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ALERT

FOR STAKEHOLDERS IN TAX REFORM, IT IS NOW OR NEVER TO BECOME INVOLVED

The September 27 release of the United Framework for Fixing Our Broken Tax Code (the “Framework)  by the “Group of Six” (Senate Majority Leader Mitch McConnell (R-KY), Senate Finance Committee Chairman Orrin Hatch (R-UT), Speaker of the House Paul Ryan (R-WI), Ways and Means Committee Chairman Kevin Brady (R-TX), Treasury Secretary Steve Mnuchin and National Economic Council Director Gary Cohn) marked the formal beginning of the legislative process which the Republicans hope will result in a tax reform bill that will be signed into law by the end of this year. The odds are long but their goal is not impossible.  

Those with any interest in having an impact on provisions in tax reform should be engaged immediately. Chairman Brady would like to begin marking up the Ways and Means Committee’s version of tax reform within 30 days, and Chairman Hatch could begin the Senate Finance Committee’s markup of its version by as early as mid-October.   Although this time line could shift, any stakeholder with the desire to get its positions before tax policy makers and influencing the outcome must act on the best available information on timing. 

The Ways and Means Committee will begin its markup process with a fully drafted bill.   The Senate Finance Committee normally does not begin with a draft bill but with a set of detailed principles and proposals. In either case, months of staff work have produced policy options along with detailed and drafted language. Decisions on which options to adopt will not be made in a vacuum but only after significant input from those with an interest in their outcomes. 

The Framework was very carefully drafted so as to provide flexibility to the tax writing committees. For example, it is not clear whether the opportunity to write off business assets in the year acquired applies to commercial buildings. The proposal to disallow net interest deductions applies to C corporations but it is not clear whether it applies to pass through entities like LLCs and partnerships. The Framework would preserve the mortgage interest and charitable donation deductions but left open whether these deductions would be capped for taxpayers above certain income levels. There is also the likelihood that there will be an additional top individual rate over 35 percent but the income level at which that whatever rate that might be is left to the policy makers. It is also unclear whether deductions for state and local taxes would remain who repealed, although the Framework leans heavily in the direction of repeal. 

The Framework provides for a separate 25 percent rate for pass through entities but does not describe the safeguards that would be provided to ensure against high income taxpayers converting to their businesses to pass throughs so as to become eligible for the lower rate. The Framework also does not address how it will treat the taxation of capital gains and losses or how they might be treated in private equity firms and hedge funds organized as pass throughs. The allowance for like kind exchanges under section 1031 of the Internal Revenue Code is also not addressed in the Framework, but rumors have circulated that it could be repealed. 

The Framework would preserve corporate tax credits for R&D and for affordable housing but would put every other corporate tax expenditure on the table. Chairman Brady has said that it will be his Committee’s work to repeal as many of the remaining corporate tax expenditures as possible. Those interested in maintaining their particular corporate tax credit or deduction should be working now with their Congressional delegations to demonstrate their value to economic growth and job creation which are the underlying goals of tax reform. At the very least, they should be working on long term phaseouts of these credits and deductions.  

The Senate Finance Committee also may seek to apply a concept called corporate tax integration to its tax reform bill. Its proposal would allow corporations to deduct their dividends paid but would tax those dividends to shareholders regardless of the tax status of the shareholder. The idea behind this proposal is to eliminate the double taxation of corporate earnings and to equalize the treatment of debt, the interest on which is deductible and equity, where dividends are not currently deductible. The dividends paid deduction proposal, as it is called or the DPD, would make investment by corporations in tax favored items such as R&D and affordable housing less attractive. Pension funds and private foundations which hold heavy stock interests in corporations would be subject to taxation for the first time on the dividends paid out by these corporations.  

The task of writing a tax reform bill that can go to the President’s desk by the end of this year has begun in earnest. The staffs are working around the clock and seven days a week to meet that schedule. Stakeholders in tax reform should be equally as active.

 

 

TAX REFORM AND THE IMPACT OF THE EFFORT TO REPEAL AND REPLACE THE ACA

The debate over the repeal and replacement of the Affordable Care Act (“ACA”) is having a significant impact on the timing, shape and potential outcome of tax reform. The House bill that would repeal and replace the ACA includes the termination of $600 billion in tax increases which funded the subsidies under the ACT, such as the 3.8 percent tax on investment income. The shape of the tax reform bill now under development in the House Ways and Means Committee depends on whether the repeal of those taxes has been signed into law. If those taxes are repealed, then the Ways and Means Committee will have greater flexibility with regard to maintaining a number of corporate and individual tax credits and deductions. As the debate in the House and the Senate continues to play out on the resolution of replacing and repealing the ACA, the uncertainty will continue surrounding what tax breaks can remain or be modified in the House tax reform bill.

