House Tax Legislation Advances ACA Tax Reform Aims
November 7, 2017 •
Over the past several years, ACA has asked Congress to overhaul the tax code to create a climate that encourages innovation and spurs investment, job creation and economic growth. ACA has communicated to Congress that in its view, the key ingredients for a comprehensive tax reform plan to include:
- A lower Corporate Tax Rate;
- Equitable treatment of small businesses filing under Subchapter S of the tax code in areas such as expensing of certain investments;
- Encouraging investment by making permanent a competitive R&D tax credit;1
- A modern International Tax System that does not contain disincentives to U.S.-based manufacturing; and
- A robust Capital Cost-Recovery System.
Late last week, the House Ways & Means Committee released its long-awaited tax overhaul proposal, the Tax Cuts and Jobs Act (H.R. 1), and ACA’s initial review indicates that the legislation’s business tax provisions are quite consistent with the ACA’s views on business tax reform.
The key corporate tax provision in H.R. 1 is a permanent reduction of the corporate rate to 20 percent from its current statutory rate of 35 percent. The bill also establishes a largely territorial system of taxation, and does away with graduated rates, so that the new 20 percent cap also constitutes a flat rate. In addition, the corporate AMT (alternative minimum tax) is eliminated.
There is also broad relief available for pass-through entitles (PTEs) – there is top rate of 25 percent on at least a portion of the business income of PTEs (vs. the top individual rate of 39.6 percent). The intent is to mirror for S Corporations the lower effective rate at which C Corporations would be taxed under the bill, and attempts to implement the concept that a PTE owner’s compensation (i.e., salary) from the business should be taxed in the same way as other salaries earned by workers, while the “profit” portion would be taxed at a lower rate (25 percent).
Such active business owners would be able to choose between a simple formula and a more complex business capital formula to separate compensation income from non-compensation business income. In some cases, capital intensive businesses can have up to 30 percent of income taxed at this lower rate based on a calculation which involves the book value of entity. H.R. 1 looks at the activities of PTE, with so-called “passive activities” being subject to a 25 percent rate, while up to 30 percent of the income from “active activities’ being taxed at a 25 percent rate. The lower tax rates are not available to PTEs set up to provide services, such as accountants or law firms, so those persons will not be given tax relief under this bill.
H.R. 1 also addresses how businesses finance their activities by limiting Interest expense to 30 percent of adjusted taxable income plus interest income. Note that this calculation involves “net interest,” so banks would be protected under this change. Small businesses (i.e., those with gross receipts of $25 million or less) would be provided an exception to this disallowance rule because of their more limited access to capital markets. Regulated utilities and real estate also receive an exception from these rules that disallow interest deductibility. However, those entities would be disallowed from using full expensing and their assets would be moved back to a slower depreciation schedule under the Modified Accelerated Cost Recovery System. The intent of eliminating interest deductibility is to equalize the marginal tax treatment of debt and equity financed investment and would therefore reduce tax-induced distortions which now bias investment financing decisions against equity in favor of debt.
The legislation provides a one-time tax on unrepatriated foreign earnings, which are deemed repatriated by the legislation. Foreign earnings that are held in cash will be taxed at 12 percent and those that have been converted to fixed assets will be taxed at 5 percent. The bill also provides complicated base erosion rules intended to discourage profit-shifting maneuvers that erode the tax base by putting dollars outside the reach of U.S. taxation. There are also some changes to the treatment of net operating losses (NOL), with NOL carrybacks generally not allowed, while NOL carryforwards are permitted with limited exceptions.
The bill provides full expensing of capital expenditures for five (5) years (until 2023, for budget reasons), a treatment that is not limited to equipment only, and separate Sec. 179 limits would be increased from $500k to $5 million under the Act.
The prospects for the bill remain unclear, and most political opposition has focused on the changes to the manner in with individuals are taxed. There are no clear Democratic votes for this bill at present, and several “Blue State” Republicans have expressed concerns about the bill as written due to the elimination of the State and Local Tax (SALT) deduction. Any major changes would have budget implications that could prove problematic, especially given that the cost of the bill is projected to be $1.5 billion over 10 years, and it could potentially increase the national debt to nearly 100 percent of GDP.2 The SALT deduction is the largest revenue raiser in the bill as constituted, so preserving that would be quite difficult in terms of budget goals.
From a corporate tax reform perspective, H.R. 1 is a very good start, but given that many of its provisions have attracted political opposition, it’s unclear what the bill’s fate will be. However, it’s important to recognize that it implements virtually all of tax reform objectives of the manufacturing sector, including ACA, so it’s expected to receive substantial industry support as it progresses.
Contact ACA’s Allen Irish for more information.
1 This objective has been previously implemented in tax legislation and continues in the new bill.
2 As projected by the Joint Committee on Taxation