Tax

Legislative Outlook Favors Tax Extenders Over Reform

2014
Author:  Andrew Klemens

Andrew Klemens

Partner

Tax

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Over the past several years, politicians have discussed the need to reform the U.S. tax system to reduce corporate and individual tax rates while simplifying the tax code. Comprehensive reform will require a proposal on which both houses of Congress and the president can agree.

Following the November midterm elections, Republicans now control the Senate and continue to control the House. This makes President Obama a critical player in tax reform because he could veto any bill passed by the GOP Congress. With 2016 being an election year, it may not be likely for a tax reform bill to be signed into law before 2017. However, the following proposals are the product of much research and bipartisan effort and may highlight many potential target areas for future reform.

The Camp Proposal

Early in 2014, the first of such plans to move beyond oversimplified suggestions, the “Camp proposal,” was introduced by former Chairman of the House Committee for Ways and Means, David Camp, R-Mich. The Camp proposal would include:

  • Seven tax rates, ranging from 10 percent to 39.6 percent, reduced to 10 percent, 25 percent and 35 percent
  • More generous standard deduction ($22,000 married or $11,000 single)
  • Repeal of the alternative minimum tax (AMT)
  • Limitations on the use of cash method of accounting
  • Repeal of the last-in, first-out (LIFO) inventory method
  • Permanent Section 179 expensing limit up to $250,000
  • Permanent alternative simplified research & experimentation (R&E) tax credit
  • Increase in amortizable life for Section 197 intangibles from 15 to 20 years
  • Reduction in S corporation built-in gains window from 10 to five years
  • Repeal of like-kind exchange rules
  • Ten-year amortization of 50 percent of advertising expenditures in excess of $1 million
  • Repeal of current deduction for research expenditures, including software development costs
  • Changes to retirement contribution deductions
  • Additional limitations on deductible home mortgage interest
  • Two percent of adjusted gross income floor on deductible charitable contributions

Another Take on Reform:  President Obama’s 2015 Budget

More recently, President Obama laid out a tax reform plan that reduces corporate rates from 35 percent to 28 percent (25 percent for manufacturing) for C corporations and proposes changes to the taxation of income earned in foreign countries, including a deemed repatriation of all cumulative foreign earnings held abroad. Other changes include:

  • Repeal of LIFO and lower of cost or market inventory methods
  • A permanently restored and enhanced R&E credit
  • Enhanced green energy provisions
  • Elimination of oil, coal and natural gas subsidies, including elimination of intangible drilling costs and percentage depletion
  • Changes to depreciation rules for business aircraft

Proposed changes affecting flow-through entity income reported on individual returns include:

  • Expanded expensing of capital assets for small businesses
  • Reduction in S corp built-in gains window from 10 to five years
  • Subjecting S corp flow-through income to self-employment taxes

The president’s plan also includes several other changes impacting individuals:

  • Expansion of the Child Tax Credit and Earned Income Tax Credit
  • Exemption for sales of small business stock
  • Limit on the tax benefit of itemized deductions to the 28 percent rate, regardless of the taxpayer’s marginal rate
  • Minimum 30 percent tax for high earners
  • Required use of FIFO method for determining cost basis for sales of securities
  • Increased estate tax rate from 40 percent to 45 percent and lowered estate exclusion from $5 million (indexed for inflation) to $3.5 million (nonindexed)
  • Taxation of carried interests in partnerships as ordinary income
  • Limits on contributions to tax-favored retirement accounts with balances in excess of $3 million

Is Comprehensive Tax Reform Beyond Our Grasp in 2015?

Although discussions regarding a comprehensive plan to reform the tax code are popular in the media, Senate leadership appears to favor passing a yearlong stopgap funding measure that would allow them to restore many expired incentives. These typically are referred to as extenders, although in recent years they have become known as the expirers.

The Senate Finance Committee proposed the EXPIRE Act, a bipartisan effort to provide a final extension of certain tax deductions that would offer more certainty regarding which incentives would be available for 2014 and 2015. Each extender would expire after 2015 and be scrutinized as part of a plan for tax reform. Because tax returns must be completed early in 2015, this bill likely would include much of what will be retroactively restored for 2014, including the following:

Expired Deductions that May Be Restored

  • Mortgage insurance premiums
  • Expenses incurred by teachers
  • Higher education expenses
  • State & local sales taxes

Expired Income Exclusions that May Be Restored

  • Cancellation of indebtedness income from mortgage loan modifications on a principal residence
  • Employer-provided transit & parking benefits from income
  • Up to $100,000 of distributions from IRAs to charities

Other Likely Extenders

  • Credit for energy-efficient improvements to existing homes
  • Increase in Section 179 expensing of eligible property from $25,000 to $500,000, limited to $250,000 for qualified leasehold improvements
  • Fifty percent bonus depreciation for qualified property placed in service before January 1, 2016, including acceleration of AMT credits in lieu of bonus depreciation for C corps
  • Extension of 15-year life for qualified leasehold improvements, qualified restaurant property and qualified retail improvements
  • Enhanced deduction for energy-efficient commercial buildings, up to $1.80 per square foot
  • R&E credit (The EXPIRE Act also includes a new modification to the credit that would allow companies less than five years old and with less than $5 million in gross receipts to claim unused credits against payroll taxes)
  • Reduction in S corp built-in gains window from 10 to five years
  • Work Opportunity Tax Credit

Although we cannot say which incentives will be extended, we expect many of these expired provisions to be restored through December 31, 2015, which would increase deficits by $84.1 billion through 2024 according to Congressional Budget Office cost estimates. This would set the stage for comprehensive tax reform, as many of these extenders could then be eliminated in favor of making certain incentives permanent.



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