On Thursday, Republicans in the US House of Representatives released an ambitious plan to reform the federal tax code for individuals and corporations. The Tax Cuts and Jobs Act seeks to lower the tax rate for corporations and small businesses and simplify the tax code.
There will be considerable political debate in the days and weeks ahead on how the House proposal balances the economic needs of individual taxpayers versus corporations, and on the overall cost. Nonetheless, it is clear that the plan seeks to redesign dramatically the federal tax code for corporations in a variety of ways that are intended by its authors to stimulate economic growth and modernize the international tax system.
A few of the key provisions included in the House reform proposal include:
- Immediate and permanent reduction of the corporate tax rate to 20 percent beginning in the 2018 tax year;
- Repeal of the Alternative Minimum Tax in 2018;
- Full and immediate expensing of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023, with an additional year for certain property with a longer production period; and
- Reduces the tax rate for a portion of net income distributed by a pass-through entity to no more than 25 percent. The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary individual income tax rates.
As part of its effort to simplify the tax code, the legislation increases the standard deduction for tax payers to $24,000 for joint filers and $12,000 for individuals. The increase in the standard deduction is designed to substantially reduce the number of people who itemize deductions on their tax returns. A reduction in the number of people who itemize will jeopardize financial contributions to charitable organizations as fewer people will use the charitable tax deduction. While the House proposal does not make any changes to the charitable tax deduction, organizations that rely on financial donations will be impacted.
The proposal makes dramatic changes to tax rates for multinational companies. Some of the key provisions that would apply to multinational companies include:
- Imposing a “back-end value-added tax” that taxes certain related party transaction at a 20 percent tax rate beginning in 2019;
- Permitting a disallowance of a deduction for the net interest expense in excess of 30 percent of the business’s adjusted taxable income in 2018;
- Limiting the deduction of net interest expense of US companies which are members of an international financial reporting group to the extent the domestic corporation’s share exceeds 110 percent of its share of the group’s global earnings before interest, taxes, depreciation, and amortization beginning in 2018; and
- Repealing the tax on US corporations with respect to untaxed foreign subsidiary earnings reinvested in US property.
Former Congressman Phil English, Co-chair of the Arent Fox Government Relations Group and who served on the House Ways and Means Committee for 14 years notes, “The House Republican tax reform proposal is the first bid in the most ambitious overhaul of the tax code in a generation. The Senate and House will have to weave together their reforms and priorities to define a tax system that is simpler, more fair and transparent, and that encourages job investment and family security.
The proposed business tax rates and limited cost recovery will boost growth, but will disappoint many advocates of more radical reform. The proposal unveiled on Thursday highlights the challenge of reforming the tax code within the existing budget structure.
The territoriality reforms are intended, with lower rates, to reduce the hemorrhaging of jobs to countries with more competitive corporate tax systems. The repatriation proposal is designed to draw hundreds of billions in stranded overseas profits back to the domestic economy and boost investment.
The debate over tax reform will involve competing experts and estimates, foundations and associations, but ultimately competing philosophies and world views. In a political system dominated by tweets and 30 second advertisements, politicians will be challenged to explain to the voters why the tax code needs to reflect the Twenty First Century, and how tax policy reflects our needs and values.”
Former US Senator Byron Dorgan, Senior Policy Advisor at Arent Fox, who served in the House of Representatives and was on the House Ways and Means Committee when it passed the 1986 Tax Reform Act notes, “The tax reform proposal that was announced today is just the start of a robust debate about how to simplify our tax code and make it more fair.
Thursday’s proposal will attract both supporters and opponents of many of the bill’s specific provisions. This proposal seems more oriented toward tax cuts than major tax reform, but there will be changes along the way and this is just the start of a long process that I expect could last into next year.
I expect the major controversies will be over the elimination of a number of specific deductions, including the state and local taxes paid, a mortgage interest deduction limitation, the eventual repeal of the estate tax, and more. In addition, you can expect there to be a debate about the impact the bill will have on the federal deficits and debt. The Ways and Means Chairman described this as a work in progress, and I expect this will go through many revisions and changes prior to passage of a bill.
Real tax reform is a heavy lift, and my hope is that the Congress will find a bipartisan way to work through this process to give people confidence about the fairness of the tax system and do so in a way that will encourage economic opportunity for our country.”
Congress passed legislation last month, along a party-line vote, that will allow the House and the Senate to use a legislative mechanism, known as Budget Reconciliation, to expedite the consideration of the tax bill in the Senate. Under the Budget Reconciliation structure, the tax bill will only require a simple majority of votes (51 votes) in the Senate to pass. The Budget Reconciliation instructions allow Congress to increase the federal deficit up to $1.5 trillion over 10 years. Further, due to a related Senate rule, unless Congress passes legislation in the years to come to provide funding to pay permanently for the tax provisions in the proposal, most of the policy changes will sunset in 2027.
The House will begin formal consideration of the tax proposal in the Ways and Means Committee on November 6. House Speaker Paul Ryan has vowed to complete consideration of the proposal – including passage of the bill in the House – before the Thanksgiving holiday. Meanwhile, Senate Republicans plan to introduce a tax reform proposal after Thanksgiving. It is likely that there will be some key differences in the House and Senate proposals. Nonetheless, the House and Senate Republican Leadership and the president have vowed to enact tax reform legislation quickly.
Sonja Nesbit, Senior Government Relations Director at Arent Fox notes, “The Republican Leadership in the House and the Senate have expressed their commitment to getting a tax reform proposal signed into law as quickly as possible. What remains to be seen is how much the Senate tax reform bill might differ from the House proposal, and the amount of time it will take to reconcile any differences with the plans.
There will be Republican Members in both chambers who will seek changes to the legislation – particularly on the individual side of the ledger on state and local tax deductions and the cap on the mortgage deduction – that will take some time to resolve. Given the absence of support from House and Senate Democrats for this effort, Congressional Republicans will have to work quickly with their Members to address their concerns.
There is strong desire to get the bill enacted into law by early next year, well ahead of the 2018 midterm elections. Congressional Republicans – and the White House – are clearly looking for a legislative win.”
Other highlights of the Tax Cuts and Jobs Act in the area of corporate tax include:
- Repealing the tax credit for clinical testing expenses for certain drugs for rare diseases or conditions in 2018;
- Allowing for a deduction on net operating loss carryover or carryback only to the extent of 90 percent of the taxpayer’s taxable income beginning in 2018; and
- Repealing the special rule treating the transfer of a patent prior to its commercial exploitation as long-term capital gain in 2018.
It is worth noting that the House tax reform bill does not include a repeal of the taxes included in the Affordable Care Act, such as the Health IT tax, medical device tax, or the Cadillac tax.