Senate Majority Leader Mitch McConnell has confidently predicted that the Senate will pass ACA repeal and replacement legislation in the Senate prior to the Easter Recess. He plans to send the bill that passes the House – assuming the House can pass a bill – directly to the Senate floor and bypass the Senate Finance Committee. There are a lot of “ifs” in this timeline, not the least of which is whether the House Freedom Caucus and Senator Rand Paul and his allies in the Senate will vote for the legislation promoted now by the House leadership. For his part, Ways and Means Committee Chairman Kevin Brady has said that his Committee will begin to take up tax reform in the Spring and pass a bill trough the House in the Summer. Chairman Brady’s timeline for tax reform depends entirely on whether a bill repealing and replacing the ACA can make its way to the President’s desk in early Spring.

The tax reform effort itself is fraught with uncertainty largely surrounding the so-called Border Adjustment Tax (the “BAT”) which would forgive corporate taxes on exporters and impose corporate taxes on importers. The BAT would raise over $1.2 trillion over 10 years and is needed to maintain the revenue neutrality of the House tax reform bill. Revenue Neutrality is important because if the bill were to lose revenue outside a 10 year budget window, the bill would only last for 10 years like the tax cuts passed under George W. Bush. The problem with the BAT is that US retailers are strongly opposed and have won over many Republicans in the Senate to oppose a BAT. Many key Republicans in the House represent retailers and would be hard pressed to vote for a tax reform bill that contains the BAT if they know that it will not pass in the Senate. These Republicans would have severely hurt their re-election chances on an unnecessarily harmful vote. In addition to those Republicans, many others are opposed to the BAT because they regard it as a tax increase that will fall on middle Americans. The House Leadership appears to be firmly behind the BAT because they know that without it, they would have to propose the repeal of many popular tax breaks in order to keep the corporate and individual tax breaks low. An effort by previous Ways and Means Committee Chairman Dave Camp took the route of repealing those tax breaks and failed before it even got out of the starting blocks.

The Senate Finance Committee is keeping its powder dry on tax reform while the ACA repeal and replacement effort and the House tax reform process plays out. Leader McConnell has publicly stated that he does not see tax reform happening until later this year. He is also looking to the White House to provide leadership on taxes and whether the President supports the concept of a revenue neutral tax reform bill or, rather, an across the board cut on corporate and individual tax rates in the same vein as the Bush tax cuts. The President is not expected to completely show his hand on taxes until late April or early May when his Budget is released. His proposal, even in outline form, has been delayed by the fact that his Treasury tax policy team is not yet in place and that his White House economic policy team is severely understaffed.

Regardless of the eventual outcome, the staffs at the Senate Finance Committee and the House Ways and Means Committee are busy drafting alternative proposals and meeting with interests that would be affected by tax reform. Even the understaffed White House team, led by the National Economic Council, is meeting with outsiders with a stake in tax reform. Those experienced in the ways of past tax reform efforts in Washington understand that meetings that take place months before any final legislation is sent to the President are critical to the development of that legislation.

THE HOUSE REPUBLICANS PRODUCE A TAX REFORM BLUEPRINT FOR 2017
Led by Speaker of the House Paul Ryan and Ways and Means Committee Chairman Kevin Brady, the House Republicans just released a tax reform blueprint that will be a key plank on which they will run in November and then seek to pass in 2017. It is highly unlikely that any compressive tax reform measure will pass in 2017 regardless which Party wins the White House and controls the Senate or the House. However, the tax reform plan released by the House Republicans demonstrates their commitment to a simplified, pro-growth tax system. Those lobbying the House on tax matters must keep the blueprint in mind in calibrating their approach.

The principal feature of the blueprint is a deep cut in the top corporate tax rate from 35 percent to 20 percent. To arrive at that goal, the plan specifically would eliminate the deductibility of corporate interest and would repeal most other corporate tax expenditures but without singling them out. Supporters of the tax expenditures on which the blueprint is silent would be wise in the coming months to pound the halls of House lawmakers to make the case for their retention in a reformed tax code.

As for individuals, the plan calls for reducing the number of individual tax brackets to three from seven, with rates set at 33 percent, 25 percent and 12 percent, compared to the current range of 10 percent to 39.6 percent. It would offer a substantial cut on capital gains and dividends, a provision aimed at rewarding savings that are invested. They'd be taxed at 16.5 percent, 12.5 percent or 6 percent, depending on how much the investor earned. The top rate is currently 23.8 percent. The plan would dramatically expand the standard deduction as well as the child tax credit by consolidating various exemptions and credits. That would drastically cut the number of people who itemize their deductions, to about 5 percent, Republicans estimate, from the current one-third. Though the plan does not say how they intend to change the mortgage and charitable deductions, it says tax writers are looking for ways to make them "more effective and efficient."

