On November 8th, Donald Trump was elected the 45th president of the United States. During the transition period until inauguration day on January 20, 2017, he is working to assemble a team of advisors and cabinet members. President-elect Trump discussed tax reform as a priority during his campaign and released a package of tax proposals, but it is difficult to predict what the pace and content of tax reform will be under a Trump Administration until key appointments are made and a more detailed package of proposals is available. The key appointee for the agenda on tax reform will be Trump’s pick for Treasury Secretary, Steve Mnuchin, a former Wall Street executive who served as the campaign finance manager. Although IRS Commissioner Koskinen’s term does not expire until November 9, 2017, it is unclear whether he will be replaced sooner considering efforts by House Republicans to impeach him.
Congressman Paul Ryan (R-WI) will return as Speaker of the House with Congressman Kevin McCarthy (R-CA) as Majority Leader and Congressman Steve Scalise (R-L) as Majority Whip. House Democrats have chosen current Minority Leader Nancy Pelosi (D-CA) to retain her position, House Ways & Means Committee Chair Kevin Brady (R-TX) keeps his position and will lead the House effort on tax reform in 2017. Congressman Richard Neal (D-MA) replaces Sander Levin (D-MI) as Ranking Member on the Committee.
The Ways and Means Committee currently has 39 members, split between 24 Republicans and 15 Democrats with no announcements yet as to whether that ratio will change. Two Democrats chose to retire – Congressman Charles Rangel (D-NY) and Congressman Jim McDermott (D-WA) – and three Republican seats will be filled due to the departures of Congressmen Dold (R-IL), Boustany (R-LA) and Young (R-IL).
Senator Mitch McConnell (R-KY) will return as Majority Leader for the Republicans. His counterpart as Minority Leader will be Senator Charles Schumer (D-NY), who replaces the retiring Senator Harry Reid (D-NV). Senator Schumer named an expanded leadership team of 10 Senators including Senators Bernie Sanders, Dick Durbin, Patty Murray and Joe Manchin. Senate Democrats are viewed as the last line of defense against the Trump agenda due to the general requirement of 60 votes in the chamber necessary to break a filibuster. In the next Congress, the Senate will have 51 Republicans, 48 Democrats and one independent. Senator Orrin Hatch (R-UT) returns as Chair of the Senate Finance Committee. Senator Ron Wyden (D-OR) won re-election and returns to lead the Democrats on the Committee. Several Republican members won re-election including Senators Portman (R-OH), Grassley (R-IA), Burr (R-NC), Crapo (R-ID), Isaakson (R-GA), Scott (R-SC) and Thune (R-SD) with one member to be replaced, Senator Dan Coats (R-IN), who will retire at the end of the year.
Lame Duck Session
The GOP-controlled Congress will likely want to avoid a lengthy lame duck session in anticipation of the new administration. But with the current Continuing Resolution due to expire on December 9th, Speaker Paul Ryan has announced that House Republicans will pursue a short-term spending bill to fund the government at current levels through the end of March 2017. Senate Majority Leader McConnell has given some signs that he would also like to move a spending bill that funds the government at current levels through March 2017.
Delaying action until March on budget and spending issues allows the Trump Administration the chance to have an impact on the budget for the rest of the 2017 fiscal year and avoids a fight over these issues in the lame duck session. Some Republicans have expressed concerns about this approach, however, noting that this could result in budget fights early in the Trump Administration, which could lead to a delay in other key elements of the Trump agenda in the first 100 days.
Other issues that could be considered prior to the end of the year include the 21st Century Cures Act (a bipartisan Housepassed bill on the development of new medical treatments and prescription drugs); water and energy legislation; the Iran Sanctions Act; and the annual defense policy bill. With a short-term limited spending bill, the prospects for tax extenders legislation does not look promising, but staff representatives of SFC have indicated that a handful of noncontroversial tax bills could be approved prior to the end of the year including technical corrections and two pension-related bills.
