Tax reform as proposed under the Trump Administration is poised to impact U.S. businesses more significantly than any modification of the tax code in decades. Although it’s unclear what lawmakers will sign into action, businesses can take steps to prepare for potential changes. Now is the best time to understand what the future state of corporate tax may look like.
Tax experts can help U.S. businesses transition effectively and efficiently into the new tax model by analyzing all elements of the pro-growth tax reform blueprint. Whatever version of tax reform is finalized will likely move the U.S. into a territorial taxation system. This will reward businesses ready to invest in America with opportunities focused on domestic economic growth.
CFOs and tax executives should focus on analyzing their current tax posture and how the future may unfold. Only then can companies begin to implement planning opportunities that reduce uncertainty surrounding tax reform’s impact on their business, gaining a clear vision of their financial future.
A few topics at the top of the agenda for American businesses include:
A cornerstone of both President Trump’s campaign and the House Ways and Means Committee’s Blueprint, repatriation of overseas funds appears to be a very strong possibility. The plans differ in rates: Trump’s plan calls for a one-time, 10% tax holiday; The House Blueprint is 8.75% on cash or cash equivalents and 3.5% on non-cash assets, payable over eight years.
The Joint Committee on Taxation estimated that a whopping $2.6 trillion in unrepatriated funds were stored overseas by U.S. companies at the end of 2015, up sizably from a 2010 estimate of $1.7 trillion 2010. 1 Whenever the tax is paid, those profits could then be moved back to the U.S. without additional income tax.
To decide whether current repatriation proposals are good a business decision, it’s critical to first understand the opportunities to utilize the funds in the markets where cash is held as well as any applicable regulatory restrictions. There may be benefits to holding cash overseas or redistributing money outside of the U.S. For example, if a business has minimal interest expenses and large chunks of low-taxed, foreign earnings, deferring repatriation may be the best option. Conversely, for companies that anticipate considerable net operating losses or are part of overseas tax credit pools that carry high tax rates, repatriating may be an easy choice. Companies may also find moving assets to foreign jurisdictions with generous tax rates to be more advantageous than repatriation.
Intel and IBM have demonstrated that investing heavily in research and development oversees can be a profitable alternative. Both companies have invested more than a combined $100 million in R&D in Ireland recently because of the country’s favorable R&D tax structure. 2 Companies should keep in mind that although overseas investments are often profitable, foreign markets are more volatile than the U.S.
How foreign tax credits effect repatriation must be considered as well. Many multinationals have overseas earnings eligible for special foreign tax credits. Foreign tax credits provide a valuable way for businesses to save, but the regulations behind them are complex. With repatriation looming, businesses need to assess how or whether to use them.
Businesses with offshore assets that are highly taxed should start looking today at whether it would be advantageous to repatriate before any one-time tax is levied. A business with overseas cash may only have to pay an incremental 5% domestic tax after foreign tax credit upon repatriation, but could have foreign tax rates of 25% of more. If those earnings were to be taxed in the U.S. at a one-time rate, the rates could be as high as 10%. 3
Once topic President Trump and the House Blueprint differ on is destination-based cash flow. Border adjustment is absent from the President’s tax plan and yet featured in the House Blueprint. The House Blueprint would eliminate U.S. tax on exported goods and services while placing a 20% tax on imports
Businesses that import much of their equipment for construction and manufacturing could be hurt, as they would not be able to deduct those expenditures. House Ways and Means Committee Chairman Kevin Brady recently suggested a five-year phase-in of border adjustability. The chairman’s plan would make just 20% of import costs nondeductible in the first year, increasing every year after until 100% is reached in year five.
Many economists anticipate that price and exchange rate adjustments may offset any windfall gained from subsidizing exports and discouraging imports. While a boost to exports would strengthen the value of the dollar, border adjustment would also trigger a reduced cost on imports, many economists say, meaning minimal or no change to the post-tax cost of imports. 4
Both the House Blueprint and the President’s plan include forms of immediate expensing of capital investments. President Trump’s plan gives U.S. manufacturing firms the option to deduct the full cost of their investments. The House Blueprint has no limits on industry, allowing businesses to fully and immediately write off investment costs, including tangible property such as buildings and equipment, as well as intangible assets.
Companies need to consider how this type of expensing may impact how the structure of their future deals (purchasing stocks versus assets, for example). Some businesses may benefit from being able to fully expense their acquisitions of intangible assets. The House Blueprint also denies deductions for net interest expense, meaning businesses need to consider whether fully expensing is worth it if they would lose interest deductions. 5 Recently, House Ways and Means Committee Chairman Kevin Brady said he would not eliminate the interest deduction for small businesses, utilities or real estate purchases, meaning small businesses would be able to both fully expense and have interest deductions.
