By Amy S. Elliott -- email@example.com
With the congressional taxwriting committees and the Obama administration getting serious about tax reform, some surprising statements have been made in recent days that will likely alarm tax practitioners. Fasten your seat belts, because if these concepts are used to shape tax reform, we could be in for a bumpy ride. Just in case you missed them, here's a quick rundown.
Scary Concept #1: Deferral Isn't That Important
- Peddled by: Senate Finance Committee, April 11
Business tax planning is all about timing -- postponing when you have to pay tax. Tax practitioners who don't realize that deferral is the goal quickly become unemployed. And yet on April 11, in its paper on tax reform options for business investment, the Senate Finance Committee wrote that while deferral is valuable from a time-value-of-money perspective, it isn't valuable from a financial income perspective. That appeared not in the section that lists reform options, for which members specifically disclaim any endorsement, but in the preliminary background section regarding the taxation of business investment.
It's true that taxes that have been deferred until sometime in the future are counted currently against income as a deferred tax liability. But Robert Willens of Robert Willens LLC told Tax Analysts that most of the analysts and investors he works with know that corporations "whose tax provision is heavily skewed towards deferred taxes can use the cash they would otherwise be paying in taxes for other corporate purposes. They also realize that the deferred taxes the company is accounting for might never have to be paid." Willens said he disagrees with the notion that corporations don't value tax deferral, adding that a company's "cash tax rate" matters more than its book or effective tax rate. "The financial community highly values the ability to defer taxes and rewards companies with a favorable mix of current and deferred taxes," he said.
Here's what the Finance Committee wrote:
Limited business effect of tax incentives that defer tax liability: Some tax incentives allow businesses to pay tax later than it would otherwise be due. Such timing changes do not affect the nominal amount of taxes due, although they can be very valuable due to the time value of money. For example, accelerating depreciation deductions means that a business pays less tax in the years immediately following the purchase of an asset, but pays correspondingly more tax later in the useful life of the asset. Many publicly-traded corporations and certain private businesses often plan with a focus on financial income. In general, changes in the timing of paying a tax do not impact financial income and, as a result, may not significantly affect business behavior. Therefore, to incentivize business behavior, it may be more effective to provide tax incentives that are not timing-based, but instead are, for example, rate reductions or credits. (Emphasis added.)
Scary Concept #2: A Big Gap Between Top Corporate and
Individual Rates Is Fine
- Peddled by: Senior Treasury official, April 10
The most disturbing part of the administration's fiscal 2014 budget is its continued silence on how businesses taxed as passthroughs will be affected by tax reform (kudos to House Ways and Means Committee Chair Dave Camp, R-Mich., and Ways and Means member Vern Buchanan, R-Fla., for calling Treasury out on that point). The administration said it wants revenue-neutral business tax reform that will "raise about the same amount of revenue from the business sector as you plan to raise now," a senior Treasury official said April 10. The president also said he wants to lower the top marginal corporate tax rate to 28 percent.
With the fiscal cliff deal's permanent reinstatement of such hidden marginal rate increases as the personal exemption phaseout and the Pease limit, owners of businesses taxed as passthroughs are staring at a top rate in excess of 40 percent. A 28 percent versus 40 percent rate differential will matter even more if a corporate rate cut is achievable only by reducing or eliminating items like accelerated depreciation, the section 199 domestic production activities deduction, and the deductibility of interest for all businesses -- C corporations and passthroughs alike.
Most tax policy experts would agree that it's undesirable to have a wide gap between the top corporate and individual rates because of the arbitrage potential. That potential is evident both in the incentive to incorporate investment portfolios and in the compounded after-tax return on businesses in which the owners can afford to leave some of their earnings inside. (See Edward D. Kleinbard, "Corporate Capital and Labor Stuffing in the New Tax Rate Environment," USC Law Legal Studies Paper No. 13-5 (Mar. 21, 2013).)
