Thoughts on the Upcoming 2017 U.S. Tax Policy Changes: Part 2

Link to previous article in this series: Part 1

As many of you may know, the U.S. House, on April 16, 2015, passed the Death Tax Repeal Act of 2015. (Source: House Congressional Website) This bill would repeal the U.S. estate and generation-skipping transfer taxes, and would also revise U.S. gift tax rates to lower the top rate to 35%, with a lifetime exemption for gifts set at $5 million and a cost-of-living adjustment.  The bill failed to pass the Senate.  There is every reason to expect that a similar bill will be reintroduced in 2017 as part of a comprehensive tax reform package.  This is probable since House Speaker Paul Ryan (who set up the Republican Task Force On Tax Reform, which released a “blueprint” on tax reform on June 24, 2016, which also called for the elimination of the estate and generation-skipping transfer taxes) will undoubtedly push the “blueprint” recommendations into law.

The proffered Trump tax plan he campaigned on will repeal the death tax, gift tax, and generation-skipping transfer tax systems, but capital gains held until death (and valued over $10 million for couples) will be subject to tax with exemptions for small businesses and family farms. (Source: Trump Campaign Website)

III. Upcoming 2017 Changes in the U.S. Worldwide Corporate Tax System: Great Caesar’s Ghost, The 2000 Year Old Roman Empire System to be Revised.

The theoretical core of the U.S. corporate tax system (and the individual tax and transfer tax systems as well, for that matter) is a worldwide basis.  As I have told many clients over many years, if you are a U.S. citizen or income tax resident, you can have a soda pop stand on Mars selling lemonade to aliens from the Andromeda Galaxy, and the IRS will want a piece of your action.  This stems from the jurisdictional mechanics of the income tax as enacted in the Civil War and was really brought about because Lincoln feared that Americans currently living abroad would not pay their fair share of the income tax into the war effort, and that U.S. citizens and residents in the U.S. would purposefully move abroad to negate their obligation to pay U.S. income and other taxes helping the war effort.  

But the genesis for this global view of tax liability is far deeper in history  Dictator Julius Caesar instituted a republic-wide sales tax on all commercial transactions wherever occurring.  Imperator Caesar Augustus, who actually instituted an estate tax, instituted it on all Roman citizens’ estates wherever their property lay (inside or outside Italy), and wherever they lived (inside or outside Italy).  These taxes violated traditional rules which had typically differentiated between the peninsula of Italy (i.e., that which was viewed as uniquely “Rome” and uniquely “Roman”) and the rest of the territories outside of the Italian peninsula (i.e., that which was viewed as the “republic” or “empire,” and “non-Roman”) in which differing rules of assessment and collection and liability existed.  Thus, the Romans were essentially the first and only government to assess taxes on its citizens on a true “global” basis, irrespective of source.  No other significant government, besides the U.S.A., has ever done this.   The real story of Rome is therefore the extension of “Romanism” to persons all over the empire, not just to those inside Italy.  With Romanism came citizenship and taxes on an extent yet then unseen or thereafter, with the exception of the U.S.A. Roman tax collectors would easily and quickly do well at the modern IRS.

As a result, U.S. resident corporations pay tax on worldwide income wherever earned, if earned directly by the parent corporation, and can and do pay income tax on repatriated dividends from overseas subsidiaries stemming from earnings that have been previously deferred under the so-called controlled foreign corporation rules (i.e., rules which require, on the one hand, U.S. shareholders to report and pay tax on certain elements of the foreign income of foreign subsidiaries, even if not distributed, which is considered to be classified in certain “bad” classes of income related to certain party sales, which on the other hand, otherwise allow the deferral of certain classes of income such as active business income, stemming from unrelated party transactions and meeting certain other requirements).  

Therefore, large U.S. corporations often create foreign subsidiaries in foreign low-tax jurisdictions in which income is “stored” from foreign activities (not directly taxed by the U.S.) – and may never be repatriated to the U.S. for fear of it being taxed twice by way of the dividend tax.  Current estimates suggest that there may be trillions of dollars in such overseas low-tax jurisdictions being “stored.”  There is evidence to suggest that these funds, if brought back to the U.S., would substantially stimulate economic activity and create enormous revenues for the federal government.

By way of background, European governments have historically applied a more limited “territorial” system, whereby corporate residents (and in certain circumstances individuals) pay income tax only on income earned or sourced or repatriated to the home country.  In these countries, companies may repatriate earnings from foreign subsidiaries without any additional tax in the home country.  This is typically done by way of a “participation exemption,” which allows parents to eliminate any such subsidiary dividends from their home country’s taxable income base.

As a result, U.S. corporations face a significant competitive disadvantage to their European counterparts.  In addition, the U.S. corporate tax rate by many accounts is practically the highest in the world.

The Republicans in Congress and President-Elect Trump both have proposals to end the Roman style “global” taxation model for corporations, and replace it with a European-style “territorial” model.  This in and of itself will encourage the repatriation of hundreds of billions of dollars in future corporate earnings from foreign subsidiaries to the U.S.  Public and private shareholders will simply demand it.  There are also proposals to have a one-time low tax on deemed (or perhaps actual) repatriations of past accumulated foreign subsidiary income.  Congressional Republicans and President-Elect Trump also have proposals to lower the overall corporate tax rate to the high teens or the low to mid-twenties, from its current rate of the mid-thirties.  To most current observers, these changes would necessarily involve the en masse repeal of the bulk of the controlled foreign corporation rules excepting the rules of passive foreign deferred and accrued income.

IV. What to Expect: I look at the Tana Leaves to See Which Changes, Like the Mummy from Karnak, Arrive.

U.S. taxpayers can expect the following changes, in my opinion:

1) a significant lowering of individual rates;

2) a significant lowering of corporate rates;

3) the end of the estate and generation skipping transfer tax and its replacement with a single lifetime gift tax system at reasonable rates, and or the actual or deemed taxation of capital gain assets at death under capital gains rates;

4) the end of the worldwide U.S. corporate tax system, and its replacement with a European-style territorial system requiring the repeal of the anti-deferral controlled foreign corporation rules.

Link to previous article in this series: Part 3