After a dramatic upset victory in one of the most bitterly contested presidential races in recent history, Donald Trump now has some serious work to do. His corporate tax policies—which are vital to his platform of domestic growth and repatriation of U.S. income and jobs—will require significant changes to the Internal Revenue Code. CFOs should familiarize themselves with these proposed changes well before Trump’s inauguration in order to fully explore the opportunities and risks associated with each corporate tax policy.
As a threshold matter, it is important to bear in mind that Trump’s pre-election positions on tax reform may not necessarily translate into proposed legislation. George H.W. Bush at the 1988 Republican National Convention famously pledged “Read my lips: no new taxes,” only to agree to several tax increases in a budget compromise two years later. But Trump is unlikely to follow Bush’s footsteps in this regard, especially because Trump, unlike Bush, will assume the presidency with Republican control of both chambers of Congress.
Here’s a brief summary of Trump’s top five proposed corporate income tax policies as listed on the Trump/Pence Tax Plan website and a description of how each could affect both large and small businesses.
1.Lower the corporate income tax rate from 35% to 15%. This is a clear game-changer, not just with respect to existing C corporations, but also with respect to certain S corporations that may wish to abandon their S corporation status. Most small businesses are deterred from C corporation status because it imposes two levels of taxation on the same income—once at the entity level when the income is earned and again at the individual level when the corporation distributes the income to its shareholders in the form of a dividend. (Not all distributions to shareholders from C corporations trigger the same double taxation as dividend distributions—for example, employee salaries and employer contributions to pension and profit sharing plans are available as deductions for C corporations.)
With the highest corporate income tax rate currently at 35% and the highest individual tax rate on qualified dividends currently at 20%, the highest aggregate income tax rate is 55%. But if Trump is successful in reducing the corporate income tax rate to 15%, the highest aggregate income tax rate will be 35%, which is only two points higher than Trump’s highest proposed individual income tax bracket of 33%.
Thus, a reduction in the corporate tax rate to 15% would remove a significant disincentive to selecting C corporation status during entity formation, and may also prompt certain S corporations to abandon their S corporation status under section 1362(a). S corporations may discover that they can enjoy substantially similar tax benefits as a C corporation without the restrictions associated with S corporation status, such as limits on the type and number of shareholders and the inability to retain interest and profits. Trump also stated earlier in his campaign that he would reduce the rate of individual income tax from all pass-through entities to 15%, but he recently appears to have abandoned that position.
2.Allow repatriation of corporate profits held offshore at a one-time tax rate of 10%. This is basically a one-time amnesty for large corporations that have engaged in multinational inversions, in which a U.S. corporation acquires a foreign corporation that conducts at least 25% of the affiliated group’s total business activities. These inversions enable the newly-created foreign corporation to engage in “earnings stripping” by saddling the U.S. subsidiary with debts owed to the foreign parent, and then expatriating any U.S.-source profits to the foreign parent in the form of interest payments on those debts.
Trump’s plan would offer these MNCs the opportunity to repatriate “corporate profits held offshore at a one-time tax rate of 10 percent,” according to his tax-plan website. Thus, a company like Burger King—which in 2014 inverted from being a Miami-based company to a Canadian company by buying the Canadian chain Tim Hortons and shifting its corporate headquarters to Canada—may contemplate shifting its headquarters back to the United States in exchange for a one-time repatriation tax of 10% on its accumulated earnings and profits since the inversion.
This repatriation proposal—combined with the proposal to lower the corporate tax rate to 15%—could dramatically change the tax incentives for large multinational companies like Google, Apple, and Microsoft to pursue complex tax structures such as the “double Irish with a Dutch sandwich” that require shifting a significant portion of the companies’ profits and business operations overseas.
3.Eliminate most business tax credits and “special interest” tax outlays, except for the R&D credit. While Trump’s tax plan would reduce most corporations’ overall tax burdens, it also would “eliminate the Carried Interest Deduction and other special interest loopholes” such as the domestic production activities deduction (section 199) and all business tax credits other than the research and development credit (section 41). (Carried interest is income flowing to the general partner of a private investment fund, which is currently taxed as capital gains rather than ordinary income.)
Although Trump’s proposal to eliminate carried interest and business credits stems from his objective to “drain the swamp” and reduce corruption and the influence of special interests in Washington, many of the tax expenditures he seeks to repeal originate from public policy concerns rather than special interests.
For example, the business tax credits Trump proposes to repeal include the work opportunity credit under Code section 51(a), which allows employers to claim a credit for a portion of the wages paid to targeted groups such as qualified veterans. If Trump plans to fulfill his election victory speech pledge to “finally take care of our great veterans who have been so loyal,” then he may have to soften this hardline position on the work opportunity credit.
4.Entitle manufacturers to expense capital investment and lose the deductibility of corporate interest expense. This is actually two proposals in one. Trump’s plan to allow manufacturing companies to expense (rather than depreciate) capital investments is not nearly as dramatic as those of several of his competitors during the Republican primary. Jeb Bush, Marco Rubio, and Rand Paul all advocated full current-year expensing of investment costs for all companies, not just manufacturing corporations. The Trump tax plan does not offer any specifics on the disallowance of interest deductions for manufacturing companies that elect to expense capital investments.
5.Provide tax benefits for corporations offering on-site childcare and pay part of employees’ child-care costs. Trump’s tax plan increases the annual cap for the business tax credit for companies that offer on-site child care—one of the few business tax credits that would not be eliminated— from $150,000 to $500,000. The plan also allows employers who pay a portion of an employee’s child-care expenses to exclude these contributions from the employers’ gross income. In consideration of these proposals, CFOs may want to weigh the relative costs and benefits associated with the expansion of their companies’ on-site child-care programs and/or childcare reimbursement policies.
Over the first 90 days of his presidency, we will have the opportunity to see how vigilantly Trump plans to pursue an aggressive agenda of corporate tax reform. Even if Trump immediately proposes corporate tax legislation, he may be forced to compromise some of his original objectives to achieve consensus with more traditional “establishment” Republicans like House Speaker Paul Ryan and Senate Majority Leader Mitch McConnell. Despite these challenges, however, Donald Trump is likely to initiate some of the most significant corporate income tax changes that we have seen in recent history.
Matthew A. Morris is a Framingham, Mass.-based partner in the estate, financial and tax planning and tax and tax controversy practice areas of Bowditch & Dewey, a law firm.