I. Intro: This is DC Dynamics, a podcast about what’s coming up in US tax policy, with a look to the past as our guide. I’m Ray Beeman, Head of Washington Council Ernst & Young, and I will be your tour guide for this pre-August summer recess edition, Monumental Decisions, that borrows a little inspiration from the important messages that are written on the walls around Washington, DC. And it is a monumental time. Even with a divided government and the most pressing deadline of the debt limit behind us, there is a lot going on in the tax world right now. Some deadlines are overdue, including the Tax Cuts and Jobs Act (TCJA) “pre-cliffs” on R&D amortization, interest deductibility and 100% expensing. Others are on the horizon, including those related to the Organisation for Economic Co-operation and Development OECD-led global tax agreement and the very steep “fiscal cliff” on the TCJA at the end of 2025, when individual provisions are set to expire and rates on three major international provisions — Global Intangible Low Tax Income (GILTI), Base Erosion and Anti-Abuse Tax (BEAT) and Foreign Derived Intangible Income (FDII) — all increase. There has been some action on treaties and also a pretty high-profile Supreme Court tax case.
II. One of the axioms of the tax world in at least the last decade, especially on the tax reform runway to the 2017 TCJA, has been tax certainty to allow businesses to plan. That was part of the at least partial dismantling of the tax extenders process in recent years, making some provisions permanent and extending others for longer than just a year or two, though some are still up for short-term extensions.
Even going back to the country’s beginnings, one of the main architects of the US government, Thomas Jefferson, said, “I am not an advocate for frequent changes in laws and constitutions, but laws and institutions must go hand in hand with the progress of the human mind.” Well, minds change about taxes frequently, and the flip-flopping nature of the elections in recent years gives each party the ability to change them. There are also features of the legislative process that foster change, like the reconciliation rules that forced the TCJA to fit into a revenue box and led to the looming expiration of individual provisions and increases in international rates.
Enter the House Ways and Means majority who in June, laid out their broad vision for at least near-term tax changes, including on the TCJA deadlines. There are three packages, including one to expand the standard deduction and another with small business changes and reverting to the previous de minimis reporting exception for commercial payments to third-party settlement organizations of $20,000.
A third bill, the Build It in America Act, would fix the TCJA pre-cliffs through 2025; that is, restoring R&D expensing instead of five-year amortization, basing the Section 163(j) deduction limit on the higher earnings before interest, taxes, depreciation and amortization (EBITDA) threshold and preventing the phasedown of 100% expensing. The bill would also provide for the creditability of certain foreign taxes without regard to the current foreign tax credit (FTC) regulations. Importantly from a political perspective, Republicans laid down their priorities for raising revenue in rolling back some Inflation Reduction Act (IRA) energy tax incentives, but only a small fraction of the more comprehensive IRA rollback we saw in the House passed GOP debt limit bill earlier this year.
The bills aren’t expected to be enacted as is, given the TCJA business provisions remain stuck in a partisan impasse over the Child Tax Credit (CTC) expansion sought by Democrats, who are also opposed to rolling back clean energy provisions. The bills more likely represent the House GOP’s negotiating position for talks later this year aimed at constructing a year-end tax extenders package should the opportunity arise and a government spending or other must-pass vehicle for the package emerge.
Some Republican Ways and Means members said they expected the bills on the floor fairly soon, before the August recess, despite uncertainty over whether the full House will consider the bills due to:
- Freedom Caucus opposition to additional spending in the wake of the debt limit bill plus
- Potential demands from Republicans in high-tax states to include relief from the $10,000 SALT cap
The combined bills would cost around $21 billion dollars after the offsets are taken into account, though some have speculated that the true cost of the tax changes over the long term could be in the hundreds of billions of dollars.
III. A fourth bill put forward by Ways and Means Republicans but not marked up in the Committee yet, the Defending American Jobs and Investment Act, is aimed at discouraging countries from adopting a key component of Pillar Two, the Undertaxed Profits Rule (UTPR), focusing on the potential impact on US multinational corporations that have an effective tax rate of less than 15% within the meaning of Pillar Two on their US profits because they’ve availed themselves of US tax incentives. The bill would increase taxes on the US businesses of companies headquartered in countries that enact the UTPR, but it would also apply in the context of other taxes imposed on US businesses if those taxes meet a set of criteria deeming them to be either extraterritorial or discriminatory in nature.
There are big changes for corporations on the horizon because of the OECD-led global tax agreement, with the minimum tax rules being implemented in some countries beginning in 2024, the Undertaxed Profits Rule — or UTPR — in 2025, and increases in TCJA international provisions (GILTI, FDII and BEAT) taking effect in 2026. Democrats were unable to enact changes to GILTI to comply with the agreement – increasing the rate and making the calculation country by country – even in the last Congress when they controlled the House, in addition to the Senate and White House.
Republicans have been vocally critical of the deal and are not open to propelling it along — including Ways and Means Chairman Jason Smith, who has described its elements as “attempts to undermine our tax sovereignty.” The UTPR, which Republicans have sharply criticized, allows a country to increase taxes on a multinational company if that company has a taxable presence in the UTPR country and another subsidiary or branch of the parent company pays less than the global minimum tax of 15% in another jurisdiction. A number of countries are in the process of enacting both the Income Inclusion Rule and the Qualified Domestic Minimum Top-up Tax for effect in 2024 but have put off enactment of the UTPR, as many countries have agreed it should not take effect until 2025 at the earliest. South Korea, however, has enacted the UTPR to currently take effect next year.