With regard to multinational companies, the plan would move to a so-called territorial system, where the government would not attempt to tax companies' overseas profits. The plan would apply a one-time 8.75 percent tax on money that is already overseas in liquid assets, with a 3.5 percent tax on money invested abroad in things like factories.

As we analyze the House tax reform blueprint further, we will provide additional reports in the coming weeks.

The Elections and the Prospects for Tax Reform

The election of Donald Trump to be President of the United States has clearly shaken up Washington like no other election in U.S. history. Trump ran on a platform that was not ideological but populist in nature. However, on tax policy he has supported tax reform that generally is within the Republican framework and made it a top priority. He advocates tax reform that would set the top corporate rate at 15 percent. A rate that low would not leave any room for tax expenditures. Even the House Republican Blueprint would not set the top corporate rate that low (its rate is 20 percent). The recently completed House Ways and Means Committee Republican retreat resulted in a vote by the Members to keep a few tax expenditures. In that regard, Ways and Means Committee Chairman Brady made it clear that he would like to release legislative language as early as February. That will be easier said than done. The process of rewriting the tax code is enormously complex, and the transition from the current system to a new system presents major challenges. Stakeholders in tax reform also began making their cases -- both protecting current interests and advancing new policies -- within days of the election and will continue unabated through the year.

The House and Senate Republican Leadership and President Elect Trump are on the same page on making tax reform a very high priority. They have made it clear that they will seek to pass tax reform through the Budget Reconciliation process whereby the Minority in the Senate cannot stop legislation with the filibuster. The process will involve the passing of an FY2018 budget resolution in April which will call for tax reform. The House Ways and Means Committee will then proceed to markup with its Blueprint. The Senate Finance Committee Republicans will also proceed in regular order sometime in late Spring, and they have not bought into the Blueprint. Indeed, Chairman Hatch has shown some skepticism as to the announced rapid pace of tax reform in the House. He experienced the process which led to the Tax Reform Act of 1986 and understands fully that it is likely to be a very extended process.

Chairman Hatch also intends to introduce his long promised corporate integration tax reform proposal sometime next year. It would provide for a deduction for corporations for dividends paid, but also withhold taxes (right now at the current rate of 35 percent) on dividends paid to shareholders, regardless of tax status. That proposal has occupied the time of his staff for months. They are serious and so is he. However, it also appears that his proposal may have little support among his fellow Republicans on the Senate Finance Committee. Time will tell to what extent tax reform includes the Hatch corporate tax integration concept.

Chairman Hatch is also wary about passing tax reform through the budget reconciliation process which could result in legislation that attracts few Democratic votes. Most agree that for tax reform to be accepted by the Nation, it should pass with bipartisan support. The 1986 Tax Reform Act passed with over 80 percent of the support of Congress. The Republican Majority in the Senate is narrow and will require Majority Leader McConnell to reach across the aisle to Minority Leader Schumer on any reform effort if he wishes to have bipartisan support. If not, he would try to ram a bill through under the budget reconciliation rules.

The next Congress begins on January 3, and there will be no let up, particularly through the new President's first 100 days following his Inauguration on January 20. The first orders of business will be repeal of the Affordable Care Act, the roll back of regulations and the confirmation battles over the new President's nominations. These matters will not be easy, and the Democrats will not simply roll over. Meanwhile, an army of lobbyists will be marching across the Hill on a sustained basis to preserve and protect various interests and to advance new proposals in tax reform. The action will be nonstop.

For more information on the House Blueprint itself, please see below.

The House Republican Blueprint for Tax Reform

The following link contains the details of the House Republican Blueprint for Tax Reform which they will seek to adopt in 2017. It would provide for a top corporate tax rate of 20 percent and expressly preserve only the R&D tax credit for corporations. It would reduce the individual tax rates and provide for a territorial tax system for multinational corporations. The plan is unlikely ever to become the law of the land, but it provides insights into the policy direction of the House GOP Leadership and the influence of the House GOP Freedom Caucus which wields increasing clout.

Download the Republican Blueprint for Tax Reform here


Tax Legislative Solutions, in partnership with Total Spectrum, is well prepared to work with clients this year in framing and executing major education efforts. We will focus not only on sustained efforts on Capitol Hill but also on effective measures back in the States and Congressional Districts. Through local media and intelligent use of social media, we can assist in driving legislation or blunting harmful legislative initiatives. On the other hand, we also understand that more discrete efforts can be especially effective as the issue and client interest warrant.

James Miller
Partner
Total Spectrum/Steve Gordon & Associates
507 Capitol Court NE #100
Washington, DC  20002
Cell: (202) 489-3711
www.totalspectrumsga.com

 



 

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