Many Business Provisions Still Being Reconciled in Federal Tax Reform

We’re almost there. Tax reform has passed both the House and Senate. It now seems very possible that the President will have a bill to sign by Christmas. As some have described: All they need to do now is “sand the rough edges”. But another saying is equally applicable to the business tax components: “The devil is in the details”. Specifically, details directly relating to the taxation of both C-corporations and pass-through entities. Terms that will impact those who do business here and those who do business around the globe. In other words, details that will significantly affect big businesses, small businesses and everybody in between.

The process for reconciling the two versions of tax reform is already underway as the House and Senate name members to the conference committee that will determine exactly what will be in the package before it is voted on one last time. Indications are that majority leaders want to have a committee report for their respective bodies to act on by the end of next week. So while the details still have to be worked out, both bodies are very engaged and they’ve passed legislation that defines the general parameters.

There will continue to be debate, in public and in private, over the deficit, how much growth tax reform will generate, who benefits and who doesn’t, but the House and Senate are effectively committed to getting something done at this point. On the individual income tax side, they will need to find agreement regarding the limits on the deductibility of state and local taxes (SALT), as well as mortgage interest. These items are important to individuals, important to the numbers and important politically. But the two sides really aren’t that far apart. A $10,000 SALT deduction of some kind and a healthy mortgage interest deduction will almost certainly remain in the final product.

But where they land on many items critical to business is harder to predict; a lot is up in the air. Let’s start with the corporate rate itself. While both plans call for a 20% rate, the President hinted it could still change slightly. That appears unlikely, however, but the rate is tied closely to the fiscal projections. And the fiscal projections are why the Senate delayed the effective date for corporate rate change to 2019, to reduce the cost of the bill. So when exactly the change goes into effect is at issue.

Similarly, the taxation of pass-through income is also unsettled. The House limits the pass-through rate at 25%. The Senate approach was to give a deduction to pass-throughs to keep their tax down. Effectively, the different approaches would not have drastically different bottom line impacts for most pass-through income recipients. The real complications come via provisions directed at guarding against individuals in higher brackets from categorizing personal income as business/pass-through income.

What about the issues of interest to multinationals who conduct huge volumes of business activity around the globe? The House and Senate agree that the U.S. must move to a territorial system and companies shouldn’t be taxed here on income they earn overseas. But beyond that basic principle, how multinationals and their foreign-sourced income is handled is anything but clear right now. Both the House and Senate have included forms of supplemental taxes intended to prevent their perception of “base erosion” and to discourage what they view as corporations “gaming the system”.

Likewise, they are still working through how best to address the repatriation of foreign-earned profits and are looking at special, one-time tax provisions to encourage companies to bring those assets back to the U.S.  Another item important to many businesses of all types and sizes is how quickly, to what extent and for how long will they be able to claim deductions for capital expenditures/investments. Two final differences to note: (1) The Senate preserves the corporate alternative minimum tax; the House repeals it; (2) the House and Senate versions both limit the interest expense deduction, but in materially different ways. (A good summary of all the differences can be found in this report from the Tax Foundation.)

Of course, there are many, many other pending issues wrapped up in this legislation for the tax folks in Washington to resolve in short order. They include the health care mandate, estate tax, exemptions for educational institutions and nonprofits, and the list goes on. Tax reform appears close. Let’s hope good solutions are close too.

Some Puzzling State Revenue Numbers

The Indiana State Budget Agency recently released the revenue collections report for October. The overall collections for the fiscal year now stand 2.8% ($136 million) below projections; not good, but not critical at this juncture.

The troubling numbers for the revenue watchers are the corporate tax collections. They were down again this month and are now at 52% below the April revenue forecast projections. Nobody really knows how to fully explain the drop. While the corporate collections historically fluctuate widely from month to month and are the hardest to predict for many reasons (that are not directly related to predictable economic activity), the gap between projections and collection is extraordinary. Fortunately, corporate collections have never represented a big piece of the pie (only around 6%) when compared to sales (48%) and individual income (36%) tax collections. Still, the unforeseen drop accounts for $126 million of the $136-million-dollar shortfall.

