There is broad political support for the proposition that the U.S. corporate tax system makes U.S. companies less competitive. The House tax bill responds to this challenge by proposing to lower tax rates and reduce or eliminate deductions and credits. Here are the noteworthy items:
Rate Reduction. The bill would replace today’s graduated corporate tax rate, which includes a top marginal rate of 35%, with a flat rate of 20%. Personal service corporations would be subject to a 25% rate. The changes would take effect next year and would be permanent. The bill would eliminate the corporate alternative minimum tax.
Increased Expensing. Corporations (and other businesses) would be entitled to deduct 100% of the cost of certain capital expenditures, an increase from 50% under current law. The benefit would also be extended to taxpayers who buy used property. The new rules would apply to expenditures made after September 27, 2017 and would expire after five years.
Expensing would not be available to certain regulated utilities and real estate businesses. As a tradeoff, these businesses are exempt from the new interest deduction limits (see below).
Interest Deduction Limited. In simple terms, the bill would cap the annual deduction for net business interest expense at 30% of a taxpayer’s business cash flow. The bill would allow a five-year carryforward of unused interest expense. Additional, new earnings stripping rules would apply to interest payments to foreign affiliates.
- The bill does not, as currently drafted, include an exception for financial or insurance businesses, although it allows interest expense to fully offset interest income.
- The rules would not apply to certain small businesses, certain regulated utilities or real property businesses.
Net Operating Losses. In one particularly notable change, net operating loss carryforwards would no longer expire (they currently expire after 20 years), and net operating loss carrybacks generally would be eliminated. Net operating loss carryforwards would be increased by an interest factor equal to the annual federal short-term rate plus 4%, but could be used to offset only 90% of taxable income in a given year.
Excess Capital Contributions. The bill targets relocation incentives and concessions granted by State and local governments by treating the receipt of a capital contribution as gross income to the corporation to the extent its value exceeds the value of the equity issued. But it also potentially penalizes closely held corporations (and other entities), such as cooperative apartment corporations and wholly owned subsidiaries, for which the issuance of additional equity for a pro rata contribution would be a meaningless, and in some cases costly, gesture. The proposed provision may also be in conflict with section 1032, which otherwise applies to provide that certain “off market” corporate stock transactions like options do not result in the recognition of gain or loss to the corporation.
FDIC Premiums Deduction Limited. The bill disallows a deduction for a percentage of the premiums paid to the Federal Deposit Insurance Corporation by financial institutions with greater than $10 billion in assets. The percentage is equal to the financial institution’s assets in excess of $10 billion divided by $40 billion, capped at 100%, which would result in the largest financial institutions being ineligible for the deduction. These premiums can amount to hundreds of millions of dollars for the largest financial institutions.
Modification or Elimination of Various Deductions and Credits. The bill eliminates or limits certain other deductions and credits, including those for:
- Lobbying expenses (current law allows a deduction for local lobbying expenses),
- Income attributable to domestic production activities (section 199),
- Entertainment expenses and de minimis fringe benefits,
- Historic rehabilitation,
- New markets,
- Employer-provided childcare, and
- Renewable energy.
Changes Not Included in Proposal. A number of changes that some feared or predicted were not included. The bill’s proposed limitations on deduction of state and local taxes, for example, would not apply to corporations. There are no changes to the R&D or low income housing credits. Nor does the bill propose any changes to the corporate reorganization rules or make any significant movement toward corporate tax integration.
We would note that this is not a comprehensive list of all the provisions that are of interest to corporations. Notably, the bill proposes changes to the employee compensation and international tax regimes that will be discussed in subsequent blog posts.
Finally, while we are not suggesting that any changes on any of these points is expected, we note that the process is very much in flux, and it is expected that significant changes to the House bill (for example, in the Chairman’s mark, expected as soon as today) are possible, if not likely. And that doesn’t even take into account what will happen in the Senate. Bottom line – stay tuned.