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Businesses aren't treated equally under GOP tax reform proposal

Wondering how tax reform will affect your business? Some more details on the GOP-proposed plan outlined in the “Unified Framework for Fixing Our Broken Tax Code” are trickling out of Washington, D.C. Among the details coming to light are the following.

Corporate tax rate

Lowers federal income tax rate for profitable C corporations from 35% to 20% and eliminates many corporate tax breaks, which advocates of the proposal say will result in:

  • More competitive corporate tax rate with other countries globally
  • Simplified tax code

Bottomline: For some companies, the 20% rate could be higher than the effective rate they’re currently paying after existing tax breaks are figured in. According to one U.S. Government Accountability Office report, in some recent years profitable large U.S. corporations (generally those with at least $10 million in assets) paid, on average, federal income tax amounting to about 14% of the pretax net income reported in their financial statements. However, in some cases, low effective tax rates are achieved by keeping earnings offshore where they aren’t subject to U.S. taxes.

Pass-through entity tax rate

Partnerships, limited liability companies and S corporations that “pass-through” their taxable income, deductions and credits to their owners would see some changes. Under the proposed plan:

  • Income earned by pass-through entities and sole proprietorships would be taxed at a maximum federal rate of 25%, significantly lower than the current rate of 39.6%
  • Some tax savings would be lost due to eliminated tax breaks

Bottomline: Congress would need to adopt measures to prevent wealthy individuals from using pass-through entities to recharacterize personal income into lower-taxed business income. Hard work would need to be done to make sure the tax rate structure for pass-through entities is fair in comparison to the corporate rate structure without re-introducing complexity. 

Expensing of business capital investments

Under existing law, capital investments are generally depreciated over several years, though there are exceptions. And bonus depreciation allows an additional first-year depreciation deduction of 50% for qualifying assets placed in service in 2017. (The bonus depreciation rate is scheduled to drop to 40% for 2018 and 30% for 2019 and to expire on December 31, 2019.) Under the proposed plan:

  • Companies would immediately be able to expense an unlimited amount of new depreciable assets, other than buildings--a feature primarily benefiting larger businesses

Bottomline: As a temporary tax savings, expensing could improve after-tax cash flow in a meaningful way, and larger businesses would be enthusiastic about that.

Business credits and deductions

The domestic production activities deduction and numerous other deductions, credits and special provisions would be repealed or cut back. Under the proposed plan: 

  • Research credit and the low-income housing credit would be retained
  • Interest expense deductions for C corporations would be limited

Bottomline: Some businesses would come out ahead because of lower tax rates while others could find themselves paying more than they do under the current tax regime.

Foreign income

The framework would remove tax provisions that currently encourage companies to keep profits and jobs offshore. Under the proposed plan:

  • No federal income tax on future foreign profits repatriated (brought back) to the United States
  • Dividends paid by foreign subsidiaries to U.S. parents that own at least a 10% stake would be tax-free

Bottomline: The changes could encourage companies to keep their earnings in the U.S., boosting onshore investments and job creation and increasing the corporate tax base. Under transition, accumulated untaxed offshore earnings would be immediately charged a one-time tax at a fixed and presumably low rate (perhaps 10%). A higher rate would apply to cash and liquid assets and a lower rate to offshore earnings tied up in nonliquid assets, such as factories. The bill for the one-time transition tax could be spread over several years as companies bring back their accumulated offshore earnings. 

The Takeaway Unpredictability and potential pushback

As Congress fills in details, the GOP-backed proposal will continue to evolve. If you have questions about how you and your business could be affected, please contact us. We’ll be keeping a close eye on legislative developments and how they might affect our business clients.

Let's talk tax

Rachel Sawyer can be reached by phone at 720.227.0068 or email at rsawyer@taxops.com. Follow Rachel on LinkedIn.

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