Taxmageddon or Tax Reform? The Outlook for U.S. Tax Reform in the Next Congress Presented by Robert Glennon, Jeff Munk, John Stanton, and Jamie Wickett

Taxmageddon or Tax Reform? The Outlook for U.S. Tax Reform in the Next Congress

Presented by Robert Glennon, Jeff Munk, John Stanton, and Jamie Wickett

September 27, 2012

www.hoganlovells.com 2

Why Reform is Likely / Necessary

• U.S. Budget pressures– Ever-increasing U.S. debt – Now above $16 Trillion– “Fiscal cliff” (in 2013 and beyond)

• Competitiveness concerns – U.S. corporate rate• More agreement than many realize

– U.S. corporate rate should be lowered– Base should be broadened, “loopholes” closed


U.S. Budget Issues – Unsustainable Debt

• If current policies extended, by 2025 Social Security, Medicare, and interest on national debt will consume all federal revenues

• U.S. gross debt = 103% of GDP (2011)*• Spanish gross debt = 75% of GDP (2011)*• Greek gross debt = 170% of GDP (2011)*

* Source - OECD


U.S. Budget Issues – Unsustainable Debt Under Current Policies


U.S. Budget Issues – “Fiscal Cliff”

• “Fiscal cliff” – As of January 1, 2013:– Expiration of 2001/2003/2010 tax cuts– Top individual income tax rate rises from 35% to 39.6%– 10% rate for low income earners disappears– Top dividend rate increases from 15% to 43.4% (3.8% ACA)– AMT patch expired 2011– from 4m to 30m AMT taxpayers– Expired “Doc fix” 30% cut in Medicare physician payments– $1.3 Trillion sequester of defense, non-defense programs, $55 Billion

each per year

• U.S. debt ceiling will need increasing around January ’13

• Business tax extenders


“Fiscal Cliff” – Fiscal Impact

• 1 year extension of current policy - $500 Billion• 2 year extension of current policy - $1 Trillion• Failure to extend any tax cuts

– Up to 4% reduction in GDP– CBO estimates reduction in employment of 1-2 million– WSJ piece May 5, 2012: estimates possible 30% decline

in stock market– Moody’s threatening U.S. debt downgrade


U.S. Corporate Tax Rate – Competitiveness

• U.S. corporate rate of 35% is world’s highest statutory corporate rate

• 35% marginal rate disincentive to invest capital in U.S. as compared to other countries with lower rates

• Average effective rate for U.S.-based corporate taxpayers (2008) - 27.1%

• OECD average effective corporate rate – 24.9%• U.S. collects 1.9% of GDP (2009) in corporate tax• OECD avg. collection 2.8% (2009) in corporate tax


Reducing Corporate Rate – High-Level Conceptual Agreement

• Obama, Romney, Camp, and Simpson-Bowles all agree U.S. corporate rate should be reduced

• Agreement on concept of broadening base to pay for reducing rate


U.S. Tax Reform By End of 2013

• Six-month or one-year extension of 2012 expiring tax provisions likely to include triggers forcing major tax reform by end of 2013

• For budget and political reasons, tax reform also likely to include changes to U.S. entitlement programs (Medicare and Social Security)

• U.S. tax reform legislation, however, is already being crafted, and development will continue in 2013


Challenges of “Broadening the Base”

• Tax reform is fundamentally about taking things away from people– In assessing impact of tax reform on your business,

important to look beyond siren call of lower corporate tax rate

– Tax reform also by necessity means eliminating tax benefits to fund tax rate reduction – “revenue offsets”

– To get to a 25% corporate and individual tax rate, most current tax preferences would have to be repealed or substantially curtailed• Obama outline: All current industry-specific preferences repealed• Simpson-Bowles: 107 tax expenditures and credits repealed


Challenges of “Broadening the Base,” cont’d

– Those facing losing a specific tax break historically fight harder than those trying to take it away to fund rate reduction.

– Tax reformers’ response: Pain must be widely-shared – no significant disparity among industry sectors.


