The dust has started to settle following the elections Nov. 8. Hopefully, that election dust has not caused any allergic reactions. There are a lot of questions about what the future holds. I can’t count the number of times I have been stopped and asked, “What will happen with U.S. taxes?” My short answer, often goes, “I am not sure,” and “it depends.”
Here is why I give those responses. No one I know has a crystal ball that can predict the future. Many promises are often made during campaigns and not necessarily enacted or kept after an election. This often occurs because of the legislative process that needs to take place when enacting legislation. If you want to review that process in some more detail, search the internet for the Schoolhouse Rock video “I’m Just a Bill” and recall watching Saturday morning television many years ago.
Most pundits believe something with regard to taxes may very well happen in 2017. There are many favorable facts that provide the possibility for tax legislation in 2017. Both Houses of Congress, as well as the White House, are in the control of one political party. Revisiting recent history may shed some light on the topic. We only need to look back at 1993 when the Clinton Administration took office and the Bush Administration in 2001 when similar conditions existed, and tax legislation was adopted in the first year of those administrations. Each of those situations had some differing results given the different parties in power at the time. Tax rates were increased in 1993 and were reduced in 2001. And, we can also look to what happened in 1981. President Ronald Reagan pulled together a coalition of the Republicans and boll weevil Democrats to enact tax rate reductions. So, recent history shows there is strong evidence significant tax legislation is a possibility in the first year of an incoming administration that has a working majority on Congress.
Comprehensive corporate tax reform is high on many lists. We have seen many of the headlines in recent years of the uncompetitive U.S. corporate tax system. The trend of inversions and other cross border tax planning in recent years has been, in part, the result of some of the provisions in the U.S. tax code. Most of the recent regulations issued to deal with inversions didn’t actually address some of the underlying issues in the U.S. tax system that were creating an environment where companies were considering an inversion transaction. And, some of the much maligned inversion transactions that were executed were taking advantage of provisions actually placed into the tax code in 2004 that were intended to stop inversions.
The U.S. corporate income rate was last reduced in 1986, when the U.S. became the low tax jurisdiction of the major developed countries. In the past 30 years, we have seen our major trading partners reduce their respective corporate income tax rates. This has resulted in the U.K., Germany, Canada and Japan having lower corporate income tax rates than the U.S. New trading partners, including China, also have lower corporate tax rates. China’s corporate tax rate is currently 25 percent.
Other features of the U.S. tax code also are considered by many as uncompetitive. This includes the taxation of earnings of foreign subsidiaries. Once again, our major trading partners, such as the U.K., Canada, Germany and Japan provide an exemption or deduction for foreign earnings repatriated to the home country. This results in little or no home country tax on the foreign earnings when such earnings are repatriated to the home country. This portion of the tax code is partly responsible for having the $2-$3 trillion in offshore earnings of U.S. corporations we read about in the financial press. There have been several recent proposals of providing for a lower tax rate to allow for a tax repatriation holiday for U.S. companies repatriating the offshore earnings. There was a similar incentive from 2004-06 for the repatriation of offshore earnings.
The last significant tax code overhaul was in 1986. That occurred early in my professional career. Many referred to that legislation as tax simplification. The Tax Reform Act of 1986 lowered corporate tax rates, reduced individual tax rates and instituted two tax brackets for individual taxpayers (15 and 28 percent). Since then, the tax code has become more complex. How complex? Just think about this, many of us could prepare our tax returns by hand in 1986. How many of us can do that 30 years later in 2016? Most of us need to use computer tax software or an outside preparer to prepare and file our tax returns. Hand-prepared returns are now an endangered species.
There are many tax proposals that were floated in 2016 that may provide some insight as to what some possible changes in tax rates, deductions and items of income may occur upon adoption of these proposals in any enacted legislation. Many of these can be found on the websites of the individuals proposing such changes.
Change always presents some opportunities. If one expects future enacted tax rates to decline, deductions are more valuable at a higher marginal tax rate in the current year than a lower rate in a future tax year. Thus, accelerating tax deductions is often a strategy many consider in this circumstance. On the income side, deferring the earning or receipt of income may be a strategy to consider. Any planning for such changes should be modeled to consider the impact of what, if any, changes in income and deductions do with respect to marginal tax rates, the impact on itemized deductions and the impact of the dreaded alternative minimum tax (AMT). There are obviously many other items, tax and non- tax, to consider in any tax planning strategy, and a professional adviser should be consulted.
There likely will be some unique tax planning opportunities, as the new president and Congress take office in 2017 and begin to enact legislation. What that legislation will ultimately include or exclude or change or not change is not certain. What is certain is what Benjamin Franklin said, “In this world, nothing can be said to be certain, except death and taxes.” One may be preferable than the other. I’ll let you decide which one.
William Roth is a tax partner with the local office of international accounting firm BDO USA LLP.