Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) unveiled their proposed “innovation box” legislation aimed at keeping intellectual property registered in the United States. The bill would lower the rate on qualified income from patents and intellectual property to 10 percent, but only for firms with domestic R&E expenses. Similar laws already exist in Europe, and there are signals that this could become part of a Ways and Means international tax package later this year. Here’s Chairman Ryan on the proposal:
The proposal from Reps. Boustany and Neal can help us stem the tide and protect good American jobs. It will also help ensure the United States continues to be the world’s leader in innovation. Their plan would allow American businesses to better compete with foreign companies and keep their research and development facilities here in the U.S. This is just one piece of international tax reform, but it’s an important one. I applaud Charles and Richie for their work, and look forward to refining the proposal as we move forward on a broader plan to make America more competitive and promote high-paying jobs.
Senators Rob Portman (R-OH) and Chuck Schumer (D-NY), who authored the Senate Finance Working Group report on international reform, were also supportive. You can read their respective statements here. With support in both chambers, it appears the innovation box will be a factor in international tax negotiations later this year.
As the proposal currently stands, it doesn’t appear as if innovative pass through businesses would be eligible for the innovation box. The sponsors have made clear that the legislative text released this week is a “draft” and that they are eager for input. We will be working with the rest of the pass through community to coordinate our comments and make sure S corporations are well represented.
Highway Bill & Patent Boxes
Why release the patent box draft now, just before the long August recess? We believe the goal was two-fold. First, it is a genuine effort to get feedback on the proposal, which is a new concept for the Ways and Means Committee and they’d like to get the policy right. Second, it helps to keep the ball moving on Chairman Ryan’s two step plan to getting international tax reforms done this year – pass a short term highway extension now and follow it up with a bigger package of highways and international tax reforms this fall. The innovation box idea is a key “sweetener” in the larger international package, so getting it out now helps to move the overall plan forward.
For the past year, Ryan’s goal has been to combine highways, international reforms, and tax extenders into one big package Congress would enact at the end of 2015. He believes the general desire by both parties to get a highway bill done can help push his international package over the finish line.
Senate Majority Leader McConnell, on the other hand, thinks any plan to reform taxes with this President in office is doomed to fail and wanted to get highways done and off the table at least through the elections. So McConnell proposed to do long-term highways now with little in the way of tax policy, while Ryan advocated for addressing highways in December with as much international reform as he can muster.
The three-month extension adopted by Congress this week represents a compromise between the two positions. It means Congress will have to revisit the issue prior to December, but it also keeps alive Ryan’s international reform efforts.
Built-In Gains Relief Introduced in Senate!
Good news! Sens. Pat Roberts (R-KS) and Ben Cardin (D-MD) introduced legislation Thursday to provide a permanent five-year recognition period for built-in gains (BIG) assets.
We’ve been advocating on BIG for years and, even after all of the leadership changes in Washington, DC over the past several elections, built-in gains relief continues to receive strong bipartisan support in both chambers. We are glad that Congress has recognized the importance of such relief by continuing to extend temporary relief – as included in the tax extender package recently adopted by the Senate Finance Committee. Permanent BIG relief, however, is the only way to offer business owners the certainty they need, so we’ll keep working to get the Roberts/Cardin bill across the finish line.
Also in the Senate this week, the Small Business Committee adopted a “Sense of the Committee” resolution endorsing legislation introduced by Committee Chairman David Vitter (R-LA) that includes “sting” tax repeal! Eliminating the “sting tax” has been a priority of the S Corporation Association for years and it’s a key part of the S Corporation Modernization Act introduced by Representatives Reichert (R-WA) and Kind (D-WI) last month.
Fixing this particular passive income rule has been long overdue—in fact, the Joint Committee on Taxation recommended the repeal of this termination rule back in 2001! As with permanent BIG relief, we plan to spend this fall pushing the tax writing committees to adopt Sting Tax relief as part of any tax legislation moving this year.
Hillary Clinton Proposes Tax Hikes on S Corps
In her bid to reform so-called “quarterly capitalism,” presidential candidate Hillary Clinton proposed this week to hike the capital gains tax on investments held less than two years to the top individual rate of 39.6% (plus the 3.8% net investment tax), or nearly double the tax today. Under her plan, the tax rate would gradually decline for investments held between two and five years, while investments held six years or longer would get the current 20% rate.
