U.S. Treasury Secretary Timothy Geithner told the Senate Finance Committee Feb. 15 that Congress should “revisit” long-standing rules that give businesses a choice of paying taxes as a corporation or through a structure such as a partnership through which they can report business income on individual tax returns. The recommendation, which Geithner repeated in a meeting with reporters this week at Bloomberg News in Washington, would affect income earned by the nation’s largest law firms, investment partnerships and so-called S corporations. It would more than double, to about $3 trillion, the amount of business income potentially affected by tax-law changes. [Bloomberg]
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White House Backs Down on Corporate Foreign Earnings Tax
This story is republished from CFOZone, where you’ll find news, analysis and professional networking tools for finance executives.
The Obama administration is slowly starting to pick its battles; starting with taxes on corporations’ foreign earnings.
The administration has abandoned its proposal to eliminate U.S.-based multinationals’ ability to defer tax on income by shifting assets to foreign subsidiaries, according to a published report.
While details are sketchy, Bloomberg reported on Tuesday that the administration’s proposed budget for fiscal 2011 shows that it has abandoned its plan to eliminate the so-called “check the box” system under which U.S. companies can defer U.S. tax on income by shifting income-generating assets to foreign subsidiaries without recognizing gains on the transfer.
The proposal would have eliminated companies’ ability to avoid tax on such transfers and forced the repatriation of earnings shifted in this way.
According to Bloomberg, the administration backed down in the face of intense opposition from multinationals. Observers note that Congress has tried to squelch the efforts of the Internal Revenue Service to clamp down on U.S. companies getting foreign tax breaks at the same time as U.S. tax breaks, although many of those breaks are facilitated by the check the box system.
“Maybe the administration figured this was one it did not need to pick a fight on,” Jasper Cummings, a partner in the Raleigh, N.C., office of Alston & Bird and a former associate chief counsel of the IRS, said in an email to CFOZone Tuesday. “They have enough fights as it is.”
Still, Cummings noted that the administration still has “a pretty long list of other changes” in international taxation that it is pursuing. Chief among them is a plan to tighten the pricing rules for transfers of intangible assets.
As CFOZone reported last fall, one such proposal would crack down on asset transfers of employee compensation. In a paper released in May outlining its budget for the last fiscal year, the administration said it would “clarify” the treatment of transfers of intangible assets to include shifts of such expenses.
At present, many companies avoid paying tax on gains resulting from transfers of so-called “workforce in place” under rules that also allow goodwill and “going concern” to go untaxed. In early 2007, however, the IRS issued a staff directive and audit guidelines warning that it was “improper” for taxpayers to classify workforce in place as goodwill and going concern. And an IRS official in September indicated that transfers of workforce in place should include the value of products or services the employees create if much of the work is complete at the time of the transfer.
According to Bloomberg, the administration’s proposals to toughen the rules on transfer pricing would generate $15.5 billion in tax revenues for the coming year and along with other international tax changes produce $122.2 billion over a decade.
Closely-Held Corporations May Want to Take a Bullet Over the Pending Dividend Tax Hike
As a role model, Andrew Jackson has serious shortcomings, not least his penchant for genocide. But some of his policies are back in vogue, like the casual destruction of the national banking system. Taxpayers may be choosing to be like Andy in another way before the end of t had the bad fortune to get crossways with Charles Dickinson, one of the best pistol shots in Tennessee, when dueling was still fashionable. He met his antagonist across the state line in Kentucky, where duels were legal. Jackson was serious about this one, so he decided to take all the time he needed to do Dickinson in. Given Dickinson’s marksmanship, that meant accepting a bullet. Sure enough, Dickinson’s shot hit home:
The bullet struck him in the chest, where it shattered two ribs and settled in to stay, festering, for the next 39 years. Slowly he lifted his left arm and placed it across his coat front, teeth clenched. “Great God! Have I missed him?” cried Dickinson. Dismayed, he stepped back a pace and was ordered to return to stand on his mark.
Blood ran into our hero’s shoes. He raised his pistol and took aim. The hammer stuck at half cock. Coolly he drew it back, aimed again, and fired. Dickinson fell, the bullet having passed clear through him, and died shortly afterward.
Taxpayers owning C corporation stock might also want to take a bullet, figuratively speaking, this year. That’s because the tax rate on dividends will either leap or soar in 2011.
The increase in the dividend rate is a consequence of the scheduled expiration of the 2001 Bush tax cuts after this year. Prior to the Bush administration, dividends were taxed as ordinary income. As dividends are distributions of corporate income already taxed at a corporate rate as high as 35%, that meant a combined rate of 57.75%. The Bush tax cuts tied the dividend rate to the capital gain rate, now 15%.
When the Bush tax cuts expire, the capital gain rate is set to return to 20%. But without Congressional action, dividends will again be taxed as ordinary income. Given the size of the deficit, the poisonous election-year political atmosphere, and that the President promised to hold the dividend rate to 20%, it’s likely that dividends will be taxed as ordinary income in 2011. That would means a 164% increase the top dividend rate.
But wait, there’s more! Starting in 2013, Obamacare will tack another 3.8% to the top rate on investment income, resulting in a top dividend rate of of 43.4%, making the total tax increase over 189%.
This makes it tempting to take the bullet – a big 2010 dividend out of a closely-held C corporation. It will be especially attractive for shareholders who lack the ability to suck out corporate cash using the usual tricks of shareholder bonuses or rent payments.
Yes, it means taking a bullet. Taking dividends out of closely-held corporations breaks the rules of the C corporation tax planning crib book. Taxpayers go to elaborate lengths to avoid taking income before they have to. But a 189% tax increase might be enough to make some taxpayers take the bullet, like Andy, for the greater good.