Both political parties agree that the U.S. needs dramatic tax reform in order to simplify our system and be more competitive in the global market. But that’s as far as the agreement goes.
“The general consensus is because you have one party in the House, Senate and as the president there is never a more likely time for this to happen. That’s not to say it’s not still without its challenges,” says Dave McClain, Tax Managing Director at BDO USA, LLP.
Almost every section in the Internal Revenue Code was created as an incentive for a specific purpose, group or special interest.
“Everybody has some skin in the game,” he says. “When you talk reform, it’s not only challenging things that Democrats have done, but it will be challenging bills that Republicans have introduced and passed over the years as well.”
But after years of talk, the momentum is gathering for something to possibly be passed this calendar year. When it could actually take affect, however, is not clear.
Smart Business spoke with McClain about what could happen to corporate taxes under the Trump administration.
What is wrong with the U.S. tax system as it operates today?
Not only is the U.S. tax code complex, it follows a worldwide tax system. Corporations are taxed on profits no matter where they are earned. There are ways to defer tax until the profit earned abroad is brought back into the U.S., but it’s still taxed. Other countries tax systems are territorial, where corporations are taxed only on profits earned in the country in which they operate.
The U.S. also has one of the higher corporate tax rates globally, which has even encouraged businesses to move overseas.
What changes are being proposed?
The GOP House Blueprint proposes reducing the corporate tax rate to 20 percent, switching to a territorial system and implementing border adjustments. These structural changes are an attempt to simplify and streamline the international tax rules and to encourage businesses to access ‘trapped cash’ overseas.
More specifically, the Blueprint seeks to move to a destination-basis tax system, where the tax jurisdiction of income follows the location of consumption rather than the location of production. Border adjustments effectively exempt exports from U.S. tax while taxing imports. In other words, it does not matter where a company is incorporated; sales to U.S. customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic.
How likely is it that the reforms go through?
It’s too early to say. What’s being proposed could change several times between now and when it’s passed — and what ultimately gets passed may or may not look at all like what’s being proposed right now. Over the summer is probably when we’ll get a better idea if something truly is going to happen in calendar year 2017.
The idea is to lower corporate rates and broaden the tax base by eliminating deductions. It won’t be easy to balance this without the border tax adjustment, the most contentious piece. Challenges surround a border tax, but it’s also the biggest issue that people want to push through.
Globally, most countries have indirect taxes with some sort of border tax associated with them. Going to that type of system wouldn’t be out of the norm. The transition would be difficult, though, because while the U.S. might end up collecting more taxes, who pays would shift. Retail imports significantly more than it exports, so retailers would share in more of the tax liability in the new system, but industries such as aerospace would benefit because those corporations manufacture here and export globally.
What should business owners do in regards to this issue?
You can only plan for what you know. You have to operate within the rules as they exist today. That doesn’t mean business leaders and their advisers can’t look to what’s being proposed and try to position themselves should these reforms actually happen, but they don’t need to go through any major restructuring right now. It’s still an evolving conversation, but you do need to be paying attention. Your accountants can speak to you now and help you plan ahead.
Insights Accounting & Consulting is brought to you by BDO USA, LLP