President-elect Trump has called for a broad legislative agenda that includes tax reform, major changes to the Affordable Care Act (ACA), expanding the military, and significant infrastructure building. These are programs that will cost billions of dollars and the impact on the deficit will have to be considered by Congressional leadership as these programs are advanced by the Trump Administration in 2017.
Congressional Republicans have indicated that repeal of the Affordable Care Act (ACA) will be one of their first priorities, and they are considering use of the budget reconciliation process to advance this legislation. The chairmen of the House and Senate Budget Committees have informally agreed to do both a 2017 and 2018 budget early in the Trump Administration which could pave the way for use of the reconciliation process, which avoids the problems of a Senate filibuster by requiring only 51 votes for passage.
Post-elections, House W&M Committee Chair Brady indicated that he hopes the incoming Trump Administration will reverse position on the Treasury Department’s Section 385 earning stripping regulations. Several business groups, including the Business Roundtable, the National Association of Manufacturers and the Organization for International Investment are also taking the position that the recently finalized anti-inversion rules, including the controversial earnings stripping regulations, should be pulled back when the Trump Administration takes over. The Treasury Department has indicated that they intend to finalize the "serial inverter" rule that it proposed in the spring, which aims to prevent non-U.S. companies from engaging in multiple merger deals that allow their U.S. partners to rebase in low-tax countries, if only on paper.
Treasury and the IRS issued final regulations on certain transactions between controlled foreign corporations (CFCs) and foreign partnerships. The regulations cover the treatment of property held by a CFC as United States property in connection with certain loan or guarantee transactions involving partnerships. The final regulations also provide rules for determining whether a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining foreign personal holding company income (FPHCI), as well as rules for determining whether a CFC holds US property as a result of certain related party factoring transactions. These rules finalize proposed regulations issued in 2015 and a portion of a 1988 proposed rule. The IRS also issued proposed rules under section 1.956-4(b) so that a CFC that is a partner in a controlled partnership determines its share of US property held by the partnership under the liquidation value percentage method, regardless of the existence of any special allocation of income or gain from the property.
In Revenue Procedure 2016-55, the IRS announced several annual inflation adjustments scheduled to be effective in 2017. Included are: (1) the standard deduction which will be $12,700 (increase of $100) for married filing jointly, $6350 (increase of $50) for single filers and married filing individually, and $9350 (increase of $50) for heads of households; (2) income limit on itemized deductions of individuals will start at $287,650 or more (with $313,800 for married couples filing jointly); (3) AMT exemption increases $400 to $54,300 and phases out starting at $120,700 (with $84,500 for married couples filing jointly with phase out to begin at $160,900); and (4) personal exemption remains unchanged at $4050 subject to a phaseout beginning at $262,500 in income (with $313,800 for married couples filing jointly).
IRS Appeals Chief Kirsten Wielobob issued a letter clarifying certain changes to the IRS appeals process as a result of recent changes that had caused concern with some practitioners. These changes included a proposed shift of authority to settle cases away from the Appeals Team Case Leaders (ATCLs) to their managers, shifting most Appeals conferences away from in-person meetings to phone conferences, and allowing Chief Counsel and/or Compliance to be present for Appeals conferences. The letter stated that settlement authority would remain with the ATCLs with possible modifications to existing processes. It also indicated that Appeals will revise its procedures to be clear that a manager must review a case and propose any changes prior to the ATCL finalizing the settlement.
The Global Forum on Transparency and Exchange of Information held its annual meeting in November with 220 delegates from 84 jurisdictions and 12 international organizations to further the shared goal of improving tax transparency and achieving a level playing field. The meeting came at the completion of the first round of the Forum’s peer review process, with the release of 17 new reports assessing the level of compliance with the international standard for exchange of information on request. A special fast-track review procedure was agreed at the meeting to enable the Forum to recognize progress made by mid-2017 and to assess changes being made in various jurisdictions. A second round of peer reviews currently in progress will include an assessment of the availability of and access by tax authorities to beneficial ownership information of all legal entities and arrangements.
