Details in Ryan’s blueprint indicate shift in GOP approach

While tax reform has been discussed at length in recent years, and many have grown skeptical of the possibility for action in the near-term, the recently released House Tax Reform Task Force blueprint demonstrates continued interest in tax reform in the U.S. Congress and lays additional groundwork for future action on reform.

Many of the reform proposals to date have been so-called 1986-style reforms, which propose to lower the tax rates and broaden the tax base. The most recent blueprint follows the road less traveled, seeking to move to a consumption-based system within the current income tax framework by reducing taxes on investment and savings, similar in concept to the American Business Competitiveness Act (H.R. 4377) introduced by Ways and Means Committee Member Devin Nunes, and the Growth and Investment Tax Plan included in the President’s Advisory Panel on Federal Tax Reform report released in November 2005. 

{mosads}On the business side, the blueprint would reduce the corporate tax rate to 20 percent and reduce the top rate on pass-throughs and other small businesses to 25 percent. The plan would thus de-link the tax rate on pass-through income from individual tax rates, which addresses a significant objection that small businesses have had to prior tax reform proposals.

The blueprint would allow 100 percent business expensing all property except land, resulting in no tax on a new investment. In addition, the blueprint proposes to reduce corporate bias for debt over equity by reducing the tax on dividends and capital gains of individual shareholders and by limiting interest deductions to the amount of interest income. Most other business credits and deductions would be eliminated, though the research and development credit would be retained. 

In the international tax area, the proposal would move to a territorial system with a 100 percent exemption for dividends from foreign subsidiaries. Accumulated foreign earnings of approximately $2 trillion could be repatriated at a lower tax rate. The proposed plan provides border adjustments that only tax imports and not exports, although it is not clear that this will comply with World Trade Organization rules. These provisions – combined with the lower corporate rate – are intended to stop inversions, prevent cash from being “trapped” overseas, and remove incentives for transferring money or businesses out of the country.

Even if tax reform does not happen soon, the blueprint represents another step in framing the discussion in Washington about the direction and shape of reform when it finally happens.  Because the blueprint is currently a relatively high-level framework, the lack of details makes engagement in the process by taxpayers essential. For example, how interest income and expenses are defined can make a big difference in the impact of this provision, as will the special interest expense rules for financial services companies that the blueprint contemplates developing. 

It will also be important to flesh out the technical aspects of the international tax rules, such as the role of the foreign tax credit, the treatment of branches, and the level of ownership of foreign subsidiaries required for the 100 percent exemption on dividends.  In addition, the blueprint provides very little detail on transition rules, which will be essential in making such a substantial shift in our tax system.   Thus, all taxpayers would be advised to review this blueprint and consider how this framework might affect them.

Lisa Zarlenga is a partner and Cameron Arterton is of counsel at Steptoe & Johnson LLP.