The State Budget Agency has drilled down on the matter and is attributing it to a high volume of refunds. But what is triggering the refunds is not clear either. Sometimes refunds can cover a number of years. They could be tied to a recent settlement of numerous cases or result from changes in the law – lots of possible factors. Whatever they are attributable to, they probably don’t mean that corporate collections will stay down; they are likely to rebound over the balance of the fiscal year and smooth out the impact, but they are not likely to recover to the total of the original projections. Let’s hope this is just a temporary mysterious dip that is evened out over time.

For those interested, you can review all the numbers and commentary from the State Budget Agency.

Federal Tax Plan = Meaningful Cuts More Than Comprehensive Reform

The “Tax Cuts and Jobs Act” (H.R. 1) has finally arrived! The long-awaited details – over 400 pages worth – are now out there for all to debate. This is a debate that will play out before the House Republican Ways and Means Committee this week. Much of the public discourse will focus on how it impacts individuals, but for the business community it is the taxation of businesses, large and small, that is of the most significance.

The plan includes a reduction of the corporate rate from 35% to 20%, an important and meaningful step. It also caps the taxation of income derived from pass-throughs (S corporations, LLCs, partnerships and sole proprietorships) at 25%. Key provisions are outlined below. And if you are truly into tax law, the full bill is also available, as is a section-by-section summary.

Now you may note that this legislation is labeled a tax cut, not tax reform. And while many will call it that, it is probably better characterized as a tax cut bill. Cuts are good, and these measures will certainly be the impetus for some level of economic growth. But the trillion dollar questions remain: How much will it spur in gross domestic product (GDP) growth? And, can that realistically be enough to offset the projected reductions in tax collections?

Nobody can really know the answers to these politically-charged questions. But as you read the “scoring” of this legislation (to be published by the Congressional Budget Office after passage out of the House Ways and Means Committee), you may consider these items for context: the GDP growth rate in the United States averaged 3.22% from 1947 until 2017; GDP has pleasantly surprised people by breaking the 3% mark the last couple quarters; and the GDP will probably need to go a good bit higher to prevent the bill from adding substantially to the already staggering federal deficit. So listen for what growth rates are assumed in the projections that will be discussed and debated – and draw your own conclusions.

Key provisions affecting businesses

  • Reduces the corporate tax rate: The rate will drop to 20% from the current 35% and is designed to be permanent.
  • Establishes a repatriation tax rate: The repatriation rate on overseas assets for U.S. companies would be as high as 12%. The bill also may include a mandatory repatriation of all foreign assets. Illiquid assets would be taxed at a lower rate, spread out over a longer period than liquid assets like cash.
  • Creates a 25% rate for pass-through businesses: Instead of getting taxed at an individual rate for business profits, people who own their own business would pay at the so-called pass-through rate. (There will be some guardrails on what kinds of businesses can claim this rate to avoid individuals abusing the lower tax.)

Key provisions affecting individuals

  • Creates new individual income brackets:
    • 12% for income up to $45,000 for individuals and $90,000 for a married couple
    • 25% up to $200,000 individual/$260,000 couples
    • 35% up to $500,000 individual/$1 million couples
    • 6% over $500,000 individual/$1million couples
  • Caps state and local property tax deduction at $10,000, but does NOT cap income or sales tax deductions.
  • Eliminates the estate tax: The threshold for the tax, which applies only to estates with greater than $5.6 million in assets during 2018, would double to over $10 million; the plan then phases out the tax after six years.
  • Does NOT change taxation of 401(k) plans.
  • Increases the child tax credit to $1,600 from $1,000. The bill would also add a credit of $300 for each non-child dependent or parent for five years, after which that provision would expire.
  • Limits home mortgage interest deduction: On new-home purchases, interest on loans up to $500,000 would be deductible. (The current limit is $1 million.)
  • Nearly doubles the standard deduction: To avoid raising taxes on those currently in the 10% tax bracket, the standard deduction for all taxes would increase to $12,000 for individuals (up from $6,350) and $24,000 for married couples (up from $12,700).
  • Eliminates most personal itemized deductions and many credits. The only deductions preserved explicitly in the plan are for charitable gifts and edited home-mortgage interest.
  • Repeals the alternative minimum tax (AMT). The tax, which forces people who qualify because of an outsized number of deductions, would be eliminated under the legislation.

