The President’s Framework for Business Tax Reform

On February 22, the Treasury Department released a document called “The President’s Framework for Business Tax Reform.” It carries a rough blueprint for the President’s plan to cut corporate tax rates, simplify corporate tax rules, and reform the international tax rules. It also carries some proposals for simplifying and reducing the tax burden for small businesses.

Arguments for corporate tax reform. The “President’s Framework for Business Tax Reform” says a corporate tax overhaul is necessary because of the following flaws in the current tax system:

• Today’s system, which trades off a high corporate rate and a base that’s narrowed by tax breaks, is uncompetitive relative to other countries, distorts business decision making, and slows economic growth.
• The complexity of today’s tax rules increases compliance costs for businesses, increases enforcement costs for IRS, and invariably leads to disputes between businesses and IRS, requiring significant expenses to adjudicate these disputes.
• Industry-specific tax preferences produce a wide disparity in average tax rates across industries, resulting in a tax system that distorts investment decisions.
• Current corporate rules encourage corporations to finance themselves with debt (because interest payments are deductible) instead of equity (because corporate dividends aren’t deductible). The resultant “outsize reliance” on debt financing can raise the risk of financial distress and thus raise the risk of bankruptcy.
• Large companies are increasingly avoiding corporate tax liability by organizing themselves as pass-through businesses. The ability of large pass-through entities to take advantage of preferential tax treatment has placed businesses organizing as C-corporations at a disadvantage. By allowing large pass-through entities preferential treatment, the tax code distorts choices of organizational form, which can lead to losses in economic efficiency.
• Current incentives to shift income abroad significantly erode the U.S. tax base and leads to lower corporate tax receipts

Small business tax proposals. In an effort to show the tax problems of small businesses haven’t been overlooked, the President’s proposal calls for simplifying the tax rules that apply to them and adding incentives to help build “innovation and entrepreneurship.” