During the week of November 18th, Senator Max Baucus (D-MT), Chairman of the Senate Finance Committee, released two long awaited staff discussion drafts outlining an approach to sweeping federal income tax reform. These papers focus on a number of concepts to revise taxation of corporate profits overseas and to make a number of changes in domestic corporate tax policy primarily through modifications of the current depreciation and accounting rules.
Taken together these proposals would generate hundreds of billions in new tax revenue from corporate taxpayers, but Senator Baucus underlined that his vision is to undertake these changes to pay for a lower corporate tax rate. The current US corporate tax rate is 35 percent. Senator Baucus's staff has indicated that he envisions lowering the current rate to less than 30 percent. Much of the initial corporate reaction to the proposals was somewhat muted because a lower overall rate could be attractive to many corporations – perhaps attractive enough to support a package that includes provisions listed in these issues papers.
Tax reform has followed a bumpy road over the last year. Both Senator Baucus and his House counterpart Ways and Means Committee Chairman Dave Camp (R-MI) have indicated great interest in pursuing sweeping tax reform. Their initial visions encompassed more than corporate tax reform, but their ambitions have increasingly been scaled back to focus primarily upon corporate tax reform. The current US 35 percent corporate rate is among the highest in the developed world and has restricted trade and economic growth with non-US companies. Focusing on corporate reform also has avoided consideration of some of the politically controversial issues, such as the home mortgage interest deduction and the charitable deduction.
The prospects for even corporate tax reform have been complicated politically by a sharp difference in views between House Republicans and Senate Democrats. House Republicans have taken the position that they oppose any new taxes, although most have left room for a reform formula that lowers the overall rate and pays for it by eliminating other tax credits and related tax provisions that would raise some corporate taxes. Senate Democrats, particularly Majority Leader Reid, have argued that any tax reform should generate substantial new revenues to narrow the federal deficit.
Camp and Baucus have walked carefully between the political markers laid down by their respective leaders to try to articulate a revenue neutral approach to tax reform under which a lower corporate tax rate is fully paid for by repeal of other current tax provisions.
The tax reform discussion is almost certain to continue – perhaps for a number of years. The debate over major tax legislation usually takes several years to form; the last major tax reform effort in 1986 began to form conceptually in the early 1980's. The specific proposals laid down by Baucus warrant attention because they could become the consensus elements of tax reform, which eventually find their way into tax reform legislation.
The Finance Committee has asked for comments on its tax reform proposals by January 17th.
There are literally dozens of separate items set out in these issue papers. The most issue packed paper on "Cost Recovery and Accounting" is attached to this issue alert, but here are a few highlights by industry sector:
Currently many US companies defer US taxes by holding profits overseas in foreign subsidiaries. Baucus suggests sharply curtailing this practice by immediately imposing a 20 percent tax on all US corporate profits currently held overseas, payable over eight years. Going forward, Baucus proposes two alternatives:
- Corporate profits would not face a US tax if the corporation pays to the foreign country in which the profits are earned an amount at least equal to 80 percent of the US taxes that would be paid on those profits. If the 80 percent threshold is not met, the corporation would pay the difference between the US rate and the amount actually paid; or
- 60 percent of active foreign market earnings (as defined) would be taxed at the US corporate rate less a credit for taxes paid abroad and 40 percent of those earnings would be exempt from US taxes.
Manufacturers could be impacted by many of the tax proposals presented in the Baucus draft, but several would have widely felt impact:
- Depreciation of Assets. Currently many corporations benefit from various accelerated depreciation provisions and related benefits. Under the Baucus proposal, all assets would be divided into four pools, each of which would be subject to a different fixed depreciation schedule. Treasury would be authorized to readjust asset pools to reflect technological and market changes.
- Repeal of Section 179 Expensing. Current rules allowing expensing of certain capital expenditures in lieu of depreciation would be eliminated. The new depreciation rules would apply.
- Section 199 Deduction for American Manufacturing: The staff draft requests comments on whether and how this deduction should be continued or used to pay for a lower corporate rate.
- Repeal of LIFO Accounting. This change would impact many sectors, including manufacturing.
- Corporate Alternative Minimum Tax (AMT). The draft does not take a position on repeal of the corporate AMT but requests comments on repeal as well as suggestions for how to treat unused credits.
A number of provisions aimed at oil companies and other energy companies are picked up in the Baucus draft, including:
- Qualified extraction expenditures would be treated as research and experimental expenditures.
- Percentage depletion rules under Section 613 would be repealed,
- Make Energy Tax Extenders Permanent. The staff draft calls for comments on the concept of making certain energy related tax extenders that are currently renewed one or two years at a time permanent parts of the US tax code.
Advertising Expenses. Taxpayers could currently deduct half of their advertising expenses with the remaining half capitalized and amortized over five years.
Repeal of Like-Kind Exchange Rules. The Baucus draft proposes repeal of the like-kind exchange rules. Comment is requested on substituting the "similar use" concept currently applied to involuntary conversions in place of the "like-kind" concept for real and intangible property. Tangible property (e.g., trucks, equipment) would become subject to the depreciation pooling rules.