Washington Tax Insight June 2015

 
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Background—Budget

After successfully adopting a Budget Resolution for the first time since 2009, Congress now shifts its focus to the appropriations process, which involves the approval of separate spending bills by relevant subcommittees of the House and Senate Appropriations Committees. Congressional Republicans remain far apart from President Obama and Congressional Democrats in most spending priorities, so reaching agreement by the end of the current fiscal year on September 30th on any of the appropriations bills will be challenging.

In the past, the appropriations process has often collapsed, resulting in the need for passing a Continuing Resolution (CR) before the expiration of the fiscal year, and that could happen again this year. It will also be necessary to address increasing the debt limit in the Fall, leading to major budget negotiations prior to the end of the year.

A major challenge is that House Democrats will not likely support all of the appropriations bills, which means that the House Republican leadership cannot afford to lose Republican conservatives. A second challenge will be the Senate, where 60 votes are needed to prevent filibusters of spending bills, which will be difficult without Democratic support. If Congress should successfully pass any of the spending bills, they could still face a potential Presidential veto.

Congressional Activity

Tax Extenders

House Ways & Means Committee Chair Ryan has been laying the groundwork for tax reform through the approval of a number of permanent extensions of key expiring tax provisions (“tax extenders”). Chair Ryan’s approach arguably lowers the cost of doing revenue-neutral comprehensive tax reform because these tax extenders become part of the permanent budget baseline. Since the start of the 114th Congress, the House has approved, without offsets, permanent extensions of the deduction for state and local general sales taxes, increased small-business expensing limits under section 179, tax relief provisions targeting S corporations, and tax incentives to promote charitable giving.

The House has now also approved legislation that would permanently extend a modified version of the now-expired R&E credit effective for tax years beginning after December 31, 2014. This bill includes no revenue offsets and would produce a revenue loss of $181 billion over 10 years. The bill would simplify the formula for calculating the credit and permit a portion of the credit to offset the alternative minimum tax of certain small businesses.

The R&E legislation will face opposition in the Senate and from President Obama despite the support for the R&D credit generally, largely because of the lack of revenue offsets. Senate Finance Committee Chair Hatch has not yet stated how and when he plans to address the tax extenders, but Chair Ryan has stated that if the tax extenders package is not considered as part of a limited tax reform package this summer, he plans to move the package separately in the Fall rather than as a last-minute piece of legislation before adjournment for the year.

The Highway Trust Fund and International Business Tax Reform

Prior to the Memorial Day Congressional recess, the House and Senate both approved a 2-month extension of the Highway Trust Fund in order to gain additional time to produce a long-term funding bill. Although Chairs Ryan and Hatch both indicated that they identified the estimated $11 billion in revenue offsets needed for the short-term extension, they did not disclose those offsets and the final bill did not include any.

There is consensus on the need for a 6-year funding bill, but that would require additional revenue. House and Senate leadership have ruled out a gas tax increase.

House Majority Leader Kevin McCarthy (R-CA) and other members of Congress have proposed using revenues from international business tax reform to pay for the highway funding bill. The specific proposal that has been offered by some is to tap into the one-time revenue increase resulting from a “deemed repatriation” that would occur from a shift towards a territorial regime for taxing foreign-source income. President Obama included a proposed mandatory repatriation plan in the FY 2016 budget proposal with the revenue used for highway funding. Senators Rand Paul (R-KY) and Barbara Boxer (D-CA) have proposed a voluntary repatriation holiday.  

Both Chairs Ryan and Hatch have indicated they are opposed to using international tax reform for any legislation unless it is part of a broader tax reform package. Chair Hatch recently released a Joint Tax Committee memorandum that pegged the revenue loss from the voluntary Rand/Boxer proposal would be $118 billion over 10 years. In order to produce a revenue gain, the repatriation proposal would have to be mandatory, which might result in opposition from many multinationals who would be taxed on foreign profits regardless of whether they are repatriated. Many corporations would not find that acceptable without a decrease in corporate tax rates, which is expected to be part of a comprehensive reform package.

Discussion of this proposal continues, however, especially because comprehensive business tax reform seems unlikely to occur this year; supporters say that any money raised from this kind of proposal should be used for other purposes—including some sort of limited international business tax reform package as part of the highway bill. Congressman Boustany (R-LA), who is a member of the House Ways & Means Committee, is working on an international business tax reform plan that will include a number of options for party leaders to consider. 

Miscellaneous Tax Legislation Issues

The Senate Homeland Security and Governmental Affairs Committee has approved legislation that would require public disclosure of information regarding the tax treatment of nonconfidential civil and criminal settlement agreements reached between taxpayers and federal agencies that involve more than $1 million in payments. The bill has not been scheduled for a Senate Floor vote.

Tax Reform Update—Senate Finance Committee

Senate Finance Committee working groups continue to meet and have briefed the entire Committee on their work to date, although it is not clear how much consensus has been reached. One specific point of disagreement between members of the Committee and the White House is the option of doing business-only tax reform. Senator Thune (R-SD), who chairs the Business Income Tax working group, has noted that it would be difficult to reform the tax rules for corporations without also addressing passthrough entities, whose owners pay tax on business income at individual rates.

