What’s Really Inside Obama's Framework for Business Tax Reform

The White House has been touting its proposed “Framework for Business Tax Reform” as a way to cut the corporate tax rate and eliminate loopholes and subsidies and strengthen American manufacturing and spur innovation all. The administration also touts it will simplify and cut taxes for small businesses, and encourage domestic investment.

What’s not to love?

Plenty, perhaps.

Whether you end up on the winning or losing side of this reform depends upon politics. In other words, are you one of the industries favored by this president? Alternative energy, for instance? There’s a tax incentive for that. Manufacturer? Your top tax rate will be lower than a service provider’s.

I’m not naïve. I recognize that the tax code is full of incentives that encourage both individuals and businesses to act in ways deemed to be positive or socially enhancing. That’s why there’s a tax deduction for charitable donations.  I also acknowledge that our current tax code is overly complex, and that many aspects are outdated. I just don’t see how replacing old “preferences” with new ones is an improvement.

And let’s be honest: Although the top corporate tax rate is currently 35%, many companies don’t pay anything close to that under the current system. According to the Treasury Department, after taking deductions, writeoffs and other tax breaks into account, the “effective” tax rate a company pays varies widely, depending upon the business it’s in:

Source: U.S. Department of the Treasury, Office of Tax Analysis based upon 2007-2008 data

In addition to lowering the maximum corporate tax rate to 28%, the administration would eliminate most of the tax breaks businesses currently receive. So many, in fact, that they more than makes up for the reduction in the tax rate.  “The president’s proposal is designed to be a net revenue raiser,” according to Mark Luscombe, principal federal tax analyst at CCH, a global provider of tax information and software.  “When you start eliminating a whole range of tax breaks, it adds up… Overall, there will be more paid.”

And, while it seems unfair that utilities pay an effective federal tax rate of just 14%, what’s going to happen to your monthly utility bill if your electric company suddenly has to pay twice that amount?  The same goes for car insurance. Moreover, why should the top tax rate on corporations be 28% except for those involved in manufacturing? (I’m sure it has nothing to with the fact that many are staffed by union workers.)

“On the international side,” says Luscombe, “Obama has backed away from a territorial say system and is moving toward a worldwide system. This would be a significant development.” Nonetheless, since most of our trading partners operate on a territorial system of taxation, this wouldn’t exactly put U.S. companies on an equal footing. In effect, the president’s “Framework” would require companies to pay tax on overseas profits in the year the money is earned as opposed to when it is actually brought back to this country.  However, since a company could offset this by any tax paid to the foreign country in which they’re located, there could be minimal impact.

To stem the loss of jobs overseas, companies would no longer be allowed to deduct the cost of moving operations outside the U.S.  In addition, there would be a tax credit for companies that bring jobs back home.

Interestingly, as CCH points out, the “Framework” proposal does not address the double taxation of dividends whereby profits are taxed at the corporate level and again when received by investors. The president’s budget proposal for 2013 would eliminate the current tax rate on qualified dividends- a maximum of 15%- but just for so-called “wealthy” taxpayers.  As the law stands now, starting Jan. 1, these investors will pay up to 39.6% tax on dividends and other types of investment income.  In Luscombe’s words, “A 28% corporate tax and a 39.6% [personal] tax in combination is not very attractive.”

Consider the impact on the stock market.

As for the hoopla about incentives to help small businesses, “There’s nothing new here,” says Luscomb. Basically, the administration’s proposal would increase the amount of equipment that could be written off to $1 million (it’s due to revert to $125,000 next year) and make this permanent.  It would also expand the use of the so-called “cash method” of accounting and give businesses with up to 50 employees (instead of a max of 25) a tax credit to help offset the cost of mandatory health insurance.

There’s lots more to The President’s Framework for Business Tax Reform . The U.S. Chamber of Commerce opposes the entire package. If read it yourself, one thing you’ll notice is the amount of specifics that are missing. For instance, there’s no information on what the minimum tax on overseas profits would be. And, as Luscombe points out, “It’s probably not something you have to worry about right away.” If we end up with a different president next year, this is pretty much D.O.A. Still, it gives you insight into how the current administration views the business world.

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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