Max Baucus, Chairman of the Senate Finance Committee (SFC), released a series of proposals outlining tax reform in a number of different areas. Senator Baucus will be retiring at the end of his current term and is working very hard to have meaningful tax reform passed before he leaves office.
This proposed tax reform focuses on specific areas that would have a broad impact to the current tax law system as we know it through a series of three proposals, which are now in the draft stage. These proposals focus on the international tax system, cost recovery deductions, accounting methods, tax administration and fraud prevention.
The first draft proposal focuses on restructuring the United States international tax system. Many of the key current elements of the international tax system have been in place since the 1960s. During the past 50+ years, taxpayers in the U.S. have become accustomed to expanding their focus and related planning as the economy has transitioned from a domestic focus to one that has become globally driven. As a result, the amount of U.S. corporations that own and operate foreign subsidiaries has grown dramatically. U.S. corporations’ investments overseas have grown from approximately $52 billion in the 1960s to $1.7 trillion today. The draft proposal would effectively end tax deferral on foreign earnings, historical and future, and treat all foreign income in a manner consistent with the current U.S. Internal Revenue Code (IRC) Subpart F income treatment for all offshore income. Senator Baucus’ proposal would also end the use of the interest-charge domestic sales corporation (IC-DISC) as well as other incentives for exporting products manufactured in the U.S. The earnings that have historically been deferred from U.S. income tax are proposed to be taxed at a reduced rate of 20 % payable over eight years. This proposal would also simplify the foreign tax credit rules and make many other less significant changes.
The second draft proposal is designed to address closing the tax gap, which is the difference in the amount of tax owed vs. tax collected. This proposal focuses on an increase in information reporting through additional bank and insurance company reporting, and in colleges and universities reporting of tuition payments and related higher education expenses and business Form 1099 reporting. Other provisions of this proposal impose levies of up to 100 % on payments to Medicare providers that are seriously delinquent in tax payments. Secondly, there is a proposal for the U.S. State Department to revoke or restrict the issuance of passports to individuals with delinquent tax debts in excess of $50,000. Finally, there are proposed changes to tax return filing deadlines to move partnership return due dates to 2 ½ months from the close of the tax year; and S Corporations would be required to file within 3 months of the close of their tax year. C corporation deadlines have no proposed change.
The third proposal released by Senator Baucus addresses cost recovery and tax accounting rules. These proposed rules would separate personal property into 4 pools, with 3 pools for short-to-mid-term property and 1 pool for longer-term property. Real property would continue to be depreciated under the current system. The annual depreciation would be based on a percentage running total balance of the pool adjusted for acquisitions and dispositions. This system would eliminate the use of asset lives that are based on the industry in which the assets are used. Like-kind exchange rules would be repealed. Involuntary conversions would still provide a mechanism to defer any resulting gain from the respective pool until the second tax year after the involuntary conversion. Any gain resulting from property in these pools would be taxed entirely at ordinary income tax rates. There would be no determination of the class of gains as is the case under the current system. The current IRC Section 179 expensing election would be made permanent for fixed asset additions up to $1,000,000 and begins to phase-out when additions reach $2,000,000. Both amounts are indexed for inflation. The amortization period for intangible assets would be increased from 15 to 20 years.
Research and experimental expenditures would no longer allow immediate expensing, but would require these costs to be recovered over a period of 5 years. The same would be true for “Qualified Extraction Expenditures” incurred for the oil and gas and mining industries. Many of these expenses such as intangible drilling costs (IDC) or mine development and exploration expenses are allowed to be immediately expensed under current tax law. In addition, percentage depletion would be repealed, and all taxpayers would be required to calculate depletion on a cost basis.
Any taxpayers with prior 3-year average annual gross receipts in excess of $10,000,000 would be precluded from using the cash basis method of accounting for tax return purposes. There is no mention of special exclusions for professional service corporations or other specified exclusions. Finally, the Last-In, First-Out (LIFO) method of accounting would be repealed. Taxable income related to the recapture of the LIFO reserve would be included in income ratably over an 8-year period. Other repealed accounting provisions include the lower of cost or market method of inventory valuation as well as the completed contract method.
It remains to be seen what provisions of these proposals would be included in a final package of tax law reform. The current state of Congress makes the prospect of any bipartisan movement on the issue of tax reform seem distant, especially with the looming periodic federal budget and debt ceiling limit impasses that must be addressed in January and February. Stay tuned for additional developments regarding tax law reform.
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