Full policy highlights of the bill can be found here.

Keep in mind this is the House’s plan and it will be subject to a different form of scrutiny in the Senate. So regardless all the prior coordination among those working together on this effort for months, some (perhaps many) things will change – they always do!

As for the timeline, it’s hard to say. But we do know that the House Ways and Means Committee will begin hearing amendments this week, and the process could take several days. A vote on the bill by the full House, as it is passed out of Ways and Means, is anticipated to come as early as November 13. From there it goes to the Senate Finance Committee, then full Senate. Optimists hope for something to pass before the end of the year. However, don’t be surprised if the debate isn’t carried over into the beginning of 2018.

Indiana’s delegation members are also weighing in with their views on the new tax bill. Chief among them is Congresswoman Jackie Walorski (IN-02), a member of the pivotal House Ways and Means Committee: “Hoosiers deserve every opportunity to achieve success and live the American Dream, and that’s what tax reform is all about. The Tax Cuts and Jobs Act will help American businesses expand, invest and hire more workers, and it will let middle-class families keep more of the money they earn. It’s time to fix our broken tax code and level the playing field for hardworking Americans by once again making America the best place in the world to do business.”

Resource: Bill Waltz at (317) 264-6887 or email: bwaltz@indianachamber.com 

What’s Up With Federal Tax Reform

Is anything really happening? Yes.
Will something eventually get passed? Probably.

A group of key individuals who dubbed themselves the “Big 6” has been meeting for a few months and more intently in recent weeks. They include two members each from the administration (Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn), Senate (Majority Leader Mitch McConnell and Finance Committee Chair Orrin Hatch) and House (Speaker Paul Ryan and Ways and Means Chair Kevin Brady.)

Are they motivated to find common ground? Certainly. Is there a consensus? Not yet. Right now, they don’t even agree on whether, or to what extent, the legislation must be revenue neutral.

But they all seem to recognize that they need to do something – failure to coalesce is not in anyone’s interest. So what have they agreed on so far? The border-adjustment tax is out. Some method for allowing the repatriation of overseas earnings (at a one-time low-rate tax) is in. The corporate rate must drop to 25% or less (depending on how many deductions and breaks they can eliminate.) They appear to be embracing a way to allow small businesses to immediately deduct investments in new equipment and facilities, i.e. “full expensing.” On the individual income side, a collapsing of the brackets and lowering of rates (no details.)

Possible tradeoffs or “pay-fors” in tax circles: eliminating some business interest deductions, eliminating the state and local tax (SALT) deductions and capping the mortgage interest deduction. These are yet unsettled issues. But listen and watch closely to the SALT discussions going forward; there is a lot of money and a lot of political (with a small p) interest in this item. It is more a geographic than partisan issue because taking the SALT deduction away will have a significant negative impact on people (constituents of Republicans and Democrats) in states that have high state and local taxes. This item could have a big bearing on the entire effort and whether we get true reform or temporary tax cuts.

Tax cuts are the easy part for these folks. The hard part is finding ways to pay for reductions. The last true tax reform was in 1986, 31 years ago, and it required a lot of time and bipartisan buy-in. The Big 6 are all Republicans and they are anxious to get something done. They could mimic the Bush tax cuts of 2002 and 2003, passed through the reconciliation process, which means whatever they do expires after 10 years. Somewhat ironically, most of those Bush cuts were only made permanent as part of the Obama budget deal of 2012.

To recap the status of tax reform: Much remains up in the air.

A Success in Protecting Taxpayer Rights

Protecting and maintaining the rights of taxpayers (as they comply with procedural requirements or seek a determination regarding a tax dispute) became a chief cause of the Indiana Chamber in several cases this session.

