A pair of Democratic senators who chair influential committees have introduced legislation aimed at closing a variety of tax loopholes to reduce the budget deficit.

The Cut Unjustified Tax Loopholes Act, or CUT Loopholes Act, was introduced Tuesday by Carl Levin, D-Mich., who chairs the Senate Armed Services Committee and the Senate Permanent Subcommittee on Investigations, and Kent Conrad, who chairs the Senate Budget Committee. The bill, S.2075, would crack down on offshore tax abuses, close tax loopholes that encourage corporations to move jobs offshore and end a corporate tax loophole that allows corporations to claim a stock option tax deduction that is greater than the stock option expense shown on their books.

The portion of the bill aimed at closing offshore tax havens is based primarily on the earlier Stop Tax Haven Abuse Act, S. 1346, which was authored by Levin and co-sponsored by Conrad and six others. President Obama, as a senator, supported a similar measure. Among other measures, the bill would give the Treasury Department the authority to take tough new actions to combat tax haven banks and tax haven jurisdictions that help U.S. clients hide assets and dodge U.S. taxes.

The bill would also stop offshore corporations that are managed from the United States from claiming foreign status and thereby dodging taxes on their non-U.S. income. In addition, it would eliminate tax incentives for moving U.S. jobs offshore and transferring intellectual property offshore. The bill would also establish in law the presumption that, unless a taxpayer proves otherwise, an offshore corporation that is formed by, receives assets from, or benefits a U.S. taxpayer is considered under the control of that taxpayer for U.S. tax purposes.

Based on estimates from the Joint Committee on Taxation and the Office of Management and Budget, the offshore tax provisions of the bill would reduce the deficit by at least $130 billion over 10 years.

The second major focus of the bill is closing a corporate tax loophole that provides a tax subsidy to corporations that compensate executives using stock options. Under current law, corporations are allowed to take a larger income tax deduction for stock option expenses than is recorded on their financial books. Between 2005 and 2009, this loophole allowed U.S. corporations to take between $12 billion and $61 billion annually in excess tax deductions.

The bill would prohibit corporations from taking a larger income tax deduction for stock-option grants than the expense shown on their books. It would also preserve the current tax treatment for individuals who receive stock options and for incentive stock options commonly used by start-up companies. The bill would apply to stock options the same $1 million overall limit on corporate tax deductions for executive pay that applies to other forms of compensation. The bill would also ensure that research tax credits use the same methodology for calculating stock option compensation expenses when computing wages.

This portion of the bill is based primarily on the Ending Excessive Corporate Deductions for Stock Options Act, S. 1375, authored by Levin and cosponsored by Senators Sherrod Brown, D-Ohio, Claire McCaskill, D-Mo., and Sheldon Whitehouse, D-R.I. The Joint Committee on Taxation has estimated that these provisions would reduce the deficit by $25 billion over 10 years.

Based on estimates from the Joint Committee on Taxation and the Office of Management & Budget, the CUT Loopholes Act overall would yield at least $155 billion in deficit reduction over 10 years, more than enough to cover the $100 billion cost of a full-year extension of the payroll tax cut.

“With federal tax revenue at its lowest level in decades and economists warning that more draconian budget cuts could damage the recovery, it is clear that we can’t achieve significant deficit reduction and meet important priorities by focusing on spending cuts alone,” Levin said in a statement. “Many in Congress have refused to consider revenue measures to meet our budget challenges, but there should be bipartisan support for closing these indefensible tax loopholes.”

The bill would allow the Treasury to take specified steps against foreign jurisdictions or financial institutions that impede U.S. tax enforcement, including prohibiting U.S. financial institutions from doing business with a designated foreign jurisdiction or foreign bank. It would also clarify when, under the Foreign Account Tax Compliance Act, foreign financial institutions and U.S. persons must report foreign financial accounts to the IRS. The bill would also stop companies run from the United States from claiming foreign status and dodging U.S. taxes on their foreign income by treating foreign corporations that are publicly traded or have gross assets of $50 million or more and whose management and control occur primarily in the United States as U.S. domestic corporations for income tax purposes.

In addition, the bill would strengthen detection of offshore activities by requiring U.S. financial institutions that open accounts for foreign entities controlled by U.S. clients or open foreign accounts in non-FATCA institutions for U.S. clients to report the accounts to the IRS. The bill would close the offshore swap payments loophole by treating swap payments that originate in the United States as taxable U.S. source income.

In addition, the bill would close the foreign subsidiary deposits loophole by treating deposits made by a controlled foreign corporation to a financial account located in the United States as a taxable constructive distribution by the CFC to its U.S. parent.

It would also require annual country-by-country reporting by SEC-registered corporations on employees, sales, financing, tax obligations, and tax payments. The bill would establish a penalty for corporate insiders who hide offshore holdings by authorizing a fine of up to $1 million per violation of securities laws.

In addition, the bill would require anti-money laundering programs for private funds and formation agents to ensure they screen clients and offshore money. It would strengthen John Doe summonses by streamlining the process used by the IRS to issue summons to a class of persons, such as the clients of an offshore bank, accounting firm, or law firm, while strengthening court oversight.

The bill would also combat hidden foreign financial accounts by allowing the IRS to use tax return information to evaluate foreign financial account reports, simplifying penalty calculations for unreported foreign accounts, and facilitating use of suspicious activity reports in civil tax enforcement.

The bill would also strengthen penalties on tax shelter promoters and those who aid and abet tax evasion by increasing the maximum fine to 150 percent of any ill-gotten gains. It would prohibit fee arrangements in which a tax advisor is paid a fee based upon the amount of paper losses generated to shelter income or taxes not paid by a client.

In addition, the bill would require bank examination techniques to detect and prevent abusive tax shelter activities or the aiding and abetting of tax evasion by financial institutions. It would allow sharing of tax information with federal financial regulators upon request when engaged in a law enforcement effort. The bill would also require disclosure of information to Congress related to an IRS determination of whether to exempt an organization from taxation.

It would direct the establishment of standards for tax opinions rendering advice on transactions with a potential for tax avoidance or evasion. It would also defer corporate tax deductions for expenses related to deferred income so that, for example, a corporation would be barred from taking a tax deduction for building a plant offshore until it also declared and paid U.S. taxes on income produced by that plant.

The bill would determine foreign tax credits on a pooled basis to prevent U.S. corporations from manipulating and taking excess foreign tax credits to reduce their U.S. taxes. It would also tax excess income from intangible property that has been transferred offshore including patents, trademarks, and copyrights, to remove incentives for U.S. corporations to move their intellectual property offshore.

In addition, the bill would limit shifting of income to offshore entities through the transfer of intangible property so that U.S. corporations would no longer receive tax benefits from creating offshore shell entities to hold ownership of their patents, trademarks, and copyrights. It would also limit earnings stripping by stopping U.S. corporations that reincorporate in another country from treating their U.S. income as foreign income. 

“The CUT Loopholes Act is a win-win as it promotes tax fairness and it will help reduce the budget deficit,” said Conrad. “This legislation identifies a series of steps we can take now to end egregious tax loopholes and offshore tax abuses. The revenue raised by cutting these tax loopholes will reduce the deficit and help pay for pressing domestic needs, such as an extension of the payroll tax cut.”

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