And yet in an April 10 briefing with reporters on the green book, a senior Treasury official suggested that such a gap isn't problematic as long as the code's anti-arbitrage provisions are resurrected. Many tax policy experts would say that's naïve. It's hard to see how simply strengthening the existing code provisions -- namely the section 531 accumulated earnings tax rules and the section 541 personal holding company tax rules -- will be enough to prevent an upending of the current choice-of-entity calculus for businesses. Maybe that's what the administration wants -- more C corporations.
The Treasury official said:
Corporate tax rates and individual tax rates have been historically all over the lot. Sometimes corporate rates are higher than individual rates. Sometimes individual rates are higher than corporate rates. We have in the depths of the tax code some provisions that would prevent taxpayers from arbitraging those rates. And so we'd have to basically resurrect those kinds of provisions if you did have a big gap between the individual and corporate rate. . . . From a tax administration standpoint, if you have big gaps between the two, you need to worry about folks trying to arbitrage them. I think really if you're thinking about trying to have a business tax system where the U.S. rates are competitive, you need to look at what rates around the rest of the world are. If you look at other countries, the rates can differ, so it's not crucial. It's just sort of where things land. [Emphasis added.]
Scary Concept #3: Special Interest Lobbyists
Should Be Publicly Shamed
- Peddled by: Finance Committee member Rob Portman, R-Ohio, April 9
The second most disturbing part of the administration's fiscal 2014 budget is its silence on the role of the section 199 domestic production activities deduction in tax reform. Just last year, President Obama proposed (both in Treasury's fiscal 2013 green book and in his corporate tax reform framework) expanding section 199 to boost U.S. manufacturing. But a senior Treasury official indicated April 10 -- and Treasury's fiscal 2014 green book confirmed -- that that effort has been abandoned, paving the way for the repeal of the popular deduction as a primary revenue raiser for a lower corporate rate. (Prior analysis: Tax Notes, Apr. 15, 2013, p. 228.)
Given that section 199 is one of the largest corporate tax expenditures -- the Joint Committee on Taxation in 2011 estimated its repeal would bring in $163.9 billion over 10 years if applied to both C corporations and passthroughs -- its elimination is almost inevitable if lawmakers are serious about significantly reducing the corporate rate.
But that doesn't mean the beneficiaries of section 199 -- particularly those that don't export their products and therefore wouldn't benefit from Camp's base erosion prevention option C -- should concede defeat. And it definitely doesn't mean they should dig their own graves. As Christopher Bergin, president and publisher of Tax Analysts, said to the Society of American Business Editors and Writers on April 5, "People like me earn their living by working for people and helping them to lower their rate to the lowest possible legal point. There's nothing wrong with that."
Elected leaders should remember that they are supposed to be the adults in this situation. They are the ones tasked with writing rational rules and saying no when necessary. Taxpayers will always ask for treats.
On April 9 during a Politico briefing, Finance Committee member Rob Portman, R-Ohio, said very reasonably that he thought tax reform that doesn't harm U.S. manufacturers is possible, suggesting that a lower rate matters more than the preservation of tax preferences like section 199 and accelerated depreciation. But he indicated that corporate taxpayers have an obligation not to ask for preferential treatment and to ask for tax reform that broadens the base and lowers the rate even if they'll end up losers.
That's absurd. It's not the lobbyists and the companies that pay their bills that are in the wrong -- it's the lawmakers lacking the courage to do their jobs who should get their act together.
Any company that's looking out for its own interests rather than the national interests ought to be exposed for that. I mean, this is an opportunity to help grow the economy, which is good for their customers, their vendors. . . . And it's true there are a lot of folks out there who are going to try to protect their own preference, but we've spent since 1986 making our code more complicated. . . . The corporate community better get their act together and come to Washington not to say don't touch my preference, but to say we must reform this tax code to make our economy more competitive. . . . [Section 199 and depreciation] are issues that can and should be resolved, and ultimately, if you're a manufacturer in Ohio, you want to have a competitive tax system. [Emphasis added.]
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