Corporate Tax Reform Outlook

• Reform likely to address taxation of– U.S. corporate income– foreign income and transactions between U.S. and foreign

affiliates– pass-through entities– individuals, including on investment income


Corporate Taxes – Limited Revenue Source

• In 1952, corporate taxes generated 32.1% of federal tax revenue

• In 2010, corporate taxes generated only 8.9% of federal revenue

• Why?– Reduction in effective tax rates due to deferral of foreign

income, new credits, and deductions– More business activity conducted in pass-through entities


Corporate Reform – Base Broadening

• Almost all tax expenditures on table, depending on who is in White House

• Largest corporate tax expenditures (2010-14 Total in $Billions)– Deferral of overseas earnings 70– State and local tax-exempt bonds 45– Sec. 199 domestic production deduction 43– R&D credit and expensing (approx.) 43– Export source rule for inventory 38– Accelerated depreciation 37– Low income housing tax credit 27– LIFO accounting 20


Corporate Reform – Base Broadening, cont’d

• Other Potential Revenue Offsets– Limit U.S. interest expense deduction to reduce tax bias toward debt

financing – Significant new “earnings stripping” restrictions on deduction of

outbound payments by U.S. affiliate to foreign multinational parent– U.S. multinationals pay tax on overseas earnings from IP (base

erosion v. minimum tax) – Repeal industry specific tax preferences (e.g., oil/gas and alternative

energy)– Large businesses operated in pass-through form (partnership, LLC,

S, MLP)• Entity level tax on business income• Partner loss of passed-through corporate tax deductions (e.g.,

accelerated depreciation)


Industry Sectors Pitted Against Each Other

• Revenue target– Revenue neutral: balance of winners and losers– Revenue positive/deficit reduction: more losers than

winners


“Bricks & Mortar” retail(accelerated depreciation)

High tech and pharma(territorial system for overseas earnings)

U.S. manufacturing(accelerated depreciation; sec. 199)

Services businesses (rate cut)

Leveraged businesses (full interest deduction)Non-leveraged businesses

(rate cut)

Industry specific preferences

(e.g., oil & gas)High effective tax rate industry

(e.g., retail)

Pass-throughs(loss of tax preferences; no benefit from corporate rate cut)

Regular corporations(rate cut in exchange for repeal of preferences)

Foreign-owned multinationals

No help from U.S. industry to fight new outbound earnings stripping rules

Industry Sectors Pitted Against Each Other, cont’d


Individual Tax Reform

• Why corporate reform is linked to individual reform– If rate disparity too large, choice of entity become key

consideration• Resurrect Irving Berlin and his incorporated pocketbook

– Pass-throughs hurt by repeal of preferences, no benefit from corporate rate cut

– Individual side drives huge industry impacts• e.g., mortgage deduction limits affect real estate, construction

industries via consumer demand

– Linkage of individual reform to corporate reform underscores enormity of challenge of tax reform


Individual Tax Reform, cont’d

• Largest Tax Expenditures for Individuals (2010-14 Total in $Billions)– Exclusion of employer contributions to health care 659– Exclusion of pension contributions and earnings 515– Mortgage interest deduction 484– Capital gains/dividends – reduced rates 403– Earned income credit 269– State/local income, property tax deduction 237– Exclusion of capital gains at death 194– Charitable deduction (other than health, education) 182– Exclusion of Social Security benefits 173– Child credit 168


Roundtable – Observations • Observations regarding tax reform regardless of who is

POTUS. E.g., does tax reform drive deficit reduction or vice versa?

• Pass-through entities and the relationship between individual and corporate tax reform

• Transition relief may lessen the pain but arithmetically, reduces “the good news” on rates

• Deferred tax assets – transition relief?• Is there a “miracle cure” on the sidelines; i.e., a very low

additional tax on a very large base?– VAT– Carbon tax– Financial transaction tax


Q&A


Appendix

www.hoganlovells.com

Tax Reform Proposals - Obama

• Lower U.S. corporate tax rate to 28%• Eliminate “loopholes and subsidies”

– Eliminate LIFO tax accounting– Eliminate tax benefits of COLI– Tax carried interests as ordinary income