The EU is moving ahead with its proposals for a uniform set of rules on taxing corporation profits which would require multinational companies to pay taxes based on where their assets and employees are located and where their sales take place. These proposals known as the common consolidated corporate-tax base (CCCTB) are aimed at curbing creative tax reporting, tax evasion and sweetheart deals that some European countries have used to attract companies as reflected in the information gathered as part of the EU state aid investigations. To become law, the CCCTB needs unanimous approval from all 28 EU member states and subsequent approval by each of their national parliaments. If enacted, the law would take effect in two phases. First, companies whose European operations have more than 750 million euros a year in revenue would have to calculate their taxable profits under a set of accounting rules that apply across all EU countries. In the second phase, companies would have to pay taxes in member states based on three criteria: assets, employees and sales. The EU’s Council of Ministers will discuss the first part of the proposed rules in 2017 and will move on to the second part of the rules only after agreeing to the first.
The European Parliament Committee of Inquiry Into Money Laundering, Tax Avoidance and Tax Evasion (PANA Committee) held a public hearing titled “Anti-money laundering and tax evasion: Who assures compliance with the rules and enforces them?” The purpose of the hearing was to “learn from law enforcement bodies how the rules against money laundering and tax evasion are enforced.” One of the recommendations from experts is to set up a European register of beneficial owners of companies.
With Donald Trump winning the presidential election and Republicans maintaining control of both the House and Senate, the prospects for tax reform in 2017 have significantly increased. Following Trump’s pick of Steve Mnuchin as Treasury Secretary, the next key position to be filled will be the Assistant Secretary for Tax Policy.
Even though the path to comprehensive tax reform now looks more promising, many questions and challenges remain. Will the Republicans want to produce a bipartisan bill and compromise with the Democrats, and, if so, what approach will the Democrats take? Will Republicans try to use the budget reconciliation process to move tax reform? To what extent must tax reform be revenue neutral, and how should revenue and distributional effects be measured? If Trump pairs tax reform with infrastructure spending, will both be advanced as part of a 100-day agenda? Will the costs of an infrastructure bill be totally offset or will there be a significant increase in the federal deficit if tax reform fails to cover the costs of the infrastructure plan?
While similar in some respects, there are significant differences between the Trump tax proposals released during the campaign and key proposals in the GOP Blueprint on tax reform released this past summer. Both plans want to lower the 35 percent corporate tax rate, call for a lower rate on pass-through businesses, and suggest a deemed repatriation of offshore earnings of US companies, but they differ in many details including applicable tax rates. Most importantly, the GOP plan for corporate taxes proposes a destination-based approach that would apply taxes based on where goods, services and intellectual property are consumed (rather than produced), and calls for a “border adjustments” system that would tax US imports but not exports, while the Trump tax plan does not specifically include these proposals.
A key issue that will affect the pace of tax reform legislation and the policy therein is whether a bipartisan effort can be successful. A Trump economic advisor, Stephen Moore, has commented that bipartisan legislation is important to this effort, and Ways & Means Committee Chair Brady has stated that he would prefer to take a bipartisan approach to tax reform. He commented, “We are going to ask for and seek [Democratic] input, and listen to these ideas as we go forward. Because at the end of the day, I think tax reform is more durable and long-lasting and pro-growth if we can find common ground between Republicans and Democrats.” Ranking SFC Democrat Wyden has also voiced his support for a bipartisan approach to tax reform. Should bipartisanship not be workable or achievable, it is likely that Congressional Republicans will look to the budget reconciliation process to move tax reform legislation, since this would allow tax reform to be passed in the Senate with only 51 votes, thereby avoiding a potential Senate filibuster.
Speaker Ryan has consistently viewed comprehensive tax reform as one of his priorities for the House agenda. Post-elections, W&M Committee Chair Brady indicated that he plans to move ahead quickly on tax reform commenting “Tax reform is going to happen in 2017,” and adding that the panel will be “ready to move this early.” He plans to use the House GOP Blueprint released in June as the starting point, and his staff has been working to produce legislative language reflecting the Blueprint proposals after meeting for months with business groups and taxpayers to get their input on the proposals.
