Which Rangel Tax Provision Affects You?

New York congressman's controversial bill frames the upcoming debate over corporate tax issues.
Marie LeoneOctober 31, 2007

Rep. Charles Rangel (D-NY) hit a corporate nerve when he issued his new tax reform bill last Friday.

Since Rangel chairs the House Ways and Means Committee, the group most responsible for writing U.S. tax policy, his proposed bills are tracked closely and elicit a good deal of both criticism and support. Most groups with vested interests in the bill already have announced they will scrutinize its provisions and implications in the coming weeks.

A few, however, are weighing in early, including the trade association Financial Executives International and the U.S. Treasury Department. FEI likes Rangel’s proposal to cut the top marginal corporate income tax rate from the current 35 percent to 30.5 percent. But the group is less keen on several “revenue offset” provisions that would, for example, defer research and development deductions for U.S.-based companies and repeal the last-in, first-out (LIFO) accounting method for inventory.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The offsets, noted FEI chief executive Michael Cangemi, would hurt U.S. competitiveness in the global marketplace. “Competitiveness is the name of the game in the world economy, and all aspects of corporate tax reform should put U.S. companies on a level playing field with their foreign competitors,” Cangemi said in his official statement.

Treasury Secretary Henry Paulson vowed to oppose the bill, echoing the White House’s position. In a statement, Paulson asserted that Rangel’s “large, complex tax bill would dramatically raise taxes in ways that in my judgment would hinder America’s ability to compete in the global economy.”

To be sure, Paulson’s main thrust seemed to be promotion of the president’s alternative-minimum-tax patch, a proposal floated in February aimed at stopping an automatic tax increase that would affect individual taxpayers — mostly middle-class workers. If the 40-year-old tax rule is not adjusted by the end of the year, about 20 million middle-class taxpayers could be subject to the AMT, which would force them into the highest income tax bracket for 2008.

Paulson has called on Congress to apply the AMT patch within the next few weeks to stop the automatic increase, rather than debate the issue as part of Rangel’s larger bill.

The nonpartisan Tax Foundation noted that Rangel’s proposal to cut the corporate rate would drop the United States in the combined federal-state tax rate ranking from the second highest to fourth highest among industrialized nations. Japan has the highest tax rate of the group, at 39.5 percent, and Rangel’s proposal would put the United States behind Canada and Italy.

The Tax Foundation conceded that although the Rangel proposal may seem inadequate compared to tax cuts delivered by international trading partners, it is a signal that, “Congress is finally trying to catch the wave of corporate income tax reduction that has been sweeping the developed world for more than a decade.” The report said that five industrialized countries cut their corporate income tax rates in 2006, with eight more — including Germany — slated to decrease rates by January 1, 2008.

Whether Rangel’s bill has a chance of passing in its current form remains unclear. But the proposal has framed the debate. Here’s a list of the key corporate provisions contained in Rangel’s Tax Reduction and Reform Act of 2007 that executives — and their lobbyists — will likely face in the months to come:

Reduction of the corporate tax rate. The bill cuts the top corporate marginal tax rate from 35 percent to 30.5 percent (Estimated cost over 10 years: $364 billion.)

Repeal of the deduction for domestic production activities. The tax break, according to Rangel, benefits only a few corporations, providing a 3.15 percent rate cut on domestic manufacturing income. (Estimated to raise over 10 years: $115 billion.)

Allocations of expenses and taxes for repatriated income. The provision would require U.S.-based companies that defer income through controlled foreign corporations to also defer the associated deductions. Currently, corporations are allowed to take deferred deductions and account for them on a current basis. (Estimated to raise over 10 years: $106 billion.)

Repeal of worldwide allocation of interest. Current law, which has yet to take affect, allows U.S. corporations to elect special interest allocation rules that reduce the amount of interest expense allocated to foreign assets. (Estimated to raise over 10 years: $26 billion.)

Limitations on treaty benefit for deductible payments. The bill would prevent foreign multinationals that are incorporated in tax haven countries from avoiding tax on income earned in the United States. The provision addresses multinationals that route income through structures that allow a U.S. subsidiary to make a deductible payment to a country that has a tax treaty with the Unites States. Usually, the company repatriates the earnings in the tax-haven country after the deduction is taken. (Estimated to raise over 10 years: $6 billion.)

Repeal of the LIFO inventory accounting method. Any income recorded as a result of the proposed repeal of the last-in, first-out accounting method for booking inventory would be taxed over eight years. (Estimated to raise over 10 years: $107 billion.)

Repeal of the inventory valuation choice method. The bill would require corporations to value inventories at cost, eliminating the opportunity to choose between the lower of cost and market value. (Estimated to raise over 10 years: $7 billion.)

Elimination of the special service provider rule. The provision would prevent larger corporations (defined as C corporations in the tax rules) that use the accrual method of accounting from taking advantage of the special rule pertaining to service providers. The current rule allows C corporations not to account for amounts that will go uncollected based on the history of the service provider. (Estimated to raise over 10 years: $225 million.)

Permanent extension of enhanced small business expensing. The bill would extend the current threshold amounts that small businesses can count as a tax-deductible expense. The rule is scheduled to expire in 2010, but the proposal would allow businesses to continue at current levels — that is, $125,000 (indexed for inflation) with a phase-out threshold of $500,000 (also indexed for inflation). After 2010, if the law is not changed, small businesses would only be able to expense $125,000, with a $500,000 phase-out threshold, and neither expense mark would be indexed for inflation. (Estimated cost over 10 years: $21 billion.)

Increase in the amortization period for intangible assets. The bill would increase the current 15-year amortization period for intangibles to 20 years. (Estimated to raise over 10 years: $21 billion.)

Clarification of the economic substance doctrine. In any transaction that economic substance analysis is required, the doctrine would be satisfied only if: (1) the transaction changes — in a meaningful way — the corporation’s economic position (apart from federal income tax consequences); and (2) the corporation has a substantial non-federal tax purpose for entering into the transaction. The provision also imposes a 20 percent penalty on understatements that stem from a transaction lacking economic substance. The fine rises to 40 percent if relevant facts are not adequately disclosed. (Estimated to raise over 10 years: $4 billion.)

Decrease in the deductions allowed for dividends received. For 20-percent-owned corporation, the deduction would drop from 80 percent to 70 percent. For dividends currently eligible for a 70 percent reduction, the tax break would fall to 60 percent. (Estimated to raise over 10 years: $5 billion.)

Recognition of ordinary income on stock-option exercises. This provision pertains to small businesses defined as S corporations by the Internal Revenue Service. For S corporations with a tax-exempt employee stock ownership plans (ESOP), the bill would require that option holders recognize the amount of income that was shifted to the tax-free ESOP when they recognize or sell the options. (Estimated to raise in 10 years: $606 million.)

Termination of special rules for DISCs. This would end the domestic international sales corporation (DISC) provision. DISCs, which are allowed to defer recognizing income, were established in a 1971 tax law to encourage exporting. (Estimated to raise over 10 years: $881 million.)

Clarification of gain recognition in spin-off transations. The bill would force corporations to treat distribtuions of debt in a tax-free spin-off transaction in the same way as distributions of cash or other properties. Currently, when a subsidiary distributes its own debt to a parent corporation prior to a spin-off, it is considered a tax-free transaction. (Estimated to raise over 10 years: $235 million.)