On February 22, the U.S. Department of the Treasury released President Obama’s framework for reforming the U.S. business tax system. Treasury Secretary Tim Geithner announced the plan, which he said would enhance American competitiveness by simplifying the tax code and eliminating dozens of tax loopholes and subsidies, incentivizing job creation and investment here at home and lowering the business rate while broadening the tax base.
Secretary Geithner reiterated the administration’s view that the U.S. business tax system does too little to encourage job creation and investment in the United States and creates too many opportunities that encourage shifting production and profits overseas.
The joint White House and Treasury report describes the current state of the U.S. business tax system and lays out a framework for reform that includes five major elements:
FIVE ELEMENTS OF BUSINESS TAX REFORM - excerpted from "The President's Framework for Business Tax Reform"
I. Eliminate dozens of tax loopholes and subsidies, broaden the base and cut the corporate tax rate to spur growth in America: The Framework would eliminate dozens of different tax expenditures and fundamentally reform the business tax base to reduce distortions that hurt productivity and growth. It would reinvest these savings to lower the corporate tax rate to 28 percent, putting the United States in line with major competitor countries and encouraging greater investment in America.
II. Strengthen American manufacturing and innovation: The Framework would refocus the manufacturing deduction and use the savings to reduce the effective rate on manufacturing to no more than 25 percent, while encouraging greater research and development and the production of clean energy.
III. Strengthen the international tax system, including establishing a new minimum tax on foreign earnings, to encourage domestic investment: Our tax system should not give companies an incentive to locate production overseas or engage in accounting games to shift profits abroad, eroding the U.S. tax base. Introducing a minimum tax on foreign earnings would help address these problems and discourage a global race to the bottom in tax rates.
IV. Simplify and cut taxes for America’s small businesses: Tax reform should make tax filing simpler for small businesses and entrepreneurs so that they can focus on growing their businesses rather than filling out tax returns.
V. Restore fiscal responsibility and not add a dime to the deficit: Business tax reform should be fully paid for and lead to greater fiscal responsibility than our current business tax system by either eliminating or making permanent and fully paying for temporary tax provisions now in the tax code.
In addition to reducing the corporate tax rate from 35% to 28%, the President’s plan would eliminate many of the business tax loopholes and tax expenditures for specific industries. Specifically, "The President's Framework for Business Tax Reform" mentions the following loopholes and industry expenditures:
- Eliminate “last in first out” accounting. Under the “last-in, first-out” (LIFO) method of accounting for inventories, it is assumed that the cost of the items of inventory that are sold is equal to the cost of the items of inventory that were most recently purchased or produced. This allows some businesses to artificially lower their tax liability. The Framework would end LIFO, bringing us in line with international standards and simplifying the tax system.
- Eliminate oil and gas tax preferences. The tax code currently subsidizes oil and gas production through tax expenditures that provide preferences for these industries over others. The Framework would repeal tax preferences available for fossil fuels. This includes, for instance, repealing the expensing of intangible drilling costs, a provision that allows oil companies to immediately write-off these costs rather than recovering the cost over time as for most capital investments in other industries. This also includes repealing percentage depletion for oil and natural gas wells, which allows certain oil producers and royalty owners to recover the cost of oil and gas wells based on a percentage of the income they earn from selling oil and gas from the property rather than on the exhaustion of the property. Percentage depletion allows deductions that can exceed the cost of the property.
- Reform treatment of insurance industry and products. The tax code currently allows insurance to be used as a form of tax shelter for major corporations. In particular, corporations can invest in life insurance for their officers, directors, or employees, benefit from “inside build up” (gains on that investment) that are tax-deferred or never taxed, and finance that investment through debt that allows the corporation to take interest deductions earlier than any gain realized on the life insurance. The Framework would close this loophole and not allow interest deductions allocable to life insurance policies unless the contract is on an officer, director, or employee who is at least a 20 percent owner of the business. The Framework would also make a number of other reforms to the treatment of insurance companies and products to improve information reporting, simplify tax treatment, and close loopholes.
- Taxing carried (profits) interests as ordinary income. Currently, many hedge fund managers, private equity partners, and other managers in partnerships are able to pay a 15 percent capital gains rate on their labor income (on income that is known as “carried interest”). This tax loophole is inappropriate and allows these financial managers to pay a lower tax rate on their income than other workers. The Framework would eliminate the loophole for managers in investment services partnerships and tax carried interest at ordinary income rates.
- Eliminate special depreciation rules for corporate purchases of aircraft. This would eliminate the special depreciation rules that allow owners of non-commercial aircraft to depreciate their aircraft more quickly (over five years) than commercial aircraft (seven years).
The President also proposes to protect the U.S. tax base and strengthen the international corporate tax system by establishing a new minimum tax on foreign earnings, repealing deductions for shipping jobs overseas and providing new incentives for bringing jobs back to the U.S.
Now the tough part--putting his plan before Congress. The entire copy of the President’s plan can be found at http://www.treasury.gov/resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf.
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