Republican “Blueprint” Aims at Designing a Simpler Tax Code
On June 24th, House Republicans released the most recent of six proposals in House Speaker Paul Ryan’s “A Better Way” initiative, a “Blueprint” to act as the basis for potential tax reform to be legislated upon in 2017. The blueprint was created by the Tax Reform Task Force, headed by Ways and Means Chairman Kevin Brady. It focuses on simplifying the existing tax code, increasing economic growth in the U.S., and restructuring parts of the IRS. In short, the plan hopes to make our “broken tax code” more straightforward and fair.
For businesses, the Blueprint outlines a number of revisions, listed below:
- Lessen the corporate tax rate to a flat tax of 20%. This is a sizeable reduction from the current maximum corporate tax rate of 35%. The double taxation of corporate income will also be favorably affected by the lesser taxes on dividends and capital gains for shareholders.
- Eliminate net operating loss (NOL) carrybacks and instead allow NOLs to be carried forward indefinitely, with an additional amount added to the carryforward based on “an interest factor that compensates for inflation and a real return on capital.” Additionally, a limitation of 90% of taxable income would be applied to the deduction of NOL carryforwards.
- Immediately expense all business investment costs in both intangible and tangible property, excluding land. This quick write-off would be in lieu of depreciation and amortization and would function similarly to the way the Section 179 expense deduction does today. However, this change would do away with the value of Section 179 as a separate election, since assets would no longer need to be capitalized and depreciated, with the added benefit of allowing taxpayers to take an immediate deduction. Ideally, economic growth would be bolstered by the lack of tax on new investments.
- Allow the deduction of interest expense against interest income only, with any net amount of interest expense remaining carried forward and deducted against future interest income indefinitely. This would eliminate interest expense as a regular deduction on the tax return, and limit its utility to cases wherein interest income has been earned by a company. Since interest income fulfills a unique role in some industries, specific rules will be drafted in the future to be applied to affected companies.
- Get rid of the corporate alternative minimum tax (AMT).
- Remove unstipulated “special-interest deductions and credits” – such as the domestic production deduction – which the Blueprint views as “crony capitalism” causing businesses to center decisions around tax implications as opposed to economic impacts.
- Maintain the last-in, first-out (LIFO) method of accounting for inventory, with the potential for an updated treatment of inventory in the future.
- Transition to a territorial tax system. This “destination-basis tax system” would pursue “the location of consumption rather than the location of production,” by taxing imports and exempting exports. This is referred to in the Blueprint as a “cash-flow based approach.”
- Permit a 100% exemption for foreign subsidiary dividends, in order to remove the “lock-out effect” currently preventing American companies from reinvesting their foreign income in America due to tax costs. There would also be a repatriation tax on currently accumulated foreign earnings that previously had not been repatriated under the existing tax code, in order to ensure that funds covered by the current tax code were appropriately taxed upon repatriation. Presently accumulated foreign earnings would be taxed at 8.75% if held in either cash or cash equivalents, or 3.5% if not. Businesses would be permitted to pay any tax due over the course of 8 years. This could make “more than $2 trillion in foreign earnings” available to American businesses; and,
- Revoke the majority of the subpart F rules, while simplifying international tax regulations. Foreign personal holding company rules may be preserved to “counter the potential for truly passive income to be shifted to low-tax jurisdictions.” The Ways and Means Committee will also evaluate the future treatment of individual persons living and working in foreign countries.
The Blueprint suggests that the above modifications may allow the United States to maintain “internationally competitive” tax rates, as well as internally boost its economic growth by forcing companies to focus on the best economic decision making, rather than what tax implications their business decisions might ultimately have. The reduction in the corporate tax rate, when combined with the proposed cross-border changes and territorial tax system, is anticipated to stop the recent uptick in inversions.
At the individual level, the Blueprint proposes the following changes:
- Reduce the number of tax brackets from the current 7 to only 3 brackets. The new brackets would be taxed at 12%, 25%, and 33%, respectively. This is a noteworthy reduction from the current top tax rate of 39.6%.
