible assets and restricted (or eliminated) use of accelerated depreciation.
• Reduce the deductibility of interest by corporations.
• Establish greater parity between large corporations and large noncorporate counterparts.
One suggestion that has been floated before is to tax, as corporations, pass-through entities with gross receipts exceeding a specific level, for example, $50 million.
• Require greater disclosure of annual corporate income tax payments, to improve transparency and reduce accounting gimmicks.
• Overhaul the current research tax credit, which makes businesses choose between using a complex formula to calculate their R&E credit at a 20% rate, and a much simpler approach that provides a 14% credit. The rate of the simpler credit would be increased to 17% and the credit would be made permanent to increase certainty and effectiveness.
• Extend, consolidate, and enhance key tax incentives to encourage investment in clean energy. The tax credit for production of renewable electricity would be made permanent and would be refundable.
• Subject income earned by subsidiaries of U.S. corporations operating abroad to an unspecified minimum rate of tax. This would stop the tax system from rewarding companies that move profits offshore. Thus, foreign income deferred in a low-tax jurisdiction would be subject to immediate U.S. taxation up to an unspecified minimum tax rate with a foreign tax credit allowed for income taxes on that income paid to the host country.
• Create a 20% income tax credit for the expenses of moving business operations back to the U.S., and disallow deductions for moving business operations abroad.
• Taxing currently the excess profits associated with shifting intangibles to low-tax jurisdictions.
In an effort to show the tax problems of small businesses haven’t been overlooked, the President’s proposal calls for simplifying the tax rules that apply to them and adding incentives to help build “innovation and entrepreneurship.” Specifics include: allowing small businesses to expense up to $1 million under Code Section 179; allowing cash method accounting for businesses with up to $10 million in gross receipts (up from the current $5 million); doubling the amount of currently deductible start-up costs from $5,000 to $10,000; and expanding the health insurance credit for small businesses.