The GOP Blueprint calls for cutting tax rates for corporations, passthrough businesses, and individuals; adopting a territorial system for taxing foreign-source income of US multinationals; and moving the US toward a border-adjustable cash flow tax system without adopting an explicit consumption levy such as a national sales tax or value-added tax (although the plan functions economically as a subtraction-method VAT rather than as an income tax). His goal is to produce a revenue neutral bill measured under a “dynamic” scoring model. Whether and when legislative language might be released is unclear, and no schedule for Committee and House Floor action has been released.
House Democrats have targeted inversions and earnings stripping as well as higher taxes on corporations and wealthy individuals, but they have not produced a comprehensive blueprint to counter the GOP plan.
Senate Majority Leader McConnell has not shared the interest of Speaker Ryan in making tax reform a top priority issue. SFC Chair Hatch does support moving ahead on tax reform, but he has focused his attention in 2016 on an alternative approach consisting of a corporate integration plan lowering the corporate tax rate by combining a dividends-paid deduction with a withholding tax on dividend and interest payments. The details of his plan have not been made public to date but a Senate Finance Committee staff representative recently commented that a draft could be completed during the lame duck session.
The two leading Democrats on the issue of tax reform are Schumer, the soon-to-be Minority Leader, and Wyden, who continues as the Ranking Democrat on the Committee. Wyden has supported moving on the issue of inversions in the short term, but has also issued several discussion drafts on tax reform topics in the past several years. Schumer, who has not always aligned with Wyden on approach and policy, has been active on the topic of tax reform, supporting international tax reform paired with infrastructure spending.
Procedural Issues – Using Budget Reconciliation?
The budget reconciliation process has often been used in past years to advance targeted tax changes through Congress. A budget resolution is necessary first with the inclusion of budget reconciliation instructions, after which the legislation then enjoys certain protections including the requirement of 51 votes for passage (thereby avoiding a Senate filibuster). Under current reconciliation rules, however, the legislation must be deficit neutral over a 10-year period. If it is not, the legislation must sunset after the 10-year period. The plans currently put forward by Republicans would likely result in a significant increase in the deficit, so this issue must be addressed by Republican leadership if they decide to utilize the budget reconciliation process. An alternative to using the budget reconciliation process would require compromise with Senate Democrats, who must decide whether they want to work with Republicans to advance some of their own tax reform proposals or whether they will choose to block tax reform legislation under a Trump Administration.
Emerging Key Policy Issues in the Tax Reform Debate
One of the key issues in the tax reform debate is what the treatment will be of the offshore income being held currently by US companies – whether there will be a requirement that it be repatriated subject to a low tax rate and, if so, how will that money be used – to lower rates generally or to fund infrastructure spending. The GOP Blueprint includes a one-time deemed repatriation of deferred active foreign-source income of US multinationals with differential rates for cash (8.75 percent) and noncash assets (3.5 percent), which could be paid ratably over eight years at the taxpayer’s election. Chair Brady has stated that the one-time revenue generated from deemed repatriation should be used to offset the cost of reducing the corporate tax rate to 20 percent and the pass-through business rate to 25 percent. In contrast, other key players have supported using that revenue for infrastructure spending, notably Speaker Ryan who worked with Senator Schumer on legislation, and potentially the incoming Trump Administration. The Trump tax plan includes a one-time deemed repatriation of accumulated deferred foreign income at a 10 percent tax rate along with a $1 trillion investment in infrastructure spending, although the two proposals have been linked only by comments after the election from his advisors including Stephen Moore.
Another proposal in the House GOP Blueprint which has drawn interest relates to “border adjustments” and provides that exports would not be subject to US taxes regardless of where they were produced, whereas imports would be taxed in the US regardless of where goods were made, with businesses taxed not on where the headquarters are but where they sell their goods. This proposal was not included in prior year tax discussion drafts so input from the business community has been requested. Some advocates of this proposal believe it will gain bipartisan support, raise over $1 trillion worth of revenue over a 10-year period and help stop the increase in inversions, but it could also result in a significant tax increase on retailers, which will make it controversial.