W&M Committee examines extenders with eye toward economic growth and job creation
W&M Committee examines extenders with eye toward economic growth and job creation
April 9, 2014
On April 8, the Ways and Means Committee held a hearing on the expired business tax provisions that Chairman Dave Camp (R-MI) proposed making permanent or extending for the long-term in his tax reform proposal, the “Tax Reform Act of 2014,” released earlier this year. The hearing focused on the effect that making these provisions permanent would have on businesses’ ability to grow, create jobs, and increase wages. This article examines the Joint Committee on Taxation’s report on these extenders issued in conjunction with the hearing as well as the opinions of various witnesses who were invited to testify.
For more details on Rep. Camp’s business-related tax proposals, see Weekly Alert ¶ 20 03/06/2014. For more details on the recent extenders bill approved by the Senate Finance Committee, see ¶ 1 and Weekly Alert ¶ 25 04/03/2014.
Provisions covered by the proposal. The JCX highlighted the following expired business provisions which would be made permanent or extended, and in some instances modified, under Rep. Camp’s “Tax Reform Act of 2014”:
- … Research and development (R&D) credit. For amounts paid or incurred after Dec. 31, 2013, the research credit would be made permanent, and the traditional 20% research credit calculation method and the energy research credit would be repealed. The rate under the alternative simplified method for calculating the research credit would equal 15% of qualified research expenses that exceed 50% of the average qualified research expenses for the three preceding tax years. The rate would be reduced to 10% for a taxpayer with no qualified research expenses in any one of the three preceding tax years. The credit rate for the basic research credit would be reduced to 15%, and the base period would change from a fixed period to a 3-year rolling average. (Code Sec. 41) The proposal would also eliminate the research credit with respect to research related to computer software.
- … Expensing deduction. For tax years beginning after Dec. 31, 2013, a taxpayer would be able to expense up to $250,000 of the cost of qualifying property placed in service for the tax year. The $250,000 amount would be reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $800,000. Both amounts would be indexed for inflation for tax years beginning after 2014. For tax years beginning after 2013, the treatment of off-the-shelf computer software and qualified real property as eligible Code Sec. 179 property would be permanent. In addition, investments in air conditioning and heating units would qualify for expensing.
- … Active financing income exceptions. The proposal would modify and extend for five years (i.e., to apply for tax years beginning before Jan. 1, 2019) the present-law temporary exceptions from subpart F foreign personal holding company income, foreign base company services income, and insurance income for certain income that is derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business. (Code Sec. 953 and Code Sec. 954)
- … Look-through treatment of payments between related controlled foreign corporations (CFCs). For tax years of foreign corporations beginning after Dec. 31, 2013, and for tax years of U.S. shareholders with or within which such tax years of foreign corporations end, the “look-through rule” would be made permanent. Under this rule, dividends, interest (including factoring income that is treated as equivalent to interest under Code Sec. 954(c)(1)(E)), rents, and royalties received or accrued by one CFC from a related CFC (i.e., one that controls or is controlled by the other, or a CFC that is controlled by the same person(s) that control the other) are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the payor that is neither subpart F income nor treated as ECI. (Code Sec. 954(c)(6))
- … Basis adjustment—S corp stock. For years beginning after Dec. 31, 2013 and thereafter, for charitable contributions made by an S corporation, an S corporation shareholder would be able to reduce his basis in the stock of the S corporation by reason of the charitable contribution by an amount equal to the shareholder’s pro rata share of the adjusted basis (as opposed to fair market value) of the contributed property.
- … Reduction in S corp recognition period for built-in gains. For tax years of S corporations beginning after Dec. 31, 2013, the 5-year (as opposed to 10-year) built-in gain recognition period for S corporations, which provides special rules for recognizing built-in gains of C corporations that convert to S corporations, would be permanently extended. (Code Sec. 1374)
- … Race horses. The proposal would assign a 3-year recovery period for any race horse placed in service after Dec. 31, 2013. (Code Sec. 168)
Hearing. As described by Chairman Camp, the hearing was on “explor[ing] the value in having stable, permanent tax policy for employers.” He stated that “the practice of short-term tax policy, extending important business tax provisions for one or two years at a time makes it very difficult for employers to plan and adds immense confusion and complexity for taxpayers,” and that “[t]he long-standing tax provisions that help businesses grow the economy and create jobs should be made permanent once and for all.”
