The Senate Finance Committee has been asking corporate executives questions about their ideas on “tax reform” in subchapter C. The committee of 12 senators and representatives that is to come up with spending cuts by Thanksgiving might consider “tax reform.” Politicians of all stripes are and have been calling for “tax reform.” The grand example of “tax reform” that is the Tax Reform Act of 1986 seems to have come unraveled. Will there be “tax reform”?

That is a political question that can’t be answered, at least not here. But the targets of “tax reform” are pretty well known.

C Corporations

The only remaining C corporations are (or should be) publicly traded business entities and foreign corporations. Everyone else has gotten out of the C corporation lobster pot (you can put property in easily, but pulling property out can be expensive). Despite the fact that C corporations and their shareholders are subject to the two-tier tax regime, C corporations are a likely target of “tax reform” for several reasons:

  • they are some of the corporations that attract adverse public attention for other reasons;
  • they tend to be highly leveraged, perhaps in part because of the deduction for interest paid;
  • they tend to do business abroad, which can produce tax results that some question; and
  • they tend to work hard to reduce their world-wide effective tax rates.

However, any effort to change the deduction for interest, make dividends deductible or otherwise produce parity between dividends and interest payments would amount to a much more intrusive corporate integration regime than the “integration lite” effected by the creation of the 15-percent rate for dividends received by individuals.

Numerous extensive integration proposals were produced in the 1990s, including “Taxing Business Income Once,” written by the Treasury. Those efforts morphed into “flat tax” proposals, mostly for individuals, in the later part of that decade. Both discussions have been relatively quiescent since.

It is likely that the simple solution will again be seen as the better solution to the problem of taxing business income twice: lower the tax rate for C corporations. That step, combined with the existing reduced rate for dividends received by individual shareholders, would go a long way toward taxing business income once.

Pass-Through Entities

The question has already arisen whether “tax reform” for business can be limited to the corporate tax. Likely, it cannot. Competitors of C corporations pay the single tax through S corporations, proprietorships and partnerships, and enjoy other advantages of those taxing regimes. The divergence between taxation of C corporations and other entities is striking, not only because of the two tier taxation issue, but also because of the extensive flexibility for adjusting the economics of a partnership investment afforded through subchapter K, as compared with subchapter C.

If Congress truly becomes concerned with complexity, it would attack those features of both subchapter C and subchapter K that produce the most complexity; for example, section 355 and section 704 allocations. But those subjects have accreted layers of compromise over decades, and there seems to be little appetite for peeling back those layers. VAT It is a commonplace observation that once one party realizes the VAT is a money machine and the other party realizes it is a consumption tax, it will be enacted. Those realizations have been a long time coming. But once again the VAT is in the news. In a sense, adopting a VAT would be returning to the 19th century methods of taxation. Prior to the income tax, federal excise taxes and import duties carried the federal budget. Import duties were “easy” taxes to vote for because frequently they served the purpose of protecting domestic industry and they were largely invisible to the ultimate payors, who were largely domestic consumers. If a political decision is made that is in effect a vote against the income tax, a pure consumption tax like a VAT is the natural replacement choice, or the choice to augment a reduced income tax.

Foreign Business Operations

Last but not least, “tax reform” likely would impact foreign business operations. This subject is tied to the two-tier tax problem and the corporate tax rate. If the C corporation tax rate is reduced, one of the quid pro quo could be some sort of increased current taxation of foreign business income.

But this would be a very heavy lift. It impacts different industries differently; it is too complex to explain in simple terms, unless they be territoriality versus world-wide taxation; it is unlikely that so fundamental a change as moving to territorial taxation would occur in the context of a revenue or expenditure-reduction driven compromise; the lobbying would be (and already has been) both tremendous and incomprehensible in terms of evaluating the competing claims.

But the issue will be on the table, and so some tinkering could occur.


Revenue neutral rate lowering for C corporations, some tightening of rules for partnerships and foreign income, and perhaps a “study” of a VAT might come out of “tax reform.” Or perhaps we could be surprised.