Land is not eligible to be fully expensed under the House Blueprint, meaning debt-financed buyers of land would neither be able to fully expense the land or deduct interest expenses on the debt.
Base Erosion and Profit Sharing (BEPS)
Many of the details of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Sharing (BEPS) were actively negotiated by the Obama Administration, meaning the current White House could have a different view on the OECD recommendations.
The high chances of extensive tax reform under a Trump presidency have also complicated how companies are planning for BEPS, with both the Trump and House Blueprint incentivizing territorial economic shifts back to the U.S. This comes at a time when the regulatory changes brought by BEPS are in place and immediate in many countries. Countries directly involved in BEPS make up 84% of the world’s economy. 6 Companies should be addressing the concerns of BEPS by modeling for reforms with BPES concerns in mind.
There are fears that BEPS implementations will lead to lower profits and higher taxes, particularly with more pressure on cash tax outlays and effective tax rates. For multinational companies, the increased tax burden may force them to reconsider how to best structure their worldwide operations.
Companies should be looking to adjust to BEPS regulations before earnings are affected. Having flexibility as a corporation and adopting strategic thinking with BEPS in mind are critical. Companies should also make sure their global tax reporting systems can handle the coming onslaught of reporting and data. 7 Country-by-country reporting, which is implemented under BEPS, means more tax information will be more visible and possibly subject to increased audits and disputes. Excellent records and document management along with strong data tracking can offset or prevent any increased compliance burden brought to businesses.
Individual Tax Rates, Brackets and Deductions
Individual income taxes – the largest driver of revenue in the U.S. – are set to see arguably the most drastic changes. The House Blueprint calls for a reduction to three tax brackets from the current seven, with the bottom and middle tiers at 12% and 25%, respectively. The top bracket would be a marginal rate of 33%, down from the 39.6% at the current highest bracket. While Republicans have touted the bracket shift as lowering tax bills for middle Americans, the reduced rates may have larger effect on the biggest earners. 8
The House Blueprint also proposes tax dividends, capital gains and interest at 50% of individual tax rates. This would occur by allowing 50% of those items to be deducted. President Trump’s tax plan keeps the capital gains tax at its current 20%.
The Alternative Minimum Tax, which wipes out most itemized deductions for individuals with high net worth, is removed under the House Blueprint. President Trump has proposed a $100,000 cap on itemized deductions for single filers – $200,000 for married couples filing jointly. The House Blueprint calls for a complete elimination of itemized deductions, except for charities and mortgages.
Increasing the standard deduction is included in both plans as well: President Trump’s plan calls for a $15,000 deduction; the House Blueprint’s is at $12,000. Each would be doubled for married couples. For an example of how this may affect taxpayers, the combined personal exemptions plus standard deductions for a single taxpayer with one child is currently higher than it would be under the proposed House Blueprint’s plan. 9
Analyze Your Business’ Profile Today
Tax reform could be coming soon, meaning businesses should start looking now at how all these potential changes may dictate their financial future. Once reforms are enacted, corporations may not have enough resources or time to react without limiting earnings.
To help your business stay ahead, start planning today. If you’re interested in having us prepare a proprietary model to anticipate any potential tax reform concerns, contact Caroprese & Company.
By Brandon Caroprese
- “Cash: King or conundrum?” Deloitte. Accessed June 13, 2017.
- “Tax accounting considerations of recent U.S. tax reform proposals” PricewaterhouseCoopers. Accessed June 11, 2017
- “Foreign Tax Credits: A Go-To Tax Planning Tool in the Pre-Reform Landscape. Alvarez & Marasal. Accessed June 15, 2017.
- “United States: Tax reform proposals would affect energy industry. PricewaterhouseCoopers. Accessed June 11, 2017.
- “Brady suggests five-year phase-in of border adjustability, potential exceptions to denial of “net” interest” Ernst & Young. Accessed June 14, 2017
- “US Election 2016 and the Tax Landscape.” Ernst & Young. Accessed June 11, 2017.
- “Preparing for BEPS under the New Administration.” KMPG. Accessed June 11, 2017.
- “10 Minutes on the OECD’s BPES project.” PricewaterhouseCoopers. Accessed June 12, 2017.
- “Proposed Tax Reform for High-Net-Worth Individuals” Alvarez & Marsal. Accessed June 15, 2017.
- “2016 tax policy decisions.” Deloitte. Accessed June 12, 2017.
- “Potential tax reform” KPMG. Accessed June 10, 2017.
- “The House Republican Blueprint: A destination-based cash-flow tax.” PricewaterhouseCoopers. Accessed June 11, 2017.
- “Trump tax reform plan’s silence on border-adjustment tax proposal ratchets up talk of revisions.” Deloitte. Accessed June 10, 2017.