NJ: 201.445.8711     NY: 516.305.1996

Obama Tax Plan Would Lower Corporate Rate

Obama Tax Plan Would Lower Corporate Rate, Broaden Base

By Heather M. Rothman     Publication Date: 02/23/2012

Businesses embraced President Obama's call Feb. 22 for lowering the corporate tax rate, but said that at 28 percent, the rate would still be far above the average for developed countries and would continue to put the United States at a global disadvantage.

Billed by Treasury Secretary Timothy Geithner as an opportunity to modernize an aging tax code, level the playing field internationally, and increase investment domestically, the  plan would reduce the top corporate rate from 35 percent to 28 percent, drop the manufacturing rate to 25 percent, and help pay for the changes by eliminating dozens of tax expenditures currently enjoyed by businesses.

Comparatively, House Republicans have proposed a vastly different overhaul of the system that includes moving to a territorial tax system and dropping the top corporate rate to 25 percent. A senior administration official said the 25 percent benchmark could not be reached without additional deep cuts to popular items or without going outside of the corporate system.

But the framework, as Treasury is calling it, does not include many details, leading tax practitioners to question its impact, particularly in an election year occurring against the backdrop of a deeply divided Congress.

Obama's plan was unveiled the same day Republican presidential hopeful Mitt Romney announced that under his tax plan, the top individual tax rate would drop to 28 percent while the top corporate rate would be reduced to 25 percent. On the individual side, he would eliminate the estate tax and the alternative minimum tax, while on the corporate side, Romney would overhaul the corporate tax regime and move to a territorial tax system.

Maintaining the Status Quo

Marc Gerson, an attorney with Miller & Chevalier, called it surprising that the administration would maintain the current system of worldwide taxation rather than move to the territorial system that U.S. multinationals are craving, particularly given the push from Republican tax writers, the recommendation from the bipartisan Simpson-Bowles commission, and its adoption by most of the nation's global competitors.

Administration officials said moving to a territorial system would aggravate problems within the tax code such as overinvestment abroad and underinvestment in the United States.

“If foreign earnings of U.S. multinational corporations are not taxed at all, these firms would have even greater incentives to locate operations abroad or use accounting mechanisms to shift profits out of the United States,” Treasury wrote in the framework. “Furthermore, such a system could exacerbate the continuing race to the bottom in the international tax rates.”

But Dorothy Coleman, vice president for tax and domestic economic policy at the National Association of Manufacturers, disagreed, telling Bloomberg BNA that a worldwide system hurts business.

“A worldwide tax system increases costs for companies … and you have to step back and acknowledge that in the 21st century, just as it's important for companies to operate in the U.S., it's also important for them to be able to participate in the market outside the U.S.”

“I think particularly the notion of maintaining the worldwide system and then adding on this minimum tax will raise concerns from a competitiveness standpoint,” Gerson said, referring to the plan's new mandatory tax on overseas profits.

House Ways and Means Committee Chairman Dave Camp (R-Mich.), the author of the House GOP territorial plan, expressed concern that the administration's plan retains the worldwide system. He also said he would like to engage the administration in a discussion on repatriation and how to it “intends to bring home roughly $1 trillion in American profits that are currently trapped overseas.”

Revenue Neutrality, Base Broadening

Geithner said business tax reform must be fiscally responsible and not increase future deficits, adding that any incentive Congress chooses to keep must be paid for.

Because the plan would eliminate the traditional temporary business tax provisions that are extended nearly every year, it would save about $250 billion over 10 years because that is how much permanency would cost. But if any of those so-called extenders are extended or made permanent, Congress would have to offset them within the context of tax reform. For example, Obama's plan calls for making the research and development tax credit permanent, which would need to be offset, officials said.

To lower the corporate rate, many popular business tax breaks would be scrapped, including the use of last-in, first-out accounting, and subsidies for oil and gas companies. The plan continues to borrow from previous Obama offerings by taxing carried interest income at ordinary income rates and eliminating certain accelerated depreciation rules.

John Harrington, a former Treasury international tax counsel now with SNR Denton LLP, said policymakers are going to need to weigh lowering the rate with the pain of eliminating special preferences in the code. He said depending on that balance, there is plenty of room to compromise between the administration's 28 percent plan and the 25 percent plan envisioned by Camp.

“There is some pain associated with these lower rates and you have to figure out at what point do you say we just can't keep going,” Harrington told Bloomberg BNA.

Details Needed on New Minimum Tax

The plan would create a new minimum tax on foreign earnings in an effort to “protect the U.S. tax base and strengthen the international corporate tax system.” In a statement, Obama said it would target companies trying to avoid paying their fair share of taxes by moving jobs and profits overseas.

According to the framework, the new tax would be designed to “balance the need to stop rewarding tax havens and to prevent a race to the bottom with the goal of keeping U.S. companies on a level playing field with competitors when engaged in activities which, by necessity, must occur in a foreign country.”

But practitioners said more details are needed, such as how the administration defines “by necessity” and “low-tax jurisdiction.” The administration also needs to clarify whether it is addressing the effective rate or the statutory rate.

Administration officials said the framework did not include a specific minimum tax because the level needed is not yet known—it depends on the complete package and how much revenue is needed. Officials said it would not amount to double taxation because the United States would maintain a foreign tax credit against it.

Manufacturing Numbers Not So Simple

Administration officials said that currently, when the 35 percent corporate tax rate is combined with the 9 percent domestic production activities deduction, the combination yields a 31.85 percent rate on manufacturers.

Under the plan released Feb. 22, the new 28 percent corporate rate in combination with an increased 10.7 percent domestic production deduction would yield a 25 percent rate.

“In our system, 25 [percent] would in effect almost be a ceiling,” one official said. Then, when the R&D credit and other remaining incentives are taken into consideration, the level could drop.

But Coleman said the math is not as simple as the administration is portraying it. For example, she said, many manufacturers would be hit by repealing LIFO and accelerated depreciation, and by creating limitations on interest deductibility.

“We certainly understand that base broadening needs to be a part of the debate, but we don't want to end up in a situation where you lower the rates for manufacturers but you increase the base so manufacturers end up with a bigger tax bill,” she said.

Small Businesses Express Concern

To assist small businesses, the plan seeks to make tax filing simpler and would allow small businesses to expense up to $1 million in investment and allow cash accounting on businesses with up to $10 million in gross receipts, up from the current level of $5 million.

But small businesses united Feb. 22 in their discontent with the framework because of its focus on large corporations and its largely nonexistent focus on small businesses, particularly passthrough entities that file on the individual side of the code and therefore are subject to different marginal tax rates.

They also said that the framework would add to the uncertainty faced by small businesses by eliminating many of the business deductions that they count on annually.

The administration stood behind its decision to offer a corporate-only plan. “A lot of people feel ultimately the realistic, and maybe the best, way to do this is alongside and together with comprehensive individual reform and that may be the way this comes out, but we think regardless of which path we choose, it's worth starting the foundation-laying process now on the business income side,” Geithner said.

The complete text of this article can be found in the BNA Daily Tax Report, February 23, 2012. For comprehensive coverage of taxation, pension, budget, and accounting issues, sign up for a free trial or subscribe to the BNA Daily Tax Report today.   Learn more »

© 2012, The Bureau of National Affairs, Inc.