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Annette Nellen

Legislative Leftovers

As the 110th Congress wraps up, what remains to be addressed in the
next Congress?

October 23, 2008
by Annette Nellen, CPA/Esq.

While significant tax acts were enacted in 2008, congressional committees considered other tax changes as well. Some of these may surface again. This article provides a summary of selected corporate tax matters considered by the 110th Congress that did not make it into law. Commentary is also provided on the outlook for these matters in the
111th Congress.

International Taxation

Various aspects of international taxation were the subject of congressional hearings and proposals within two themes: (1) addressing rules that lead to evasion or loss of jobs and (2) modernizing U.S. tax rules.

Under the first theme, in July 2008, the Senate Finance Committee (SFC) held a hearing on the Cayman Islands and offshore tax issues. Senator Chuck Grassley (R-IA) (PDF) and the Joint Committee on Taxation (JCT) (JCX-65-08 (PDF)) described some of the issues as "offshore tax evasion." A September 2007 SFC hearing looked more specifically at offshore tax issues related to insurance companies and hedge funds. In September 2008, Congressman Richard Neal (D-MA) introduced H.R. 6969 to address offshore reinsurance tax concerns. A May 2007 SFC hearing looked at issues of moving cash offshore.

S. 96, the Export Products Not Jobs Act, illustrates a concern that the tax law affects the location of jobs. S. 96 proposed to make Subpart F rules more transparent. Deferral would end except for "active home country income." To address concerns of corporations incorporating abroad to avoid taxation of worldwide income, the definition of a domestic corporation would be modified to include a publicly-traded corporation with management and control primarily in the U.S.

Senator John Kerry (D-MA) notes that S. 96 is not intended to reduce global competitiveness of U.S. companies. A U.S. company earning income in a foreign country in serving that country could still defer income. A car factory in India selling cars there would be able to defer income, but not if the cars are sold back to the U.S. Thus, the foreign entity selling back to the U.S. would be taxed the same as the company producing and selling in the U.S. (Cong. Rec. S99, January 2007).

Under the second theme, in June 2008, the SFC held a hearing to review current tax rules and to compare worldwide and territorial approaches to international taxation. Senator Grassley (PDF) stated: "Our tax policy should enable U.S. companies to operate in the global marketplace without the artificial boundaries set in place by the tax code." He noted that any revised system should (1) support economic development, (2) raise sufficient revenue and (3) support U.S. job growth.

An August 2008 report from the General Accountability Office (GAO), U.S. Multinational Corporations — Effective Tax Rates Are Correlated with Where Income Is Reported (PDF), noted increased business activity of foreign affiliates of U.S. companies. In response to the report, Senator Max Baucus (D-MT) noted the need to consider international tax rules in the committee's work in 2009 on overall tax reform (September 2008 SFC press
release
(PDF)).

Outlook: Given concerns over outdated international tax provisions, the need to improve global competitiveness of U.S. firms and offshore tax evasion, reform of international tax rules seems quite likely in the 111th Congress. Much work has been done to get ready for reform. In 2007, the Treasury Department held a conference (PDF) on international tax reform and issued a report (PDF) on possible reforms. The SFC has held a series of hearings and various reports have been produced by the GAO, JCT
and others.

Tax Shelters

Various bills have proposed codifying the economic substance doctrine
(S. 96, H.R. 3970 and H.R. 2345). Some bills would also impose a 40 percent penalty on understatements due to noneconomic substance transactions.

Outlook: The economic substance doctrine has been discussed for years and has come close to enactment. The Senate bill that led to the Heartland, Habitat, Harvest and Horticulture Act of 2008 (P.L. 110-234) included economic substance, but it was not in the House version and was not enacted (see JCT, JCX-15-08 (PDF)). Codifying the economic substance doctrine is a revenue raiser which makes it attractive. The JCT estimated it would raise $10 billion over 10 years (CBO Cost Estimate (PDF),
October 2007).

Energy and the Environment

In addition to energy incentives added and extended in the 110th Congress, more items were on the table. Hearing and proposals dealt with tax aspects of a cap and trade system (SFC, April 2008) and a carbon tax (H.R. 2069 and H.R. 3416).

Outlook: Energy and environmental issues will remain in the forefront due to expiration of various incentives, calls for more incentives, state activities to reduce greenhouse gas emissions and the plans of either presidential candidate regarding climate change.

Healthcare

In 2008, the SFC held a few hearings, as well as a "summit" on healthcare. A focal point was the exclusion for employer-provided health insurance. Senator Baucus observed (PDF) that this provision creates inequities among workers, is an incentive for over-insurance, increases healthcare costs and results in $200 billion of federal taxes foregone each year (SFC hearing, July 2008). At the June 2008 Health Reform Summit, Intel Chairman Craig Barrett (PDF) noted how the high cost of healthcare posed a competitive disadvantage for U.S. companies.

Outlook: Healthcare reform discussions will continue and some type of change is likely. Healthcare costs are imploding, many people are uninsured and increased costs are harming the ability of U.S. firms to compete. There are various proposals for new models of healthcare delivery and insurance. These changes will likely involve the tax law because of the significant dollars in the tax system connected to healthcare (see Pot of Gold (June 2008) for data and proposals).

Worker Classification

A longstanding issue received some attention in the 110th Congress — worker classification. The House Ways and Means Committee held a hearing in May 2007 due to concerns that misclassification was increasing.

Outlook: Clarification of rules on worker classification has been postponed since Section 530 (PDF) was included in the Revenue Act of 1978. Given other pressing tax issues, worker classification will likely continue to be postponed although it could receive some attention in any efforts to address the tax gap or modify retirement plan rules. (For more information, see Worker Classification (December 2007).)

Tax Reform and Tax Rates

The SFC held several hearings on overall problems with the federal tax system and possibilities for reform. Senator Grassley (PDF) described the April 2008 tax reform hearing as "a kick-off hearing" as work was needed to better understand the current system.

Several bills proposed to reduce corporate tax rates to improve competitiveness in light of lower rates in almost all other industrialized countries (Tax Foundation, Fiscal Facts, August 2008). S. 96 would remove the top 35 percent tax rate. H.R. 3970 (Rep. Charles Rangel (D-NY)) would drop the top corporate rate to 30.5 percent and broaden the tax base.

Outlook: Many reasons are offered for major reform including complexity, inequity, outdated rules for today's global economy, economic distortions and a large tax gap. While replacement of the income tax is unlikely due to uncertain economic effects of the change and the transitional issues, we are likely to see efforts towards some type of income tax reform due to concerns with the current system and the need to address the upcoming expiration of the 2001/2003 tax cuts. A drop in the corporate tax rate seems likely, paid for with corporate base broadening.

Looking Forward

Growing deficits, a weak economy and concerns over international competitiveness of U.S. firms will lead to tax changes in the 111th Congress. Much work has already been done on the why and how,
the hard work of actually enacting changes awaits the 111th Congress.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA's Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.