First, there was a bill (SB 546) introduced to substantially reorganize the Tax Court. Why? This was our question. It seems that some feel that the governmental entities should win many more cases (meaning that taxpayers should be losing many more cases.) Yes, taxpayers do win more frequently than the officials in charge of assessing taxes. Why? Because the assessment determinations that are disputed are those where the taxpayer feels they are being charged more than the law requires them to pay – nobody needs to appeal when the government has gotten it right.

The Chamber strongly believes in the value of a specialized court with tax knowledge and expertise that allows for cases to be resolved in a consistent and uniform manner. That was the original purpose, and is the ongoing function of the Tax Court. The transition to a new judge a few years ago has been a little bumpy, but it is all smoothing out and restructuring the Court was exactly the wrong thing to do.Fortunately, we were able to convince others of this and, consequently, the bill did not receive a hearing.

Then there was the Department of Revenue (DOR) bill (SB 515); generally speaking, it’s a good bill, except that in connection with federal law changes it resulted in making corporate returns due on the same day as federal returns. Existing law gave preparers a 30-day breathing period before the state return came due. Meaning no harm, DOR and administration officials agreed to alter the provision to maintain the more favored status quo.

Another problem bill (SB 501) sought to revamp the property tax appeals procedures; it was later merged into SB 386 in the House. The objectives of the bill were admirable, and it included some real improvements to the process; most notably, it established a uniform June 15 appeal deadline statewide. Previously, the deadline was tied to the assessment notices and varied from county to county. However, the provisions of SB 501/386 extended a bit too far in attempting to streamline the process as it impacted a taxpayer’s ability to correct what are typically clerical type mistakes made by the assessor or other county officials.

These type errors have historically always been correctable for up to three years, but the bill restricted many of them to a period of just 45 days. This over encompassing contraction of rights – restricting the remedy for taxpayers to correct errors – was unnecessary and unacceptable.

The Chamber concentrated its focus late in the session on reinstating the full complement of existing rights back into this procedural recodification. Here again, with the help of several stakeholders, including the Indiana Manufacturers Association and Indiana Farm Bureau, we were successful at protecting the legislation from impinging on taxpayer rights. The Chamber wishes to recognize the efforts of Rep. Mike Karickhoff (R-Kokomo) in working with the interested parties in the waning hours of the session to successfully resolve these concerns.

Separately, an issue that didn’t make the headlines but you could have felt in your wallet centers on school bonds. The rating entities had concerns about the state’s potential role in ensuring these payments are made by the individual schools. Legislators took care of this with SB 196 and Indiana avoided a rating downgrade. Otherwise, this would have triggered increased interest rates on these bonds and cost taxpayers millions in additional property taxes.

A Pleasant (Revenue) Forecast

The revenue projections for the next two fiscal years were updated on Wednesday, giving the General Assembly revised numbers to use in finalizing a state budget before the session wraps up next week. The update also readjusted the current Fiscal Year 2017 numbers; the FY17 numbers that were reduced by nearly $300 million dollars in December were now adjusted back upward by $124 million (so FY17 won’t turn out as bad as previously thought).

That FY17 readjustment serves as a foundation for the forecasters’ confidence that the slow but steady economic growth will continue at a moderate pace over the coming biennium. The pleasant result: a modestly higher revenue forecast for FY2018 and FY2019. The forecast increase resulted from projected growth in sales tax collections (2.7% in FY18 and 3.4% in FY19), sales tax being the source that Indiana is most dependent on, and the larger percentage increase but smaller cumulative dollar increase anticipated in income tax collections (3.4% in FY18 and 5.9% in FY19) – the source that represents the next largest contributor to the state coffers.

The bottom line is that the forecast adds $200 million, only about six-tenths of one percent of the roughly $32 billion that the lawmakers now can expect to see collected in tax revenue over the next two years. While it is a small addition, it is still $200 million that they hadn’t planned on when they put together the budget numbers in HB 1001.

Understandably, the fiscal leaders caution against any major changes to what they have formulated to this point, but as the budget negotiations continue into the last days, they are certain to hear this additional money referenced as justification for some new or additional funding requests. Read the details from the forecasters’ presentation.

