United States: Significant Changes In US Tax System Likely

In the short time since the surprising election of Donald J. Trump as the 45th president of the United States, much already has been written about the likelihood and likely direction of changes in US tax law. Clues primarily are drawn from the policy proposals of candidate Trump, the "House Blueprint" and the Portman-Schumer proposals.

In broad terms, ‎likely changes include significant reductions in both individual and corporate tax rates (with corporate tax rates potentially to be set markedly lower than individual tax rates), coupled with some broadening of the tax base, and an overhaul of the US international tax system: abandoning the current worldwide taxation of US multinationals in favor of a territorial or "modified" territorial system that in general exempts active foreign earnings from US taxation (subject to safeguards against base erosion). The House Blueprint would include an even more fundamental change, moving to a destination-based corporate cash flow tax that would exempt exports and disallow deductions for imported inputs. There is likely to be a tax—at a heavily discounted rate and payable over a period of years—on the previously accumulated offshore earnings of US multinationals under a "deemed repatriation" regime. Some form of "Innovation Box" taxing qualifying income at highly preferential rates may be enacted. It is possible capital investments generally will be rewarded with full expensing (as suggested in the House Blueprint, which proposes moving towards a "cash flow" system of taxation), albeit at the potential price of an elimination of the deduction for net interest expense. Some interesting twists in the taxation of the income of pass-through entities may be introduced.

In addition, Senator Orrin Hatch has under development a corporate integration proposal the centerpiece of which is a dividends-paid deduction offered as solution to a wide range of tax policy issues. The proposal includes an increase in the dividend tax rate and calls for the imposition of a broadly applicable dividend withholding tax.

At the moment, there is considerable uncertainty as to the ultimate contours of the tax reform that is coming, but it seems fairly clear that changes along the lines outlined above are indeed impending. It is not clear whether these sweeping reforms will be accomplished in the first year of a Trump administration, or will require more time to be developed and enacted into law. There are procedural hurdles on the Senate side to the passage of tax legislation, given the slim Republican majority, but there already has been a fair amount of discussion regarding resort to the budget reconciliation process to overcome that.

Implications to Tax Planning

Given the clear thrust of the likely changes, however, taxpayers may be well served, where possible, to defer income recognition events into next year (or later) and accelerate deductions into this year. Also, while there are many fronts on which international tax planning (and implementation) should and will proceed despite the change in the prospects for the kind of tax reform described above, some taxpayers may conclude that in their circumstances it may be advisable to wait for things to sort themselves out on the legislative front before launching a major new international tax planning initiative. Whereas the current US tax system has created incentives for multinationals to engage in inversion transactions and implement earnings stripping, IP migration and similar planning initiatives, not surprisingly (given that the proposals in circulation are explicitly intended to eliminate those incentives), a reformed US tax system may suggest resort to different, or additional, planning choices. Therefore, among the key undertakings entering 2017 will be to identify the new paradigms for such tax planning.

Significant Changes In US Tax System Likely

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