This is the first in a regular series of Washington Tax Insights, in which True Partners Consulting—in conjunction with the Tax Policy firm of Beckham Advisers, LLC—will share the insights of our D.C.-focused Federal tax policy experts. We hope that this will help clients and friends of True Partners better understand and plan for potential changes in Federal tax law.
The key question for 2015 with respect to tax policy legislation is whether the Administration and Congress can find areas of compromise or whether there will be gridlock with respect to tax issues. Both parties have identified tax reform as one of the few priority issues on which they believe agreement is possible, but fundamental differences on immigration, healthcare, and economic policy will make agreement on tax reform very challenging for the last two years of President Obama’s administration.
The first test for the Republican-controlled Congress will be to agree on a budget resolution, which could allow them to move on to budget reconciliation legislation. Reconciliation could then be used to incorporate some of the Republican key policy issues for 2015, although that legislation could still be subject to a Presidential veto.
If internal conflict among Republicans derails the budget, however, the Republicans will find it very difficult to move any legislation of significance this year without some Democratic support. Such a failure could affect key Senate races in 2016, when the numbers are tough for the Republican Party—24 GOP senators are up for re-election vs. only 10 Democrats.
Budget issues will dominate the agenda for 2015. In light of the difficulties of reaching agreement on tax reform under even the best circumstances, it appears very unlikely that tax reform legislation will pass this year. The tax-writing committees are both engaged in significant activity to lay the groundwork for future consideration of tax reform, however, and we advise taxpayers to actively monitor and participate in this ongoing study and debate.
The most urgent budget issue for 2015 is to increase the statutory federal debt ceiling limit. A temporary debt limit suspension expired March 15, 2015, but the Treasury Department can use “extraordinary measures” to avoid immediate default; it is expected to do so (as it has many times in the past). According to some projections, these extraordinary measures are not expected to be exhausted until October or later so resolution of this issue may not take place until autumn. In the past, debt limit legislation has provided an opportunity for Congress to consider deficit reduction and changes to the tax law. Default on the federal debt can trigger a government shutdown, although Senate Majority Leader McConnell (R-KY) has stated that this will not occur under a Republican-controlled Congress.
A Budget Resolution is the first step in the annual budget process; it outlines the spending and tax changes required to meet the budgetary goals. After approval of the Budget Resolution, various House committees will work to advance appropriations bills that carry out the instructions included in the Budget Resolution. Congress will need to agree on spending bills for FY 2016 by September 30, 2015, or else compromise with a short-term spending bill (commonly called a Continuing Resolution).
House Republicans issued their budget proposal for FY 2016 on March 17, and approved it in the full House on March 25. The Senate Republicans released their proposal on March 18 and approved it in the full Senate on March 27.
The House budget proposal had very little detail on tax issues but stated “our budget calls for compre-hensive reform that would include lower rates for individuals and families as well as large corporations and small businesses.” The proposal does not specify which tax breaks might be targeted to finance tax reform other than referring to “special interest loopholes.” The proposal does specifically call for the repeal of the alternative minimum tax (AMT) and a “transition away from a worldwide tax system to a more competitive international tax system.” The overall budget proposal assumes the expiration of expiring tax provisions (“tax extenders”) in order to get to a balanced budget in 2024, but there is explanatory text commenting that the baseline should not require that extending these provisions be offset with revenue increases.
Budget reconciliation is a tool that can be used as part of the budget process to facilitate consideration of deficit reduction and tax law changes. The party in control can use it to move legislation that is con-troversial: under Senate rules, legislation generally needs 60 votes to advance (due to the filibuster rules), but under the reconciliation procedures a bill can pass with just a majority vote (although it can still be vetoed by the President).
There has been some discussion of using the reconciliation procedures to pass tax reform, but this ap-pears unlikely this year due to the interest in dealing with the Affordable Care Act. Senate Finance Committee Chairman Hatch (R-UT) opposes using reconciliation for consideration of tax reform, and many Members want to ensure that there is bipartisan support for such legislation. Also, reconciliation rules prohibit any permanent law change if it would result in a revenue loss beyond the 10 year budget window; this rule would complicate tax reform legislation.
Congress may be faced with resolving the debt limit ceiling issue at the same time it is working on the budget, which could facilitate a “deal” on the budget issues—or conversely complicate both issues. The White House has long refused to negotiate on budget and tax policy issues in return for an increase in the debt ceiling limit. If the Congress does not agree on a budget for the new fiscal year, then sequestration would apply, resulting in automatic budget cuts to domestic and defense programs until Congress passes a budget.
Finally, taxpayers should keep in mind that under Congressional budget rules, tax legislation must gen-erally be “revenue neutral”—that is, any reduction in taxes must be “paid for” with other revenues.
Tax policy priorities for 2015 will likely be single-issue items that are considered against the background of larger unresolved tax policy concerns including tax reform, frequently expiring tax provisions (“ex-tenders”), budget issues such as the debt ceiling, and long-term federal transportation funding.
We believe tax reform legislation will not advance significantly in 2015. Both tax-writing committees will be focusing on the preliminaries to tax reform— hearings, working groups, reports, recommendations, and proposals—rather than actual legislation. But taxpayers will need to take these efforts seriously because both the Republicans in Congress and the White House have said that they want to work together on tax reform, even though they are far apart on specifics.