So while all of Washington, including the Obama Administration, is working on ways to reduce the tax on investment and encourage more companies to remain here in the US, candidate Clinton would increase the cost of domestic investment instead. Clinton did add that capital gains would be eliminated for select long-term investments in small businesses. That doesn’t sound bad, but it begs a few questions. What is her definition of “small business”? How long would the investment need to be held?
Moreover, if lower capital gains for small businesses would stimulate long-term investment, why limit it to small businesses? Why not reduce or eliminate the capital gains rate on all domestic investments, as Senator Rubio has proposed? As the Wall Street Journal points out, this proposal may do little more than distort investment decisions in the short-term and prevent the efficient allocation of capital:
A high and sliding tax-rate scale also harms the efficient allocation of capital by expanding what economists call the “lock-in effect.” If owners of capital must wait years to pay a lower tax rate, many will decline to realize their gains solely for tax purposes. This artificially reduces the mobility of capital.
Economic growth is enhanced when capital is able to efficiently find its highest return. “Buy and hold” often works well for individual investors in specific stocks. But no economic theory says one- or two-year investments are worse than 10-year, and sometimes they’re better.
Worst of all, this would leave owners of pass-through businesses on the hook for corporate “quarterly capitalism.” Since many pass-throughs are family-owned through multiple generations, they’re already making the kinds of long-term investments that Clinton is looking to promote. Her campaign has said she is committed to producing a full tax plan, and we’ll be sure to analyze it when it becomes public.
Highway Debate Continues
Last week, we reported on the House’s adoption of a highway trust fund (HTF) extension through December. This extension is the first step of Chairman Paul Ryan’s plan to combine a longer term HTF extension with key international tax reforms.
Meanwhile, Senate leaders want to act now, not in December, on a longer-term extension. Majority Leader Mitch McConnell, Sen. Barbara Boxer (D-CA), and Sen. Jim Inhofe (R-OK) support a six-year highway deal which has offsets for the first three years, but does not include international tax reform. The Senate voted 62-36 Thursday morning to begin debate on the measure.
So both the House and Senate want a multi-year bill, but McConnell wants to pass something now and avoid revisiting the issue prior to next year’s election, while Ryan would like to leverage the highway issue to get international tax reforms. A short-term HTF extension through December gives him more time to build support for the combo package. Rumor is he will release a detailed plan, which should track closely with the Portman/Schumer International Working Group plan, as soon as next week.
So which is it? Will it be a multi-year HTF extension now, or HTF extension plus international tax reforms later? The current HTF authorization expires on July 31st so we will know next week which view prevails, and whether Congress will be debating international tax reform this fall.
Senate Finance Moves Forward on Extenders
Good news! The Senate Finance Committee voted this week 23-3 to send a tax extender package to the Senate floor. The extensions last for two years (2015 & 2016) and include S-Corp priorities built-in gains relief and charitable contributions basis adjustment. Relative to last year’s 11th hour retroactive one-year deal, early movement on a two year extension is welcome news.
The question now is how extenders will work its way through the Congress and ultimately to the President’s desk. There was some talk about attaching extenders to the highway bill being debated by the Senate right now, but that seems remote. Outstanding issues regarding certain provisions, including the application of the solar tax credit, appear to stand in the way.
Regarding the post-August schedule, The Hill reports:
Congress will also have to deal with a number of big-ticket items when lawmakers return from their August recess, including a Sept. 30 deadline for government funding and the recent agreement the Obama administration struck with Iran. Hatch sounded skeptical after the markup that the package of tax breaks could be added to the Senate’s highway bill, which was released Tuesday.
Even though the timeline for passing extenders may be in flux, the fact that the bill has been reported out of committee is a good sign that Congress is moving and may act well in advance of last year’s last minute extension.
Senator Thune Supports Permanent BIG Relief!
Provisions like built-in gains have been part of extenders packages for years, and we’re still fighting to make them permanent. The good news is that we have friends in high places who share that goal. Just this week, Senator Thune (R-SD) proposed an amendment that would do just that. During the extenders markup, Sen. Thune offered up his legislation to, among other items, make permanent the five year recognition period for built in gains. He had this to say:
“I support this legislation to ensure that American families and businesses do not find themselves facing a higher tax bill come tax season,” said Thune. “However, I believe we can do better than simply preventing a tax increase in the short term. American taxpayers deserve the certainty and predictability that only comes from making tax relief permanent, something I intend to continue to pursue on their behalf.”