IV. There have been multiple news stories noting how pivotal the next election cycle is for tax policy. The Wall Street Journal said back on June 19 that “Experts expect Congress to take a crack at extending expiring individual and business tax cuts in 2025, putting these international items on the agenda.” Politico wrote, “If either party can claim both the White House and Congress in next fall’s elections, there’s a huge prize for the taking: unchecked power to reshape taxes for millions of Americans. Much of the GOP’s sweeping Trump-era tax breaks are set to expire in 2025, which will almost certainly push Congress to act on their future. So, the 2024 campaign will determine whether Republicans can keep the cuts, Democrats can rewrite them — or, if neither party gets a clean sweep, whether a split government prompts a massive fiscal collision.” Maybe even more significant than differences in philosophy is the cost, with an extension of TCJA provisions projected to cost roughly $2.5 trillion dollars.
Just to take it from the top, the individual provisions of the TCJA that are set to expire at the end of 2025 include:
- Income tax rate brackets
- The standard deduction increase
- The Section 199A 20% pass-through deduction
- The Child Tax Credit increase
- Doubling of the estate tax exemption
- And the aforementioned $10,000 SALT deduction cap, which is a revenue raiser not a revenue loss
As has been noted, Republican leaders have signaled they will push for straight extension of the expiring TCJA provisions, with the potential to change some, like the standard deduction, for instance. Democrats have not hidden their distaste for the TCJA, which they were excluded from developing during a period of full Republican control in Washington, but haven’t been advocating for a straight repeal, which could result in them being portrayed as supporting a tax hike. Notably, in his Fiscal Year 2024 Budget, President Biden in his most direct terms yet suggested he is willing to deal on the TCJA expirations, provided there are no tax increases on those earning less than $400,000 per year. And, he expressed opposition to “cutting taxes for the wealthy — either extending tax cuts for the wealthy or bringing back tax breaks that would benefit the wealthy.”
In a speech on June 28, President Biden criticized Republicans for “pushing for tax cuts for large corporations and the wealthy and adding trillions of dollars to the deficit,” referring to the House bills, and called for “making the tax code fair for everyone — making the wealthy and the super-wealthy and big corporations begin to pay their fair share, without raising taxes at all on the middle class.” The president also specifically mentioned his proposal for a minimum tax on wealthy individuals, which he’s called the “billionaire’s tax.”
V. If all that wasn’t enough, there has been a recent curveball regarding one aspect of the TCJA, and now we’re going to veer out of our lane of Congress, the White House and Treasury to talk about it.
The Supreme Court, which normally doesn’t relish the idea of deciding tax issues, has agreed to hear the case of a couple who argue that the TCJA transition tax, under Section 965, violates the Constitution’s Apportionment Clause and the Due Process Clause of the Fifth Amendment because, they contend, it is a direct tax on unrealized income. Specifically, the Sixteenth Amendment says that “Congress shall have power to lay and collect taxes on incomes, from whatever source derived,” which has traditionally been understood to exclude unrealized gains.
Taxpayers Charles and Kathleen Moore are seeking a $14,729 refund on earnings from an Indian company that supplies equipment to small farmers, which were reinvested rather than distributed. You may recall that the transition tax was imposed on income held offshore as a runway to the reformed tax system, and a successful challenge could have wide-ranging consequences for other corporate taxes, like GILTI, not to mention, long-standing tax rules like GILTI’s cousin, the Subpart F rules, the Section 475 dealer mark-to-market rules, the passive foreign investment company — or PFIC rules — the mark-to-market rules for Section 1256 contracts and the original issue discount rules. It could also head off potential wealth tax approaches, including the President’s proposal and Senate Finance Committee Chairman Ron Wyden’s proposal to specifically tax unrealized gains, which have been under discussion for years but aren’t going to be acted on anytime soon in divided government.
VI. While there are all of these monumental decisions on tap for major tax provisions, some of the most significant recent activity on tax has been on treaties. The Senate, on June 22, at long last approved the US tax treaty with Chile, which had been pending for years and was stuck over privacy concerns of Senator Rand Paul. This step is a pretty big deal, and even Senate Majority Leader Chuck Schumer said while the treaty hasn’t gotten a lot of mainstream press attention, it is one of the more important recent items of business in the Senate.
And with that, I’ll close with a quote from the Martin Luther King, Jr. memorial: “The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy.” One way to view that, through our narrow lens of tax policy, is our abiding hope that policymakers and stakeholders remain civil and respectful through what may be a grueling round of tax debates and other controversial issues confronting Washington, not the least of which is a potentially bruising partisan fight over funding the government beyond September 30. Another way to carry that message, taking the broader view, is for us all to stay strong and kind in the face of adversity, which is something we probably can’t be reminded of too often.
All right, so hopefully that provides a full meal of tax information to chew on with the burgers and hot dogs during these long summer days. As you can tell from the many open issues we talked about, there is plenty more to come, and we will continue to discuss them right here. But that’s all for now. For the team here at Washington Council Ernst & Young, I’m Ray Beeman, and this has been DC Dynamics.