- Remove the Alternative Minimum Tax (AMT) for individuals.
- Establish a new tax rate for sole proprietorships and pass-through entities, rather than taxing them at the individual tax rates of their owners. This tax for “active business income” would be limited to 25%. Any “reasonable compensation” paid to the owners of these entities for their services would be taxed at the graduated individual tax rates, and therefore deductible at the business level. Coupled with the elimination of individual AMT and estate and generation-skipping transfer taxes, this revision would significantly benefit small business owners in America.
- Combine multiple existing tax benefits for families into two larger deductions; a standard deduction and a child and dependent tax credit. The existing basic standard deduction, additional standard deduction, and personal exemption for a taxpayer and spouse would become the new, larger standard deduction. The current personal exemption for children and dependents and the child tax credit would be rolled into the new child and dependent tax credit.
- Do away with any itemized deductions currently permitted, with the exception of the charitable contribution deduction and the mortgage interest deduction. The Ways and Means committee could make changes to the remaining deductions in order to improve their efficiency going forward. Any changes to mortgage deductions would be on a prospective basis only and would not affect existing mortgages or mortgage re-financings
- Eliminate both estate taxes and generation-skipping transfer taxes.
- Alter the taxes applicable to interest income, dividends, and capital gains by allowing individuals a 50% deduction on these amounts, with the remainder subject to the graduated tax bracket that the individual falls within. This effectively leads to investment income and capital gains being taxed at rates of 6%, 12.5%, and 16.5% depending on the income of the individual. The current top tax rate for dividend income and capital gains is 20%. This offers individual taxpayers some relief from the double taxation of investment income inherent in the fact that investments are initially made with after-tax dollars.
- Simplify existing tax benefits surrounding education in order to “enable taxpayers to understand better the tax benefits for which they qualify.”
The blueprint also notes that a large number of individual deductions, exemptions, and credits identified as “special-interest provisions” would be eradicated with the new tax plan, though the specifics of which ones might be removed remains unstipulated at this time. The overall intent of the revisions to the individual requirements is that the average American will be able to file a tax return simple enough to fit on a postcard. Further information about changes to individual taxation proposed by the Blueprint is available on the initiative’s website.
The final modifications recommended in the Blueprint relate to a restructuring of the IRS, as follows:
- Structure the agency into three larger units: families and individuals, businesses, and “small claims court.” The latter would act independently of the IRS in order to rapidly mitigate minor disputes. The revamped IRS would require all of its units to answer to a “taxpayer bill of rights,” in order to center its focus on “service first.” Likewise, the IRS workforce would be “specifically trained to handle matters relevant to taxpayers in their particular area of responsibility” and equipped with updated information technology structures; and
- Alter the leadership structure of the IRS to allow for a presidentially-appointed Administrator, subject to the “advice and consent of the U.S. Senate.” The Administrator would be appointed for a 3-year term, and the president could only reappoint the Administrator one time.
These improvements would encourage a more efficient system and a better utilization of the resources that taxpayers provide to fund the IRS while eliminating any unnecessary regulations. Taxpayers could more easily communicate with the modernized IRS, and tax laws would be implemented in an impartial fashion that encourages taxpayer trust in the IRS.
The Path Toward Enactment
It is vital to note that the proposed changes are highly preemptive. The Blueprint will serve as a foundation for future legislation to be drafted by the Ways and Means Committee. The resulting legislation is not likely to be legislated upon until 2017, though there is a possibility of further delays due to the current political environment. Ultimately, legislation on tax reform will be heavily influenced by the outcome of the upcoming 2016 elections. Regardless, the Blueprint presents substantial changes to the foundation of the existing tax code. If the proposed reform is enacted, much more legislation will need to be passed to clarify the handling of the many intricacies that extend beyond the foundation of the tax code, which places us at the very beginning of a new process if such a broad tax reform were to occur.
If you would like to share your opinion on the Blueprint, the Ways and Means Committee provides a form for comments here.