Snell & Wilmer
Legal Alert
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February 15, 2017
Tax Reform in 2017? What is in Store for U.S. Businesses
by Bahar A. Schippel and Soheila Shahidi

With Republicans in control of the White House and Congress, one of the top priorities is tax reform. President Trump’s tax reform proposal and the House Republicans’ tax reform “Blueprint” suggest many changes to business and individual tax provisions. While many eagerly await tax law reform, it is difficult to begin planning for the changes in light of competing proposals and uncertainty about important details relating to these changes. The following is a preview of some of the main proposals as they pertain to business taxes.

I. Timeline for Tax Reform

Although the timing of tax reform is hard to predict, there are factors that make it unlikely that any sweeping changes will be effective in 2017. One of the main factors is that the GOP’s top priority is repealing the Affordable Care Act, which will be time consuming. Also, tax cuts made by the proposals make the tax reform costly, requiring either 60 votes in the Senate, which necessitates support from the Democrats, or the use of the reconciliation process, which allows a simple majority to pass a bill, but limits the changes to revenue neutral ones. Because of these reasons, many do not expect tax reform to happen in 2017.

II. Business Tax Rates

Trump’s proposal suggests a 15 percent tax rate for “all businesses, both small and large, that want to retain profits within the business.” Trump’s proposal is not clear whether this tax rate would also apply to pass-through entities (e.g., partnerships, S corporations).

The Blueprint suggests a 20 percent tax rate on all corporations. Under the Blueprint, active income of pass-through entities will be taxed at a 25 percent rate, which is between the 20 percent corporate tax rate and the highest individual tax rate of 33 percent.

If the tax rate on the business income of pass-through entities is reduced to substantially below individual tax rates, that would encourage business owners to classify wage income as business income. Because of this, there is discussion of providing a clearer definition of what constitutes wages. Additionally, Trump’s campaign has stated that the administration will work with Congress to create anti-abuse rules for this purpose.

III. Corporate Alternative Minimum Tax

Both the Blueprint and Trump’s proposal would repeal the corporate alternative minimum tax.

IV. Full Deduction for Properties Put to Service in Manufacturing

Trump’s proposal provides, for businesses engaged in manufacturing in the United States, an election to deduct the full cost of property in the year it is placed in service. The businesses making this election can no longer take an interest expense deduction. The election is revocable within the first three years of making the election.

The Blueprint proposes a full and immediate deduction for the cost of tangible and intangible assets (including real property), except for land. This deduction is automatic and does not require the taxpayer to make an election. Similar to Trump’s proposal, this provision disallows deductions for interest expense.

V. Tax Credits and Deductions

Under Trump’s proposal, most credits and deductions for domestic production activities would be eliminated, except for the research and development credit (and the deduction for placing property into service discussed above). This will offset the benefit of lower corporate tax rates. Currently, there is no list naming the deductions and credits that would be repealed.

Similarly, under the Blueprint, deductions and credits available to “special interests” would be removed, except for the research and development credit (and the deduction for placing property into service discussed above).

VI. Carried Interest

Carried interest is a common way of incentivizing a fund manager to produce profits for the fund. In a typical carried interest structure, the fund manager receives a share of the profits of the fund after the return of the investors’ capital. The carried interest is in addition to the fixed fee charged by the fund manager to the fund. Under the current tax rules, carried interest is taxed as capital gain, which has a lower tax rate than ordinary income. By contrast, the fixed fee is taxed at the higher ordinary income rates.

During his campaign, Trump proposed to tax carried interest as ordinary income at the highest individual tax rate of 33 percent. The Blueprint is silent as to its treatment of carried interest.

VII. Net Operating Losses

Trump’s proposal does not mention net operating losses. However, the Blueprint allows net operating losses to be carried forward indefinitely, while prohibiting any carry backs. Under this provision, net operating losses cannot offset more than 90 percent of taxable income in any year.

VIII. Border Adjustment Tax

The Blueprint proposes taxation of imported products, intangibles and services while exempting exports. Under this provision, the cost of goods purchased abroad and sold in the United States will not be deductible. Under the current system, for example, when a company pays $200 to import a product and sells it for $230, it will be subject to tax on its $30 profit (the $200 cost of goods purchased is deducted from $230 gross receipt). However, under the Blueprint, the same company would have to pay tax on the entire $230 gross receipt. Under the border adjustment tax, gross receipts from exports will not be included in income and therefore will not be taxed. These provisions highly favor exporters and penalize importers, leading many to speculate that the cost of goods in the United States can rise substantially, unless the value of the dollar also increases.

IX. Offshore Earnings and Cash

a. Pre-existing Foreign Earnings

Trump’s proposal imposes a one-time tax at a rate of 10 percent on corporate cash held overseas, payable over 10 years. This tax applies even if the offshore money is not actually repatriated.

The Blueprint imposes a similar one-time tax payable over an eight-year period. However the tax rate under the Blueprint would be 8.75 percent for cash and cash equivalents, and 3.5 percent for everything else. Similar to Trump’s proposal, this tax applies even in the absence of repatriation. According to the Blueprint “[t]his will free up the more than $2 trillion in foreign earnings that have been locked out of the United States by the current tax rules. And no such build-up will occur . . . as businesses will be free to bring home their foreign earnings to be invested to create American jobs and grow their U.S. operations.”

b. Prospective Foreign Earnings

Currently, the United States has a worldwide system of taxation, in which U.S. companies are taxed on their world-wide income, regardless of where the income is earned. However, income earned abroad may not be taxed in the United States until such time as it is repatriated. Those companies can also receive foreign tax credits from the U.S. government for taxes they have paid to foreign countries. The foreign tax credit is a way to avoid double taxation.

Trump’s proposal would retain the world-wide system of taxation and the foreign tax credit but would eliminate deferral of U.S. tax, meaning that foreign income will be taxed immediately.

The Blueprint proposes moving toward a territorial tax system, in which tax is imposed where the profit is earned. This means that foreign income of U.S. companies would not be subject to U.S. tax.

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