President’s Framework for U.S. Federal Business Tax Reform
The White House and the Department of Treasury recently released “The President’s Framework For Business Tax Reform.” While we generally focus our Tax Alerts on important legislative enactments, final regulations and final judicial decisions, this Framework may affect significant legislative developments, so its key principles should be noted.
The Introduction provides a blunt diagnosis of America’s federal business tax system as “uncompetitive and inefficient” and doing very little to create jobs and encourage investment domestically. Ultimately, according to the report, we have a system that essentially causes businesses to locate production and shift profits overseas. Further, the Framework labels the existing business tax system as “too complicated,” especially for small businesses. The Framework deals with five structural elements of business tax reform:
1. Eliminate Loopholes and Subsidies, Broaden the Base and Cut the Corporate Tax Rate to Spur Growth
According to the Framework, greater tax expenditures – i.e., tax credits and deductions for specific activities – and tax loopholes and planning opportunities have resulted in a higher corporate tax rate relative to other countries. This tax system is far too complex for small businesses and imposes a significant compliance burden on this component of the U.S. economy.
Observation: The Framework spotlights distortive effects of the federal tax code, such as encouraging businesses to finance through debt rather than equity because interest payments on debt are deductible, but corporate dividends are not deductible from corporate taxable income. In addition, due to the disparity in tax rates between corporations and pass-through entities whose income is taxed only once at the owners’ level, the Framework claims the tax code discourages business from organizing themselves as corporations.
As one remedy, the Framework proposes to reduce the corporate income tax rate from 35% to 28%. In addition, it would eliminate dozens of tax expenditures and asserted tax loopholes. These include the elimination of LIFO accounting, elimination of oil and gas tax preferences, taxation of carried interests in profits as ordinary income, and increasing transparency between book income and taxable income.
Observation: The above measures do not address very effectively the major distortive effects in favor of debt or in favor of pass-through entities noted immediately further above. The Framework suggests addressing these without adopting specific detailed recommendations.
2. Strengthen American Manufacturing and Innovation
The Framework identifies the manufacturing sector as a vital component of the U.S. economy whose improved health would create a number of positive spillover effects throughout the economy and proposes to decrease the corporate tax rate for manufacturing to 25%. (Advanced manufacturing would enjoy an even lower but unspecified effective rate.)
Observation: The Framework proposes to make permanent the Research and Experimentation (R&E) tax credit, increase the rate of the simpler version of the R&E credit to 17% of qualified expenditures, and improve and extend incentives for investment in clean energy.
3. Strengthen the International Tax System
The Framework focuses on domestic businesses reducing their U.S. tax obligations by locating their operations and retaining their foreign profits abroad, creating erosion of the U.S. tax base and requiring income that remains in the U.S. to be taxed at higher rates to meet governmental revenue needs. Accordingly, the Framework proposes a minimum current tax (at an unspecified rate) on foreign income which would include income of corporate subsidiaries of U.S. corporations operating abroad.
Observation: The Framework restates previous proposals to tax currently certain excess profits – probably based on statutory definitions of normal profits – from intellectual property and other intangibles transferred abroad. In addition, deductions from taxable income for expenses of moving operations overseas would be eliminated, while an income tax credit would be created for 20% of expenses of moving operations back to the U.S. Arguably, this latter item would be of limited significance for most U.S.-based multinational businesses.
4. Simplify and Cut Taxes for America’s Small Businesses
The Framework addresses the time and costs which the current tax code imposes on small businesses in the U.S. and suggests these would be better reinvested in businesses and innovation. To foster growth, small businesses would permanently be able to expense $1 million of qualified investments.
Observation: This apparently would be an annual allowance and would reduce the tax compliance burden for small businesses in part by eliminating the need to track depreciation schedules.
Further – while small businesses with gross receipts up to $5 million/year are currently permitted to use the cash method of accounting – the Framework proposes to increase this limit to $10 million, so more small business can avoid the complexities of accrual accounting.
5. Restore Fiscal Responsibility
The Framework suggests that its proposed tax reforms need not increase the federal deficit and contains a general pledge to “only accept business tax reform that is fiscally responsible.”
Observation: There are no concrete proposals in the Framework here, other than the possibility that the proposed tax increases under the other four principles will equal or exceed the proposed tax reductions there.
A copy of the Framework can be found here.