The GOP tax-reform proposal framework & CreativeOne

Nothing’s certain except death and taxes (maybe).

At the end of September, the Republican Party’s leadership unveiled its framework for tax reform, a plan that lays out a roadmap without offering a specific plan (that’s for Congress to fill in with concrete language). But this is the starting point.

Here’s what we know, and here’s what to look for in the weeks ahead. We’re going to focus on just four things from a complicated proposal, and we may write more in the weeks to come, as more details of the plan take shape.

Until then, here are four things related to corporate tax reform in the new proposal.

What’s the stated goal of corporate tax reform?

In short, to boost the economy.

There are several tax-reform pieces to unpack here, but one related to corporations like CreativeOne (or individual advisors’ and agents’ companies) calls for a drop in corporate tax rates, from 35 percent to 20 percent, among other things.

Kevin Hassett, the president’s chief economist, along with Aparna Mathur, argued in 2006 that a “1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.” Presumably, advocates for this reform argue, the opposite is also true. If you cut corporate taxes, wage rates should rise — something that should boost the economy overall, since people will have more money to spend.

Likewise, the new framework would completely exempt corporations from taxes affecting their foreign profits — meaning money made in other countries would be exempt from U.S. tax law, and the government couldn’t touch it. Again, this should, in theory, help wage growth and spur the economy to grow at a higher clip, with the result that any lost revenue from tax cuts would be made up as the economy grows.

The pass-through tax rate might be going down.

Right now, businesses taxed on a pass-through basis have an advantage over “C class” corporations: they’re taxed just once, at the owner level, when, for example, a sole proprietor reports the businesses profits as income on their personal tax return filed with the IRS.

“C-class” corporations are taxed at least twice. That means money in a “C-class” corporation ends up being taxed at something like 50.5 percent.

With pass-through taxes, as the framework currently exists, the rate would drop to 25 percent. At the moment it’s more like 43.3 percent (a 7.2 percent advantage), because the income is taxed as personal income.

This drop in rates would widen the advantage that partnerships, “S-class” corporations, sole proprietorships, and other self-employed individuals have over “C-class” corporations.

You should know there’s some debate among economists about if this reform actually works the way it should, because some studies have shown it leads to tax avoidance, not to supply-side growth.

It would give a hefty advantage to smaller companies, which would greatly impact CreativeOne and many of our advisors and producers, so keep an eye on this proposal as the legislative process grinds forward.

But it’s more than tax cuts.

The tax reform framework doesn’t just change the corporate tax rate, though. It also allows corporations to “fully expense” their investments. Instead of deducting investments from their taxes on a depreciation schedule, corporations could immediately, deducting the cost of their investments from their revenue — meaning they’d pay taxes only on their profits.

Theoretically, this means the tax burden will fall on “rents,” meaning companies that have some unfair advantage on the free market, like government subsidies, monopolies or oligarchies, or companies that have some patent or copyright no one else has.

Fully expensing things requires another related reform: ending “debt deductibility,” a practice that lets corporations deduct against their interest payments. It’s complicated, but in short, debt deductibility means that if you use debt to finance a project, you’re paying a -6.4 percent tax rate for parts of the project.

In short, getting rid of debt deductibility should encourage investment but also remove the current preference that some companies have for using debt instead of capital to finance their projects.

The end of the world(-wide deferral tax system).

Right now, U.S. companies are taxed on all of the profits they make around the world. They don’t have to pay the IRS until they bring the money home, though. That’s led to a large cash build-ups overseas, in some cases.

This is known as a “world-wide deferral tax system.” Many nations don’t use this kind of system. They use something called a “territory system.”

The new GOP tax framework calls for a move to just such a territory system. That means, for corporations, all foreign profits will be taxed only in the country of origin. But what does this mean?

Let’s say, for the sake of argument, that the Really Good Corporation sells a widget in Ireland, and makes $100 in profit. They’ll only be taxed on that $100 in Ireland, and not in the U.S. That’s it.

In the meantime, for the large cash and asset reserves overseas, the framework would allow a low one-time tax rate, encouraging corporations to bring that money back to the U.S.

The first step in a long journey.

We don’t know much about how the partisan debate will unfold around tax reform. The final legislation that comes from the House and Senate may differ from the proposed framework. However, as we continue on this journey, we at CreativeOne will keep you apprised of the twists and turns along the way.

FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC.  CP-1021 – 2017/10/17

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