More on Corporate Integration

Lots of chatter on corporate tax reform last week.  First, Finance Committee Chair Orrin Hatch gave a speech on the Senate floor making clear that only comprehensive changes to our tax code would help to make our tax treatment of business income more internationally competitive and end the ongoing exodus of US companies to foreign tax jurisdictions.

Well, at the same time, most of the proposals we’ve seen to deal with inversions would amount to building a virtual wall – a wall forged in regulation and punitive tax treatment – around the country to keep companies from leaving and making every business in America – and all of their employees and their individual customers – pay the cost. 

The latest wall-building exercise came earlier this month with Treasury’s temporary anti-inversion regulations and proposed regulations aimed at earnings stripping.

Of course, the administration’s anti-inversion approach was essentially the regulatory equivalent of a doctor who wastes all of his time and energy treating a patient’s symptoms one-by-one as they arise without making any effort to diagnose, let alone treat, the underlying illness.

Senator Hatch makes an important point.  Making it more difficult for US companies to move overseas will not fix the tax code.  That’s the tax policy equivalent of building a Berlin Wall to keep in your citizens.

But this isn’t the Eastern Bloc, and we’re not the Soviet Union.  Fixing the tax code correctly would entail making the United States a more attractive place to invest, so it should start by reducing the marginal cost of investing here.

That is why the Administration’s position of advocating for lower C Corp taxes while pushing for—and enacting—higher taxes on shareholders is so remarkably mindless.  The effective marginal tax on American C Corps is the sum of the two taxes, so cutting one while hiking the other would fail to make the United States a more attractive place to do business!

On the other hand, integrating the corporate code would help dramatically.  That’s the Tax Foundation’s takeaway from their most recent paper on corporate integration. According to the Foundation:

Corporate integration would accomplish many of the same goals as a corporate rate cut, such as making the U.S. business climate more competitive. It could also end several economic distortions created by the current tax code, including the tax preference for debt financing over equity financing.

According to the Tax Foundation, an investment in a partnership or S corporation faces a top federal tax rate of 43.4 percent, while an equity investment in a C corporation faces a rate of 50.5 percent.  The net result is that dividend-paying C corporations investing equity raised from taxable investors are disadvantaged.

Of course, in real life, very little corporate investment is subject to a top rate of more than 50 percent.  Most C corporations do not pay dividends and most C corporation shareholders are tax exempt. C corporations can and do use debt to finance their investments, and larger multinational C corporations have the option of indefinitely keeping their foreign income – and much of their domestic income, if the BEPS project is to be believed — overseas, thus avoiding any US tax at all.

But avoiding the second layer of tax on corporate income by not paying dividends, loading up on debt, and hoarding cash overseas is exactly the type of harmful behavioral affect tax reform should fix.  Building the Berlin Wall of tax codes won’t do it, but integrating the corporate tax code will.

Which brings us to the latest news on Finance Committee Chairman Hatch’s plan to introduce a corporate integration plan this year.  According to our friends at Tax Notes, the Hatch integration plan is going to be budget neutral, would help deter future corporate inversions, and can be expected in June:

Hatch has been telling reporters that he would like to release a draft, after the JCT finalizes the estimates, by the first week of June. But he said on the Senate floor that he hopes the JCT will give his staff “some preliminary results before the end of May.”

Hatch continued to express confidence that he will achieve his goal of making corporate integration revenue neutral, saying in his floor speech that he hopes Democrats will give it a serious look “because this is something we could do this year to help this country resolve its problems with regard to corporate inversions.”

So there you have it – just as some policymakers are calling for building walls and making it more difficult for corporate America to compete, Senator Hatch continues to press forward on a business tax reform idea that would make the US a better place to invest.  It’s a reminder that we won the Cold War not by building walls, but by making our economy more competitive.  Something to keep in mind as we debate tax reform.

Our Chairman’s New Year Message

2015 was a terrific year for the S Corporation Association.  We saw the shorter, five-year built-in gains recognition period made permanent, we organized the Main Street business community into a coherent advocacy force, and we successfully blocked misguided efforts to enact President Obama’s corporate-only tax reform plan.

For 2016, our goal is to build on these successes to ensure more legislative wins this year and beyond.

  • That means educating policymakers on how taxes on S corps already went up sharply in 2013 and working to enact legislation to repeal that tax hike.
  • It means building out our pass-through business coalition to ensure that S corps and other Main Street businesses are at the center efforts to rewrite the Tax Code, not just an afterthought.
  • And it means tackling new obstacles to S corp capital accumulation and growth like the prohibition against non-resident alien shareholders and other restrictions unique to S corporations that limit your access to capital.

That’s it in a nutshell.  For a more detailed account of our efforts in 2015 and what we have planned in 2016, click here to read our Chairman’s annual letter to the S Corporation Association membership.

Oh, and Happy New Year!

 

Brady Identifies the Challenge

Will Congress reform our international tax rules this year?  Ways and Means Chairman Kevin Brady’s (R-TX) recent interview with Politico’s Ben White gives us some insight.  You can watch the entire interview here.  Our takeaway was that Brady did a good job of identifying both the opportunities and challenges confronting tax reform advocates this year.

On the opportunity side, Brady announced that he intends to have the Ways and Means Committee mark up an international plan later this year.  American companies continue to invert, the BEPS implementation process is moving forward, and a vocal contingent of congressional reform advocates continue to refine their plans, so there are lots of catalysts for action.  The Chairman is “optimistic” they can act on international reforms this year, and it’s likely the new Speaker will support him.

But how does action on international fit with the broader tax reform vision Brady laid out in the interview?  Brady called for a “tax code built for growth” that is “fair, flatter, and simpler” and where “small businesses aren’t paying more than large businesses.”  The Chairman has been a longtime advocate for Main Street businesses – he spoke at the release of our first EY study on pass-through businesses – and he understands the important role these businesses play in job creation and investment.

