April 29, 2016 by admin ·
For five years, the S Corporation Association and its allies have asked tax writers to pursue business tax reform that taxes all business income just once and at the same, reasonable top rates. That’s the correct way to tax business income and more than 100 trade groups, including the largest trade groups in the country representing millions of employers, have signed on to this premise.
And for five years, we’ve watched as the tax code moved in exactly the opposite direction.
Instead of preserving rate parity, the combination of the Fiscal Cliff and the implementation of the Affordable Care Act resulted in pass through businesses paying at a top rate nearly 10 percentage points higher than C corporations. Instead of reducing the double corporate tax, President Obama signed into law new polices that raised shareholder taxes dramatically. The result is that the effective marginal tax on business investment today is significantly higher than it was just a few years ago.
No wonder companies and capital are fleeing the United States.
In recent months, however, we have seen signs of hope. First, Finance Chair Orrin Hatch (R-UT) announced he was working on a plan to eliminate the double corporate tax. His plan isn’t due out until June so we haven’t seen the details, but the fact that the Chairman and his staff are spending time and resources pursing policies to create a single layer business tax is promising. A properly constructed integration plan has the potential to address many of the ills the business community faces.
And just this week, Congressman Vern Buchanan (R-FL) introduced legislation on the issue of rate parity. Entitled the Main Street Fairness Act, the bill would cap the top pass through business tax rate at the top corporate rate. Under the Buchanan bill, the same 35 percent top rate that applies to corporate income would also apply to successful pass through businesses. If Congress reduces the corporate rate next year, pass through businesses would get the new lower rate too.
Groups weighing in on the Buchanan bill include the National Association of Manufacturers, the National Retail Federation, and the Associated Builders and Contractors. You can read more about the Buchanan bill here. You can read the S Corporation Association letter on the bill here.
We would like to see the Buchanan bill expanded to apply to all active pass through income, and Congress still needs to repeal the 3.8 percent Affordable Care Act tax that applies to some S corporations and other businesses. We don’t want those concerns, however, to detract from the fact that of the three core Main Street Business principles we outlined five years ago – tax reform should be comprehensive, restore rate parity, and end the double tax — two of those principles are being actively pursued by senior members of the tax writing committees.
That’s a positive sign, and something we plan to build upon in the coming months.
April 25, 2016 by admin ·
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.
Lost in all the hoopla over the Treasury’s new inversion policies was the accompanying update to their corporate tax reform outline. You can read the whole 30-page document here, but the bottom line is that not much has changed.
The plan still treats the pass-through community as second-class citizens by broadening the tax base for all businesses while only reducing rates for those organized as C corporations. As a result, successful pass-through businesses would be subject to 45 percent top rates on a broader base of income – a double whammy coming just three years after the Fiscal Cliff hiked their tax rates.
That’s simply a non-starter with Congress. From Politico:
McConnell also said he’s not interested in corporate-only tax reform, noting “most American businesses are not corporations” and lawmakers are not going to “carve out one section of American business and give them breaks and leave the others with very high rates.”
The plan also makes clear just how far apart the Administration and Congress are on tax policy.
The Ways and Means Committee continues to work on an international reform package that, by all accounts, includes an innovation box as the sweetener to help offset some of the new enforcement provisions. Meanwhile, the Administration spends two pages explaining why innovation boxes are a bad idea.
Finance Committee Chair Orrin Hatch (R-UT) continues to refine his plan to integrate the corporate and individual tax codes – something more than 100 national business groups have argued is an essential component of tax reform. Meanwhile, the Administration stands by their budget plan to increase shareholder taxes instead. (Exactly how combining lower corporate rates and sharply higher shareholder taxes helps to improve business taxation or encourage more investment here in the United States is not discussed in the Administration’s outline or anywhere else. It’s simply incoherent.)
And finally, while the majority in Congress stands uniformly opposed to raising taxes, the Administration’s plan explicitly calls for at least two significant tax hikes – a one-time 14 percent assessment on un-repatriated profits that would pay for new infrastructure spending, and a retroactive tax hike to offset to last year’s extender package. As Politico notes:
The Obama administration now wants to pay for that giant tax deal approved in December. After agreeing to stick the bill’s $680 billion cost onto the deficit, the administration now wants business tax reform to cover that cost. “Reforming the business tax system must be done in a fiscally responsible manner, including paying for December’s business tax cuts,” the administration said in an update of its business tax reform framework.
Most observers doubt there’s any chance for meaningful tax policy this year. The net result of this framework is to make that more clear.
Corporate Tax Base v. Business Tax Base
As noted above, there’s lots to dissect in the Treasury update, but you need not go further than the first paragraph to find something offensive. When it comes to the business community, it is obvious this Administration is focused only on large corporations.
America’s system of business taxation is in need of reform. The United States has a relatively narrow corporate tax base compared to other countries—a tax base reduced by loopholes, tax expenditures, and tax planning.
But the US doesn’t have a corporate tax base – it has a business tax base that includes both corporations and pass-through businesses. The good news here is that the US business tax base is large and growing.
According to the Tax Foundation, the business tax base made up 9 percent of US income prior to the 1986 Tax Reform Act, but makes up 11 percent today. That’s bigger. True, the corporate tax base has declined from 8 percent of US income in 1986 to 5 percent today, but the growth of the pass-through business community during that same time from just one percent to 6 percent has more than offset that decline.
So corporate-only tax reform advocates like the Administration are fond of pointing out that the corporate tax base has eroded over the past three decades. What they never point out, however, is that the business tax base – including both corporations and pass-through businesses – has grown significantly since the 1986 Tax Reform Act.
That’s a good news story that every tax writer in DC needs to learn.