A major issue is whether tax reform should be “comprehensive”—covering both corporations and businesses that pay tax through the individual tax system—or cover only corporate and international issues. House Ways & Means Committee Chairman Ryan (R-WI) has stated that he would prefer to advance comprehensive tax reform.
Early in 2015, Chairman Hatch outlined 7 broad principles for tax reform focusing on economic growth, lower tax rates, a broader tax base, reduced complexity, stability, and competitiveness, promotion of savings and investment, and revenue neutrality.
The Senate Finance Committee (SFC) has established 5 bipartisan working groups on specific tax policy areas: individual; business; savings and investment; international; and infrastructure and community development. These working groups are expected to produce an in-depth analysis of options and report their legislative recommendations to Chairman Hatch and Ranking Member Wyden (D-OR) by June 1, 2015. This report could then be the foundation for developing bipartisan tax reform legislation.
The SFC has invited the public to submit input on reforming the tax code through written comments due by April 15. The Committee has also invited certain taxpayers to present their comments to the working groups in person.
The SFC has held a series of hearings (with pamphlets issued) on tax reform topics including International (March 17); Complexity, Compliance and Administration (March 10); Fairness and Progressivity (March 3); and Economic Growth (Feb. 24).
During the SFC hearing on international issues on March 17, Chairman Hatch said that the US corporate tax rate should be lowered in tandem with a “shift significantly in the direction of a territorial tax sys-tem,” and he expressed concerns that a minimum tax on foreign earnings could backfire and hasten corporate inversions. In his questions to various witnesses, Ranking Member Wyden focused attention on base erosion, deferral, and tax-planning techniques to minimize income and ways to address these issues.
On March 3, the SFC Democratic staff issued a report on “tax avoidance strategies” utilizing financial products and deferred compensation, titled “How tax pros make the code less fair and efficient; several new strategies and solutions.” The report was issued in conjunction with the SFC hearing on “fairness” in the tax code. Democrats have called on the Administration to act unilaterally on some of these issues through regulation.
In December 2014, the Republican Members of the SFC issued a lengthy report on tax reform titled “Comprehensive Tax Reform for 2015 and beyond.”
There has been less public activity in the W&M Committee in 2015 for two reasons. Since taking over the Committee after the November elections, Chairman Ryan has been organizing his staff and his agenda for the year. During the tenure of the prior chairman, Dave Camp, the W&M Committee held extensive hearings on tax reform and issued a number of draft legislative proposals, all of which are considered to be useful starting points for considering tax reform. Many of the current members of the Committee were involved in the significant work that was done previously so the W&M Committee should be well-prepared for the tax reform debate.
The Committee held a hearing on January 13 to focus on economic growth and job creation, which in-cluded a discussion of tax reform. There was also discussion of the policy implications of “dynamic scoring”, which is a budget estimating concept that was adopted by House Republicans the first week of January. Dynamic scoring seeks to incorporate larger growth effects from potential changes to tax law. In the Senate version of the FY 2016 budget resolution, the use of dynamic scoring is not mandated but is recommended to be used on a nonbinding, advisory basis. This could present an interesting situation where the House and Senate are using different assumptions for measuring the budgetary effects of legislation.
The President released his FY 2016 budget on February 2, 2015, which included nearly 200 tax policy changes that are outlined in the 312-page “Green Book” that is the Administration’s annual summary of proposed tax changes.
The proposals are generally the same as in prior years. A principal proposal is to decrease the corporate tax rate to 28% with an effective tax rate of 25% for domestic manufacturing. In the international area, a new proposal would impose a 19% minimum tax on foreign earnings that would require US companies to pay tax on all of their foreign earnings when earned, after which earnings could be reinvested in the United States without additional tax. A one-time 14% transition tax on the accumulated overseas earnings of US companies would also apply. Proposals addressing inversions and interest stripping are also included.
There are proposals to limit tax expenditures for wealthy individuals, raise capital gains taxes, impose the so-called “Warren Buffet” minimum tax, collect a fee on certain large leveraged financial firms, and repeal the LIFO method of accounting. Also included are proposals to extend the exception under sub-part F for active financing income, extend the look-through treatment of payments between related controlled foreign corporations, and permanently extend and expand the R&E tax credit.
In response to comments by White House Press Secretary Josh Earnest that the President might take executive action to make progress on his tax reform goal, House W&M Committee Chairman Ryan and SFC Chairman Hatch sent a letter to Treasury Secretary Lew urging him not to support action by the Administration to address tax loopholes and other tax reform by executive action.
Congress will need to address the May 31 expiration of federal highway program authorization legislation. An increase in federal fuel excise taxes (which have not been increased since 1993) has been suggested as a revenue source for this legislation but many Members remain opposed to this as a funding source.
There is also interest in the SFC in advancing energy tax legislation. Ranking Member Wyden is working on proposals that would “level the playing field” between fossil fuels and alternative energy, so it is possible that there could be consideration of this in the SFC later this year.
The “carried interest” issue continues to be a priority for many Congressional tax-writers. Current rules allow managers of private investment funds to pay a long-term capital gains rate of 20% on the money they earn from their work for clients. The President’s budget proposal included a change to the carried interest rules and Democratic proposals in the past have repeatedly included this issue as revenue offset in tax bills. The Camp tax reform draft proposal from the last Congress also included changes to these rules. It is likely that consideration of this issue will be included in the tax reform debate, although there is always a risk that an issue like this could be “cherry-picked” to be used as revenue offset for miscellaneous tax legislation.
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Robert M. Gordon, Managing Director