Senate Finance Committee Chairman Max Baucus (D-Mont.) unveiled a tax overhaul discussion draft last week, sequenced as three parts, which his committee staff says will modernize and simplify an outdated U.S. tax code.
The first released section addresses foreign corporate earnings, intended to lower the corporate statutory tax rate to an amount that is more competitive with foreign markets and induces multinational businesses to repatriate and invest foreign earnings and operations into the United States—ending the so-called “lock-out effect” on corporate cash. The “check the box” rule, a provision that permits businesses themselves to determine how to classify subsidiaries, would be limited in applicability for foreign subsidiaries.
One key provision could raise corporate borrowing costs, by ending a tax exemption that foreign investors recieve on interest of U.S. corporate debt, known as the portfolio interest exemption. Without the exemption, non-U.S. investors would be subject to as much as a 30% tax witholding upon earned interest from U.S. corporate bonds. As close to a quarter of all outstanding U.S. corporate debt is foreign-owned, removing this exemption has the potential of squeezing U.S. corporate debt markets.
The Baucus international tax draft is broken into two income-taxing options on earnings sold into foreign markets:
Option one would set up an immediate tax on income at 80 percent of the U.S. corporate tax rate, supplemented by full foreign tax credits and exemptions on repatriated earnings.
Option two would tax active business operations income at 60 percent of the U.S. corporate rate, whereas passive and highly-mobile income would be taxed under the full rate, also supplemented by full foreign tax credits and repatriated earnings exemptions.
As a one-time measure, historical foreign earnings that have not been taxed under U.S. jurisdiction would be granted a reduced rate of 20 percent, upon being repatriated.
The second released draft focuses on broader administration of tax filing, proposing stricter penalties on tax-related identity theft and new tools for tax fraud prevention. It also seeks to expand electronic tax filing and provide the IRS with greater oversight of tax return preparers.
To reduce the tax gap, the plan increases information reporting requirements within various areas, including a request that banks report existence of all bank accounts on record, regardless of whether or not they are interest bearing, during a given taxable year. Businesses would also have to show the gross amount of receipts and expenses reflected in separately-filed Forms 1099 by disclosing the breakdown amounts on their Form 1040.
Details of the third draft
The third draft addresses cost recovery tax expenditures and accounting, revealing what the offset expense would be in current deduction rules for reducing the statutory corporate rate in a revenue-neutral manner.
Pointing out that current accelerated depreciation rules establish undue preference for tangible assets over intangible assets and human capital, considered equally as important to today’s economy, the plan recalibrates write-off rules to reflect a more leveled treatment among industries with rates approximated by the Congressional Budget Office. Rather than write-offs on an individual asset basis, tangible assets would be grouped into four pools more accurately aligned with their speed of deduction with rates set under a value percentage each year—38 percent, 18 percent, 12 percent and 5 percent.
Accounting valuation method, last-in and first-out (LIFO) would be repealed. The advertising industry, which currently enjoys an immediate full expense deduction, would be allowed only half the deduction immediately and the rest amortized over a five-year span. Business research and development would also be deducted over a five-year period, instead of immediately, as would expenses incurred in natural resource extraction.
These reforms, if enacted, would constitute the first overhaul of the federal tax system since the Tax Reform Act of 1986. Certain elements in the Baucus plan have been pitched in the past, and Baucus’ House counterpart, Rep. Dave Camp (R-Mich.), has floated variations of these reforms within his own House Ways and Means Committee with tepid reception. Still, all parties agree current federal tax code is out of sync with today’s economy and lacks the necessary incentives for growth.
Senate Finance Committee is currently requesting public comment on these proposals, under a January 17, 2013 deadline.