The International Tax working group leader, Senator Portman (R-OH), however, has stated that his panel is close to reaching consensus and will be able to complete a report outlining recommendations. This working group has devoted a significant amount of time to considering the “patent box” idea, which has been adopted in the UK and The Netherlands. The use of a “patent box” means generally a low tax rate for income derived from research and development activities and is intended to stimulate domestic research jobs and discourage companies from moving their intellectual property offshore.

The Committee leadership has not yet stated whether they plan to release recommendations from the working groups to the public.

Treasury and the IRS

The Treasury Department recently issued several new proposed updates to the US Model Income Tax Convention addressing concerns related to permanent establishment (PE) status, royalties and interest, expatriated entities, and certain treaty benefits. The Treasury Department asked for public comments on the proposed changes, which are intended to address some of the issues that have arisen as part of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative (designed to address tax regimes which provide low rates of taxation, corporate inversions, and the inappropriate utilization of treaty benefits).

The IRS recently issued proposed regulations under section 7704(d)(1)(E) of the Internal Revenue Code providing guidance on qualifying income for Publicly Traded Partnerships (PTPs) from activities with respect to minerals or natural resources. To date, the IRS has been issuing private letter rulings to provide guidance, but the proposed regulations now provide an exclusive list of operations that comprise the section 7704(d)(1)(E) activities. Initial reaction to the proposed regulations indicates that paper companies may be negatively affected and there are questions about the use of PTPs by chemical companies and some of the services performed alongside exploration companies.

Tax Reform in Detail: Camp Corporate Income Tax Proposals

As noted in prior issues of this report, it appears unlikely that comprehensive tax reform will be enacted in 2015, but we believe that taxpayers should now be analyzing and understanding current proposals and ideas so that they can engage directly with government officials and as part of business groups as the debate progresses. In order to assist with this analysis, we will be looking at several of the more important proposals in detail in each issue over the next several months.

Former House Ways & Means Committee Chair Dave Camp (R-MI), who retired at the end of 2014, was a vocal supporter of tax reform and led the Committee during a very active period of hearings, including joint hearings with the Senate Finance Committee, culminating in the release of a comprehensive tax reform discussion draft proposal in February 2014 (introduced as H.R. 1 on December 1, 2014). Current Ways & Means Committee Chair Ryan is expected to use the Camp draft as a starting point for considering tax reform.

Generally, the Camp draft would reduce the top income tax rate for corporations and individuals to 25% and would move the US toward a territorial system for taxing domestic multinationals. In order to produce revenue-neutral legislation, the draft includes a number of base-broadening provisions that would impact corporations, individuals, passthroughs, and tax exempt organizations. This section provides detail on the Camp draft proposals related to the corporate tax rules.

The Camp draft calls for lowering the top statutory corporate tax rate from 35% to 25%, phasing in the reduction by 2 percentage points a year until fully phased in by 2019. The reduction in the tax rate would be paid for by significant base-broadening, including:

  • Phasing out and repealing the section 199 domestic production activities deduction.
  • Extending the amortization period under section 197 for acquired intangible assets from 15 years to 20 years.
  • Modifying the Research and Experimentation (R&E) credit and making it permanent. The draft would also require R&E expenditures under section 174 to be capitalized and amortized over a 5-year period rather than deducted when incurred.
  • Allowing a current deduction for only 50% of advertising expenses, with the remaining 50% to be amortized and capitalized ratably over a 10-year period; this change would be phased in over 3 years. The first $1 million of advertising would continue to be expensed, but that would phase out once advertising costs exceeded $2 million.
  • Repealing the Modified Accelerated Cost Recovery System (MACRS) and replacing it with rules similar to the Alternative Depreciation System (ADS). Class lives would generally be extended and depreciation deductions would be determined under the straight line method. Special depreciation provisions such as bonus depreciation and depreciation of leasehold improvement property would be repealed.
  • Repealing limitations on the general deductibility of interest (except with respect to multinational companies, which will be covered in a future issue).
  • Changing the accounting method rules by repealing the LIFO (last-in, first-out) method and the LCM (lower of cost or market value of inventory) rules, expanding the use of the cash method of accounting to businesses with up to $10 million in gross receipts, and repealing use of the cash method for businesses with average annual gross receipts exceeding $10 million.
  • Revising some rules for executive compensation including repealing the exceptions to the deduction for commissions and performance-based compensation and revising the definition of “covered employee”.
  • Adding rules on financial institutions and products, including derivatives, by  imposing an excise tax on large financial institutions and requiring all taxpayers to mark derivative contracts to market annually.
  • Repealing a number of energy tax incentives for alternativeenergy sources as well as a number of temporary energy ax extenders that were renewed for 2014 but have since expired.

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For further information, please contact:

Robert M. Gordon, Managing Director
Robert.Gordon@tpctax.com
312-235-3321

 

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