Testimony was provided by the following invited witnesses. Several of the witnesses represent industries that would particularly benefit from permanently extending one or more of the provisions at issue; two are tax professionals whose clients or practice would benefit; and one represents a nonpartisan think tank focused on economic policy.
Judith Zelisko, Vice President of Tax, Brunswick Corporation, spoke of the benefits that a permanent R&D credit would provide to her company (a “leading global designer, manufacturer, and marketer of recreational products”). She stated that the company continuously invests in R&D in order to improve its competitive position and to drive innovation, and that “it is critical that any tax reform recognize the important role of research and technology in the growth of U.S. jobs and innovation.” She emphasized that the U.S. has historically been a leader in R&D, but that its position has significantly eroded over the past decade. Ms. Zelisko also characterized the lapse of the credit as an effective tax increase on the companies that use it. She stated that making the credit permanent will “allow the United States to remain competitive in the global race for R&D investment dollars.”
Bob Stallman, President of the American Farm Bureau Federation (an “independent, non-governmental, voluntary organization” representing “more than 6,000,000 member families”), spoke of the importance of Code Sec. 179 expensing for the farming industry. He said that equipment and facilities must be constantly upgraded and replaced, allowing farmers and ranchers to, among other things, reduce costs and become more energy efficient. He also said that, given the large fluctuations in farm profitability from year to year, Code Sec. 179 helps farmers to “manage their tax liability” in a fair way. Mr. Stallman advocated for the expensing levels to be at least equal to what they were in 2013—i.e. $500,000, with a $2 million investment ceiling.
James Redpath, Managing and Tax Partner, HLB Tautges Redpath, Ltd., testified on the S corporation extenders described above. He described the built-in gains tax, with the 10-year recognition period in Code Sec. 1374, as carrying an overall “combined tax rate ranging from 50% to 60%”—”punitive enough to ensure that no company knowingly triggers” the tax. He claimed that the resulting effect is that many S corporations hold on to productive or old assets that should be replaced, which distorts business behavior. He further stated that temporary extensions result “in tax motivated transactions…that may not be in the best interest of the company or its stakeholders.”
Joshua Odintz, Partner at Baker & McKenzie LLP, discussed the active financing exceptions and CFC look-through rule. He described the active financing exceptions as appropriately treating the income of banks, financing, and other businesses, which looks like passive income but is derived from an active business, as active income. He also stated that the look-through rule helps U.S.-based multinational corporations “operate on a global basis… remov[ing] impediments that would make it difficult for research centers across the globe to share intellectual property.” Mr. Odintz supported making these provisions permanent because uncertainty “impedes legitimate business decisions, and forces behavior that [do] not make good business sense.”
Finally, Thomas Hungerford, Director of Tax and Budget Policy, Economic Policy Institute, spoke more generally about the impact of temporary tax provisions on the budget. He noted that the seven provisions at issue “account for almost half of the revenue loss of all the expiring provisions,” and stated that making them ” permanent with no offsetting revenue increases could add almost one percentage point of GDP to federal debt by 2023.” He noted that the justification for making these provisions permanent is that “they are believed to encourage firms to create more jobs,” but then observed that “any jobs created by these provisions would be entirely offset by jobs lost due to larger budget deficits over the longer-term.” He opined that “[t]he annual consideration of an extenders package provides an opportunity for a systematic review of many tax provisions, but only to the extent that the relevant Committees choose to do so.” This type of annual review would allow for consideration of new research, changed economic conditions, and new fiscal priorities—but “[b]alanced against this is the stability that comes with permanence, which is beneficial to taxpayers in making economic decisions and to the government in making budget decisions.” Mr. Hungerford concluded by stating that “the appropriate question regarding the tax extenders is which ones should remain in the tax code and which ones should be eliminated, rather than asking if they should be permanent or temporary.”