Those two visions – the desire to move international this year and the recognition that tax reform must address the higher rates imposed on pass-through businesses — highlight the challenge facing the new Chairman.  How he resolves it is unclear, but we know Brady understands the position of Main Street employers and we look forward to working with him to craft a solution.

 

Hatch on the Double Tax

In a positive development, Senator Orrin Hatch (R-UT) and the Finance Committee staff are planning to release a proposal to eliminate the double corporate tax.  According to Politico:

Hatch’s plan takes aim at the double taxation of corporate profits, one of critics’ chief complaints about the current business tax system. Details are sketchy, but the Utah Republican is seriously considering giving companies a deduction for the money paid out to shareholders in dividends. That would have the effect of canceling out corporate income taxes.

“The corporation will not have the double taxation anymore,” said Hatch. “It would go a long way towards topping some of these inversions.”

He hopes to release his plan, which is still being written, “in about a couple weeks.”

Tax Notes added:

One tax lobbyist familiar with discussions around corporate integration said Hatch “is looking at this as more of an incremental approach, basically the art of the doable.” He added that Hatch has not given up on “big comprehensive reform, but if it proves to be not much easier even in a new administration, then this could become a fallback to address competitiveness.”

Specifics will have to wait until the plan’s release, but our understanding of the package is that it would:

  • Eliminate the double tax through the use of a “dividends paid” deduction;
  • Be revenue-neutral without the usual base broadening associated with tax reform; and
  • Be a stand-alone proposal that is not accompanied by rate cuts, innovation boxes, or other provisions not directly related to the double tax.

On the surface, this looks like a really worthwhile effort.  The benefits of eliminating the double corporate tax are numerous and would accrue to shareholders and workers alike.  Our EY study on pass-through businesses made clear that the double tax reduces investment, jobs, and wages.  That’s the reason we made its elimination one of the three key principles in our tax reform letter signed by 120 trade groups.

Eliminating the double tax also helps curb inversions by reducing the tax paid by corporations on their overseas income.  Right now, if a corporation wants to repatriate income in order to pay a dividend to its shareholders, it would have to pay the US tax on the income, and then its shareholders would have to pay the dividend tax.  With corporate integration, only one level of tax would apply.

Finally, integration helps to level the tax imposed on debt versus equity.  If a corporation raises capital to pay for a new investment today, the tax code imposes a really high tax on it.  But if a corporation borrows the money, the tax is significantly lower, and could be negative (i.e. the taxpayer is subsidizing the investment).  The current code encourages businesses to borrow, resulting in higher debt levels and a less secure employment base.  Integration reduces this bias.

All in all, this is reform that’s worthy of the name.  The details are important – how do they pay for this? — and we’re going to review the proposal closely when it’s released, but it’s encouraging to know the Finance Committee is focused on the underlying disease of how we tax businesses.  It’s a good place to start!

A Tale of Two Speeches

The president gave his State of the Union speech last Tuesday, while his Secretary of Treasury spoke to the Brookings Institution the following morning.  The president didn’t mention tax reform, whereas Lew devoted nearly his entire speech to building the case for action this year.  It was a head-scratching juxtaposition that still has us wondering if Treasury and the White House are on speaking terms these days.

  • You can read the president’s speech here
  • You can watch the Lew speech here

Lew’s speech in particular is worth watching.  His focus was on the tax reform “framework” Treasury put forward three years ago coupled with a message that there are many areas of overlap between the Administration and Republicans.  That’s debatable, to put it mildly, but one obvious area where there is no overlap is the treatment of pass-through businesses.  Here’s Politico’s take:

Lew “glossed over a key area of contention: how to deal with small businesses that file on the individual side of the tax code. Many Republicans, including Senate Finance Chairman Orrin Hatch, and some Democrats say it is impossible to adequately address the needs of those businesses, which range from mom and pop stores to big law and financial firms.”

And:

Lew might have talked about “business tax reform” quite a bit on Wednesday, but he seems to be sending mixed messages to small businesses. Last week, he met with a group of small business trade groups to talk tax reform, and Reuters is reporting that Lew actually suggested some of them incorporate if they want to receive the benefits of a lower tax following a tax reform: “Lew’s answer was that some such firms, which are known as ‘pass throughs,’ would probably be better off becoming corporations, according to three people who were in the room and asked not to be named.”

So what does this all mean for the prospects of tax reform?  Our friends at Cornerstone Macro made this observation:

President Obama has not held a single public event designed to promote tax reform. During the last few weeks, Obama held events across the country to promote free community college, tout lower FHA fees for homeowners, and discuss other administration priorities. Over the years, he has held hundreds of public events of one kind or another to push his legislative agenda. To the best of our knowledge, he has never held a single event designed to promote tax reform.

President Obama has made clear his primary interest in tax policy is to raise revenue to pay for new spending.  Unless that changes, and quickly, it is going to be very difficult for Congress and the Treasury to come together to reform the tax code this year.

 

S-CORP in WSJ

The Wall Street Journal featured an op-ed co-authored by S-CORP President Brian Reardon and Advisory Board Chair Tom Nichols last week. The piece calls on Congress and the Administration to make Main Street businesses an equal partner in tax reform by restoring the parity in the top tax rates paid by pass-through businesses and C corps.

The op-ed came the day before the President’s State of the Union address where, contrary to expectations, the President neglected to mention tax reform and instead proposed raising capital gains taxes on businesses and other taxpayers.  As Brian and Tom point out, while President Obama’s plan is offered under the guise of helping the middle class, these changes will ultimately hurt the middle class by increasing the already heavy tax burden shouldered by many employers.

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