Proposed Corporate Tax Changes Under the GOP House Blueprint and Donald Trump
Due to the recent election and Republican control in Congress, the possibility of comprehensive tax reform has gone from a remote possibility to very likely. President-elect Donald Trump and Republicans have stated that they would like to get comprehensive tax reform on the table within the first 100 days and possible legislation passed by the spring. What detailed legislation will come out of this is all speculative at this point. However, the House Ways and Means Committee blueprint for A Better Way on Tax Reform gives a good general conceptual framework of current proposals being discussed by Republicans in Congress. Below, we have reviewed key elements discussed in this blueprint as it relates to the Corporate Tax. In addition, Trump has proposed his own ideas of tax reform, which is similar to the House Blueprint, but with some key differences. There are some slight differences with the rates and some major differences with proposals relating to international tax policy. We summarize and compare below the proposals of both for corporate tax reform.
Top Corporate Tax Rate Reduced
Like the individual tax rates, the House GOP plan would reduce corporate tax rates. Currently, there is a top rate of 35%, but under the blueprint, the top rate would be significantly reduced to 20%. In contrast, Trump has proposed reducing this rate to 15%.
New Preferences toward Dividends and Capital Gains May Reduce Effect of Double Taxation
The blueprint mentions a potential preference for dividends and capital gains at the corporate level to reduce the effects of double taxation. In contrast to individuals, current capital gains are taxed at ordinary rates for C-Corps. For individuals, the current GOP blueprint would allow an individual to deduct 50% of dividends, capital gains, and interest received from stocks with a top rate of 16.5% on that investment income. These changes could lead to significant entity planning opportunities for companies and change the current structure of double taxation significantly.
There is also another tax plan being drafted by Senate Finance Committee Chairman Orrin Hatch (R- Utah) regarding corporate integration and a dividends received deduction that would also reduce or eliminate the double taxation effect on C-Corps. However, no further details have been released from his plan as of the writing of this blog. We will continue to monitor as the plans develop and different parts of each plan are incorporated into final legislation.
Reduction of Pass-Through Business Tax Rate
The House GOP blueprint proposes a top 25% rate that would take effect on pass-through income for partnerships, S-Corps, and LLCs. This top rate would also apply to the Schedule C income of a sole proprietor. Combined with the individual rates, this would mean that no schedule C or pass-through business income would be subject to the highest proposed individual top rate of 33%. Trump’s proposals have the rates reduced to 15% on pass-through income, just as he has proposed for C-Corporations.
Reasonable compensation requirements would be in place under the blueprint, which would allow for a deduction to the pass-through company and compensation income to the individual owner at the individual rates. Currently, reasonable compensation requirements only apply to S-Corporations, but the new plan would have them apply to all these pass-through entity forms. The plan does not specify how self-employment tax may be affected after implementing this new requirement for partnerships and sole proprietors.
Changes Introduce New Entity Planning Opportunities
If the C-Corp rate turns out to be lower than the maximum pass-through rate, and depending on what kind of preferences might be proposed on dividends and capital gains for C-Corps in combination with the lower rates on investment income for individuals, significant entity planning opportunities may arise depending on where these rates and preferences ultimately end up in future legislation.
Destination-Based Cash Flow Tax that Follows Consumption
Under the blueprint, taxation would follow consumption rather than production. Full and immediate expensing of new asset acquisitions would take effect, including everything from buildings to equipment to even intangibles. This would be in contrast to the MACRS Depreciation and Section 179/Bonus provisions currently in place, which impose limits on the amount that can be expensed in a given year. A destination-based corporate tax would tax businesses based on their domestic sales. The current system taxes U.S. based corporations on worldwide income, but allows a deferral for taxation on that income until it is repatriated within the United States. The new territorial system would tax U.S. based corporate income only on income earned within the United States. Foreign income would be exempt from U.S. taxation. For any accumulated foreign earnings repatriated under the old system, there would be an 8.75% tax on cash and a 3.5% tax on other repatriated capital.
Trump, on the other hand, has proposed different policy than what is elaborated on in the House GOP plan. He would allow a manufacturing firm the option to make an election to either continue deducting interest expense or fully expensing new asset acquisitions. The election would be revocable only within a 3 year period. He also proposes a one-time repatriation rate of 10% on all repatriated earnings and would retain the policy of international taxation on worldwide income, rather than the territorial system proposed under the House Blueprint.
Border Adjustability for Imports and Exports
The blueprint outlines that exported products, services, and intangibles would not be subject to U.S. tax regardless of where they were produced. In contrast, imports would be subject to the tax regardless of where produced. The effect of this would be the disallowance of a deduction for imports purchased and a resulting reduction in the Cost of Goods Sold deduction. There would be a 100% exemption of dividends from foreign sales.
The effect of these new provisions, while still being implemented through the income tax and avoiding any new taxes such as a Value Added Tax, would be to move towards a destination-based cash flow tax that follows consumption rather than production.
Elimination of Interest Expense Deductions
Under the blueprint, interest expenses would only deductible against interest income. There would be no allowance for a net interest expense deduction until future interest income was there to offset it. However, any unused net interest expense would carry forward to future years. Trump has proposed a similar policy. However, as mentioned above, his would be an election where a manufacturing firm specifically would be allowed to either take interest expense deductions or fully expense new asset acquisitions.
Indefinite Carry Forward for Net Operating Losses
Under the blueprint, losses would enjoy an indefinite carry forward instead of the current 20 year limitation and also be indexed for inflation over time. No carry back would be allowed, and benefit from losses in any given year would be limited to 90% of taxable income.
Other Notable Changes:
- Corporate AMT would be repealed under both the blueprint and Trump’s proposals.
- Domestic Production Deduction (Section 199) and other unspecified tax expenditures would be eliminated
- Research and Development Credit would be preserved under both proposals.
While the changes proposed are speculative at this time, we will monitor the legislative process for planning opportunities. Contact an Anders advisor with questions on how the proposed changes could affect your business.