As we continue working to make built-in gains relief and charitable contribution provisions permanent, Sen. Thune’s amendment shows that there is a strong constituency in the Senate for our efforts. We expect that a permanent bill on built-in gains, similar to what was proposed last year, will be introduced soon in the Senate.
The Senate Finance Working Groups reports are done and publicly available! Many congrats to the Committee members and their staff for continuing the progress on tax reform. You can check out the reports here. The Business Income Tax report drafted by Sens. John Thune (R-SD) and Ben Cardin (D-MD) is the one of most interest to us. We have to admit, the first few pages were bit a disappointing, as the introduction could lend the impression that pass through taxation (multiple business entities) is somehow a bad thing.
Our tax system also promotes inefficiency by incentivizing businesses to make decisions based on tax considerations, rather than for business reasons. This has manifested itself in the area of business entity choice. Consider that over the past few decades, since enactment of the Tax Reform Act of 1986, there has been movement en masse away from C-corporation status to status as an LLC, S corporation, partnership, or other pass-through business.
With the experience of our members behind us, we actually see that businesses don’t change their behavior to choose an entity type; they choose an entity type so they don’t have to change their behavior. S corporations would stop paying dividends if they were forced into the double corporate tax. C corporations would scramble for funding if they lost the ability to access public markets. Partnerships would rewrite their ownership agreements if they lost the ability to formalize complex ownership relationships. Having multiple structures in which to organize your business is a positive aspect of the tax code.
The report then embraces number of principles for tax reform. We were disappointed to see that the number one principle wasn’t lower tax rates for all employers, but focused specifically on lowering the corporate tax rate.
Simply put, the U.S. corporate tax rate needs to be competitive with the nations with whom we compete in the global economy. The OECD median statutory corporate tax rate is 25 percent, a reduction of 5 percentage points since 2004.
The term “corporate tax rate” is mentioned more than a dozen times in the principles. The higher tax rates many pass through business pay are not mentioned at all. There is one reference to pass through businesses in the principles section – highlighted as a ‘distortion’, but only to suggest “that pass-through businesses are not harmed by efforts to lower the corporate tax rate.” That’s a pretty low bar. Simply not harming pass-through businesses should not be confused with actually improving the tax code to make those businesses more competitive.
Other parts of the report reference the need for pass through businesses to “benefit” from tax reform, which is clearly helpful, as is the accurate reflection of our basic challenge:
To summarize, pass-through businesses fear that they could find themselves with the worst of both worlds: no rate reduction combined with higher effective tax rates from base-broadening efforts. This is a valid concern and one that any business tax reform effort needs to consider with the utmost seriousness.
The Working Group summed up their debate over pass-through businesses in this way:
“Members of the Business Income Tax Working Group were not able to resolve the treatment of pass-through businesses in business tax reform, one of the most vexing challenges in business tax reform, given the constraints the group faced. However, members of the group believe that any tax reform effort must fully take into account the concerns and opinions of America’s pass-through businesses. Business Income Tax Working Group members strongly urge the chairman and ranking member to examine the options above, in addition to any other approaches the committee may consider, to ensure that pass-through businesses are treated equitably, should the Finance Committee decide to move forward on business tax reform.”
The “constraint” faced by the working group is the Obama Administration’s total opposition to reducing tax rates for individuals. The “options above” referred to the list of alternatives considered by the working group in lieu of individual rate cuts, including the Grant-Thornton business equivalency rate idea. We examined this proposal at length previously and, of all the alternatives to individual rate cuts, to us it appears the closest to embracing the pass through principles endorsed by more than 100 trade groups earlier this year.
So, all in all, a mixed bag. The working group makes clear the challenge pass through taxation poses to the goal of overall tax reform, but they failed to recognize that pass through taxation is also the key to the solution. Taxing business income once, when it is earned, and at a reasonable rate is the way we should tax all business income. The sooner we embrace that model, the sooner we can achieve the more competitive business tax structure policymakers are seeking.
