Corporate tax planning in a time of uncertainty
CPAs and their business clients and corporate tax departments need to consider different scenarios for the possible corporate tax reforms now being weighed in Congress.
“The good news is that for taxpayers in the corporate tax space, they have opportunities that are available to them when tax reform is afoot,” said Diane Tinney, director of product management for Bloomberg BNA Software. “From a provision standpoint, they need to understand what could become law and put aside any reserve or release any reserve that they may need based on that tax law, more likely than not coming into effect by the end of the year. The other thing for corporations is that they understand what their levers are, that they could perhaps move quickly this year. Let’s say tax reform doesn’t get completed by the end of this year, but there is enough information around what will change, that certain elections and certain positions should be maximized this year before the tax law changes. Looking at it from both angles is important.”
One of the most hotly debated possibilities is a border adjustment tax on imported goods. However, it’s unclear whether that will become law, given the heavy lobbying against it by many companies, although it is believed that the border adjustment tax is one of the few viable ways to pay for the drastic tax rate reduction that’s being proposed under the House Republican and Trump administration tax plans.
“Unclear is the right word right now,” said Tinney. “If you look across the Trump tax reform plan, the one-pager that was presented, and you look back to the blueprint from the House last summer, both are still not fully developed. There aren’t enough facts there to really say anything is certain, but the border tax may come into play as could the reduction in the corporate tax rate. I’d say out of all the things that I’ve seen, like the 199 depreciation expensing, the lowering of the corporate tax rate seems to be the one item that has the most support across the board.”
One big question is whether drastically lowering the corporate tax rate would prompt more companies to give up on being pass-through entities, such as S corporations, and become C corporations instead.
“As soon as the corporate tax rate goes down, no-one’s going to want to get into the mess of having a partnership, having a pass-through, an LLC and so on,” said Tinney. “It’s a lot cleaner to have a C corp.”
Another tax reform proposal is to let multinational corporations bring back the profits they have stashed in low-tax countries to the U.S. at much lower tax rates, similar to the 2004 tax holiday, although that repatriation process was later criticized after it turned out that the money did not lead to more investment in jobs and factories, as originally promised. Instead many companies simply used the money for share buybacks.
“I think politically it’s a very favorable thing to have, but it will be interesting to see what the details are of how that will come to pass,” said Tinney. “When there was a little dalliance into repatriation, there were no regulations or requirements around it. So what companies did is they just passed on the benefit to their shareholders. It did not end up creating new jobs. It will be interesting to see if this administration and Congress are able to tie a repatriation approach with some concrete regulations that will truly drive job creation.”
Tinney doubts that much more will be done to stem corporate tax inversions, pointing to the impact of the Section 385 regulations that were finalized in the closing months of the Obama administration.
“I think that the most recent regs that I saw on 385 really closed that loophole quite well, maybe even in a stronger way than corporations would like,” she said. “The way the 385 regs are today, coupled with the repatriation at a lower tax rate, together would make corporate inversions not attractive because it’s a lot of work to do that. Basically the United States would become a tax haven, and more and more companies globally would want to be C corps here. The challenge for corporations is going to be to look in a holistic way across all of the different tax reform suggestions because they’re going to impact each other.”
Bloomberg BNA has produced an infographic laying out some of the possible scenarios.
“In the infographic there’s an example where if depreciation was a full write-off, if basically everybody had bonus depreciation for everything and suddenly your deferred tax liability comes down, then what you’re going to see is your tax expense goes down,” said Tinney. “And as your tax expense goes down, now your taxable income goes up, and your earnings per share would go up. Then on the other side you’re creating more losses potentially. Anyone that’s in an NOL position will now have a huge NOL carryover, and that’s a deferred tax asset on the balance sheet. That’s the opposite effect.”
She pointed to what might happen in the various states in reaction to federal tax reform, as some states may decide to “decouple” from the new federal tax policies as they wait to see the impact on their budgets. Using software to try out different what-if scenarios can help corporate tax planners make decisions on future strategies.
“You can’t really try to just look at one item in isolation,” said Tinney. “You absolutely need to be able to model it out and be able to see the impact of what if we have a border tax, what if depreciation is a write-off, what if we have the ability to carryover a loss indefinitely on the federal return, but the states then decouple. If you look back to the ’86 [Tax Reform] Act, that’s exactly what they did. As soon as it was passed, the states ran into their state Congress and they passed laws that said we’re decoupling from whatever the federal [government] just did because we don’t understand it. Then it takes another year or two until they understand, and slowly they start to either couple or they do something completely different, which makes for more challenging tax planning and provision analysis.”