Sen. Ron Wyden, D-Ore., has proposed to simplify the complicated capital depreciation rules for businesses.
Wyden, who is the ranking Democrat on the Senate Finance Committee, offered a discussion draft of legislation to simplify one of the most complex areas of the tax code—capital depreciation rules—making it easier for businesses to invest in everything from trucks to computers, as his committee held a hearing Tuesday on business tax reform.
Investing in capital is critical for companies looking to grow their business and helps drive overall economic development, with more than $40 trillion in capital assets in the U.S. economy, Wyden’s office noted. Currently companies have to navigate the high costs and complexity imposed by the tax code every time they want to buy or sell a piece of equipment. Small businesses are at a disadvantage as they invest in basic items to run their companies when needed, rather than when it makes the most sense from a tax perspective. In addition, the Congressional Budget Office has found that the existing rules, written in the 1980s, create bias between different industries and hit high-tech companies the hardest.
To address this complexity, the Wyden proposal would condense the 100 existing depreciation rules into six “pools,” while maintaining accelerated depreciation. The proposal would simplify the amount of math a business has to do, eliminating unnecessary rules requiring three complex calculations per asset every year. It would also significantly simplify and expand tax-free reinvestment rules to help business owners focus on growing their operations.
“You shouldn’t need a PhD in advanced mathematics to navigate the tax code when deciding to invest in a new computer or pick-up truck,” said Wyden in a statement. “This proposal addresses the lopsided rules and complexity, putting the tax code to work for small businesses and growing industries.”
The draft would also modernize the tax rules to remove existing barriers for investment in high-tech industries and infrastructure.
Last year, Wyden and Senate Finance Committee chairman Orrin Hatch, R-Utah, asked members of their committee to participate in various Tax Reform Working Groups to help identify issues and develop some consensus, if possible, around tax policy proposals. Tuesday’s hearing focused on business tax reform issues, including topics that were covered in the report issued by the Bipartisan Business Income Tax Working Group.
Rather than the depreciation rules, Hatch focused on tax reform in the context of corporate integration. “In very general terms, corporate integration means eliminating double taxation of certain corporate business earnings,” said Hatch during his opening statement. “Under current law, a corporation’s earnings are taxed once at the corporate entity level and then again at the shareholder level when those earnings are distributed to shareholders as dividends. In other words, under our system, if a business is organized as a C corporation, we tax the earnings of the corporation itself and those same earnings when paid out to the individual owners of the business. This creates a number of inequities and distortions, and my staff and I have been working for a few years now to develop a proposal to address this problem.”
Hatch said he was glad to see that the business tax working group addressed corporate integration in its report. “Depending on its design, corporate integration could have the effect of reducing the effective corporate tax rate and help address some of the strong incentives we are seeing today for companies to relocate their headquarters outside of the United States,” said Hatch. “It would also have the likely effect of making the United States a more attractive place to invest and do business.”
The American Institute of CPAs sent a letter to Hatch and Wyden in conjunction with the hearing on business tax reform, stressing the need to maintain the availability of the cash method of accounting for tax purposes.
In a letter submitted for the record of the hearing, AICPA president and CEO Barry C. Melancon wrote, “As the Committee drafts its proposals, we urge maintaining the current availability to use the cash method of accounting for pass-through entities and personal service corporations, such as accounting firms. Determining taxable income under the cash basis is simple in application, is a method of accounting which the service industry has used for decades, and must remain an option for these businesses.”
The letter explained that under the accrual method, many accounting and other service-type firms would need to accelerate a significant amount of income into the current taxable year despite not receiving the actual payment from their clients. This increase in tax liability could have a significant negative impact on a new owner’s ability to finance entrance into a partnership. Additionally, limiting the use of the cash method may result in the requirement of a CPA to take out a personal bank loan for the sole purpose of paying his/her increased tax liability. In addition to income tax consequences, some partners would also pay more self-employment taxes under the accrual method. Further, the AICPA believes a gross receipts restriction on the use of the cash method would unfairly impact accounting firms and could threaten their ability to expand.
“The AICPA has consistently supported tax reform efforts that promote simplicity and economic growth and do not create unnecessary administrative and financial burdens on taxpayers,” Melancon wrote. “An accrual method mandate falls short in that regard. We strongly urge retaining use of the cash method of accounting.”
Thomas Barthold, chief of staff of Congress’s Joint Committee on Taxation, testified about how there may be conflicting goals in tax reform. “Policy design to promote economic neutrality may conflict with goals of fairness,” he said in his written testimony. “Policy design to promote fairness may lead to complexity and increased compliance costs. Additional constraints that may also shape reform include: maintaining budget neutrality as conventionally estimated, maintaining the current distribution of tax burdens across income groups, and not achieving low tax rates on C corporate business income at the expense of higher taxes on passthrough business income. There are always tradeoffs. Many business tax reform proposals are the result of such tradeoffs.”
Some proposals, he noted, undertake comprehensive tax reform by broadening the tax base and lowering tax rates. Other proposals seek to maintain parity between corporate and pass-through entities. Other proposals involve corporate integration and dealing with patents.
James R. Hines, Jr., an economics professor at the University of Michigan, pointed to the need to lower taxes on businesses. “Heavy tax burdens threaten the vitality of U.S. businesses by discouraging business investments and reducing funds available for business expansions,” he said. “A tax system that imposes undue burdens on U.S. businesses reduces the productivity of the U.S. economy, and in so doing reduces the wages and employment opportunities of Americans. Given the economic challenges facing the country now and in the future, it is important that U.S. businesses operate in a tax environment that does not excessively discourage investment and that is conducive to normal business operations.”
Eric J. Toder, co-director of the Urban-Brookings Tax Policy Center, noted that while corporate tax rates in the U.S. are comparatively high, the actual taxes paid by corporations are relatively low.
“No one is satisfied with the current rules for taxing income of corporations,” he said. “The U.S. corporate tax system discourages investment in the United States, encourages U.S. multinational corporations to report income in low-tax foreign jurisdictions, places some U.S.-based multinationals at a competitive disadvantage compared with foreign-based firms, and has encouraged U.S. companies to accumulate over $2 trillion in assets overseas. At the same time, the U.S. corporate tax raises less revenue as a share of gross domestic product than the corporate taxes of most of our major trading partners.”
Toder pointed out that corporate receipts have been fairly steady at about 2 percent of GDP for most of the past three decades, but the Congressional Budget Office is now projecting that corporate receipts will decline to 1.6 percent of GDP in 2026, as U.S. multinationals continue to shift reported profits to low-tax foreign countries and more U.S. corporations “re-domicile” themselves as foreign-based corporations.
“The current corporate tax system is outdated because it has failed to adjust for four major developments: the increased globalization of economic activity, the reduction in corporate tax rates in other major countries and their shifts to territorial tax systems, the increased share of business wealth in the form of intangible property, and the increased share of economic activity in the United States by businesses that are not subject to corporate income tax,” he added.
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