Highway Funding & International Tax Reform
The outlook for highways and international tax reform is coming into focus. Senate Majority Leader Mitch McConnell announced that the Senate will take up a short-term highway bill as soon as next week, but downplayed pairing the extension with more aggressive international tax reforms and completely ruled out raising gas taxes.
Let me just say we’re not going to raise the gas tax. We’re not going to raise the gas tax,” McConnell said. “The environment committee has come out with a six-year bill … but there is considerable skepticism that you could pay for a bill of a six-year duration.
McConnell (R-Ky.) also said he was “skeptical” about the prospect of using a bipartisan plan from Sens. Chuck Schumer (D-N.Y.) and Rob Portman (R-Ohio) to overhaul some corporate taxes as a way to pay for crumbling highways, bridges and public transportation and said it would be too difficult to take on something so ambitious with just three weeks before the deadline.
So short term highway extension this month, but no international reforms. What about the longer term outlook?
On that front, there is a concerted effort to pair highways and international reforms, and that the new international report from Senators Portman (R-OH) and Schumer (D-NY) clearly outlines what they have in mind. As the Examiner reported this week:
Ryan, the chairman of the powerful tax-writing House Ways and Means Committee, said at a breakfast event hosted by Politico in Washington that he was optimistic about a deal to reform international taxation that would include a one-time surge of revenues from deferred taxes of multinationals’ earnings.
Such a deal isn’t possible in the next two weeks before the highway trust fund is expected to be exhausted, the Wisconsin Republican said, and Congress will have to pass a short-term funding patch through the end of the year.
But the agreement on taxing overseas earnings announced Wednesday by Sens. Rob Portman, R-Ohio, and Chuck Schumer, D-N.Y., “gives me a bit of hope” that a six-year infrastructure funding deal can be reached, he explained.
The report itself calls for moving to a territorial tax system, creating a patent or innovation box to incent the development and retention of domestic intellectual property, and taxing existing balances of overseas corporate income to pay for both the international reforms and offset the cost of highway funding. That latter bit has been endorsed by a number of Democrats and Republicans, including Portman and Ryan, while others have expressed strong opposition to using “deemed” repatriation for anything other than tax reform.
The key remaining question is how long the extension considered this month will be – just through the end of the year or through the 2016 elections? Late today, reports surfaced that Rep. Ryan was working on an $8 billion extension that would last through the end of the year. This runs counter to what Senate leaders have supported—an 18-month extension that would push international tax reform into 2017. When discussing the extension in The Hill, Ryan responded to that difference:
“Mitch and I have the same long term goals, we want comprehensive tax reform and we want a long term highway bill,” he said. “They have their body to deal with, we have ours to deal with. We…think we should do a long term highway bill and we think tax reform is the best way.”
Ryan did specify how he plans to pay for his proposed temporary highway funding extension, saying only “I think we’ll be able to put together a package that kind of innocuous, boring stuff that shouldn’t be a surprise to people.
“We’ll post it when we have it ready,” he said.
If this passes, that would mean fewer revenue offsets this month, with an enhanced possibility for the prospect of international tax reforms to gain traction before December. Of course, we’ll be watching the short-term patch closely, particularly to see what Rep. Ryan comes up with to find the needed $8 billion.
Extenders are back under discussion, thankfully. Rumor is that the Senate Finance Committee will take up a 2-year extender package in the next couple weeks, while Chairman Ryan said Thursday that he’s looking for Ways & Means to move extenders in September.
This accelerated time table is good news—at least when compared to last year’s delay in an agreement until the very end of December. Another positive is the emphasis on making at least some of these provisions permanent. There is no reason the R&E tax credit, higher 179 expensing limits, and shorter built-in gains recognition period expire every few months. That said, there is opposition to the House has made to enact these very extensions permanently. According to Politico:
Democrats are opposed to efforts to make extenders permanent, arguing that the revenue losses must be offset. Republicans are quick to note that quirks of legislative scoring allow the cuts to be temporarily renewed — often cumulatively surpassing the 10-year “permanent” scoring window — without counting as a revenue loss.
Bottom line is that we expect to see action on extenders, at least at the committee level, soon. Our hope is that this new activity results in a package adopted by Congress well before the end of the year. Fingers crossed.