• Eliminate “distortions”– Decelerate accelerated depreciation– Reduce corporate deductibility of interest on debt– Eliminate tax advantage for large pass-through entities

23


Tax Reform Proposals – Obama, cont’d

• Encourage U.S. manufacturing– 25% Corporate rate for U.S. manufacturing– Lower rate (22%) for “advanced technology property manufacturing”– Increase and make permanent simple R&E credit to 17%– Extend and consolidate clean energy tax incentives

• Encourage domestic investment– Apply minimum tax to overseas profits– Remove deductions for moving production overseas– 20% credit for expense of ‘insourcing’ production to U.S.– Tax excess profits of shifting intangibles to low-tax areas– No deduction on U.S. interest expense on debt invested abroad until

foreign income taxed in U.S.

24


Tax Reform Proposals - Romney

• Permanent extension of Bush tax rates• Repeal Affordable Care Act Medicare tax• Broaden tax base by “eliminating preferences”• Reduce corporate tax rate to 25%• Move to territorial U.S. tax system

25


Tax Reform Proposals – Romney, cont’d

• Make R&E credit permanent• Extend 100% bonus depreciation through 2013• Repatriation tax holiday• Broaden corporate base and “reduce preferences”• Repeal corporate AMT

26


Tax Reform Proposals - Camp

• Reduce corporate tax rate to 25%• Broaden the corporate tax base• Move to territorial U.S. tax system• DRD of 95% of CFC dividends to parent• Exclude 95% of capital gains from sale of CFC in

active trade or business• Transition rule would apply 5.25% tax on all existing

foreign earnings held offshore• Passive, highly mobile foreign income subject to

U.S. tax under Subpart F rules

27


Tax Reform Proposals – Camp, cont’d

• Reduce risk of income shifting – particularly related to intangibles – to lower tax jurisdictions; 3 options:– Obama “excess returns” proposal - new subpart F

category: income from transferred intangible property earning high return in low tax jurisdiction

– CFC income subject to a foreign effective tax rate of 10% or less treated as subpart F income, with exception for same-country active income

– Income for low-taxed worldwide income derived by a CFC from intangibles is Subpart F; and domestic corporation gets 40% deduction for income attributable solely to the foreign exploitation of intangibles

28


Tax Reform Proposals – Simpson-Bowles

• Reduce corporate tax rate to between 23% and 29%

• Eliminate all but a few tax preferences• Move to territorial U.S. tax system• Maintain U.S. tax on passive foreign source income

29


Contact

• Robert Glennon, PartnerEmail: [email protected]

• Jeff Munk, PartnerEmail: [email protected]

• John Stanton, PartnerEmail: [email protected]

• Jamie Wickett, PartnerEmail: [email protected]


Hogan Lovells has offices in:

Abu DhabiAlicanteAmsterdamBaltimoreBeijingBerlinBrusselsBudapest*Caracas

Colorado SpringsDenverDubaiDusseldorfFrankfurtHamburgHanoiHo Chi Minh CityHong Kong

HoustonJakarta*Jeddah*LondonLos AngelesMadridMiamiMilanMoscow

Munich New YorkNorthern VirginiaParisPhiladelphiaPragueRiyadh*RomeSan Francisco

Shanghai Silicon ValleySingaporeTokyoUlaanbaatarWarsawWashington DCZagreb*

“Hogan Lovells” or the “firm” is an international legal practice that includes Hogan Lovells US LLP and Hogan Lovells International LLP.

The word “partner” is used to refer to a member of Hogan Lovells International LLP or a partner of Hogan Lovells US LLP, or an employee, or consultant with equivalent standing and qualifications, and to a partner, member, employee or consultant in any of their affiliated businesses who has equivalent standing. Where case studies are included, results achieved do not guarantee similar outcomes for other clients. Attorney advertising.

For more information, see www.hoganlovells.com

© Hogan Lovells 2012. All rights reserved.

* Associated offices

Documents

Taxmageddon or Tax Reform? The Outlook for U.S. Tax Reform in the Next Congress Presented by Robert Glennon, Jeff Munk, John Stanton, and Jamie Wickett