Ways and Means Chooses Not to Act on Internet Sales Tax Collection Bill

For unknown reasons, the House Ways and Means Committee – after taking testimony – elected not to take a vote on SB 545 last week prior to the deadline for committee passage.

The bill represented a well thought out and sound approach for collecting Indiana sales tax on online transactions. While the bill died in committee, there remains the possibility that its provisions could find their way into another bill before the session ends. The Chamber will continue to advocate for this bill to be incorporated into another piece of legislation.

Internet Sales Tax Collection Bill Heard in House

The Chamber again testified in support of SB 545 last week. We are pleased it is receiving broad, bipartisan support. As we have noted previously, this bill represents an important step toward the Legislature requiring online retailers who have no physical presence in Indiana to collect Indiana sales tax from their Indiana customers when they make online purchases.

Senate Bill 545 is a well thought out and sound approach. Senator Kenley is to be commended for his pursuit of this legislation that will serve the dual purposes of leveling the playing field between in-state brick and mortar retailers and their online competitors, while also boosting Indiana’s sales tax base. The bill will further a key objective in the Chamber’s Indiana Vision 2025 plan.

Senate Puts Its Mark on State Budget Bill

Senate Appropriations Chairman Luke Kenley (R- Noblesville), primary drafter of the Senate version of the budget, has now put his touches on the House-drafted version. After a concise explanation and short discussion in committee, HB 1001 was passed unanimously (although the Democrat leadership expressed mild discomfort with some particulars) and now goes to the full Senate.

A few highlights of the $32.14 billion budget package include:

  • a 1.7% increase each year in K-12 education funding – $348 million over the biennium
  • $4 billion to higher education
  • $5 million to the governor’s office for substance abuse prevention, treatment and enforcement
  • $500,000 for homeless veterans
  • a 24% salary increase for state police officers
  • $6 million to double-track the South Shore Line

The budget will maintain an 11%, or $1.8 billion, reserve. But there is a lot still to be determined about how the final negotiated budget will shape up. Unresolved at this point is the fate of the House’s desire to direct all the sales tax collected on gasoline to road funding and an increase to the cigarette tax – both of which could impact the budget. And finally, it must be recalled that the budget-makers will receive an updated revenue forecast in a couple weeks; that too could change the picture some. So, while the Senate has spoken, the last word is still a few weeks away.

A Step Closer to Sales Tax Collection for Online Purchases

The Indiana Chamber supports SB 545 (Sales Tax Collection by Remote Sellers).

This bill takes an important step toward the Legislature requiring online retailers who have no physical presence in Indiana to collect Indiana sales tax from their Indiana customers when they make online purchases. Ultimately, one of two things must happen for the requirement to go into full effect. Either the U.S. Supreme Court has to determine that states are allowed to impose this requirement based on their economic activity in the state (and the nominal burden associated with it), or Congress must pass legislation to authorize states to require the online sellers to collect a state’s sales tax.

The issue is pending before both bodies and several states are passing legislation to put pressure on one of the two entities to act and resolve the issue. Senate Bill 545 is modeled after a South Dakota law that is under review by the high court. It is designed to put Indiana in the position of making the requirement effective as soon as an Indiana court declares the collection valid under federal law. So this remains legally complicated, but SB 545 is a thoughtful and sound approach.

Senator Luke Kenley has pursued this issue diligently for many years – doing everything possible to address the problem of the sales and use tax on these transactions going uncollected. He is to be commended for his pursuit in the past and for formulating this legislation. In-state brick and mortar retailers are put in an unfair position when their online competitors are not required to collect and remit Indiana’s sales tax (as they are), effectively giving the “remote sellers” a 7% price advantage. Additionally, Indiana’s sales tax base is diminished each year as the online sales market continues to grow at rapid rates. What’s more, this is not a new tax since purchasers are already legally obligated to report their online purchases and pay the “use” tax when they file their income tax returns. But the reality is very few people comply with this law.

The Chamber supported the bill in committee this week and, in fact, has been working along with Sen. Kenley for years to achieve, by some means, state authorization for collecting these unpaid taxes. The objective is set forth in our Indiana Vision 2025 economic plan and we just might, after years of complications, be getting closer to obtaining this goal.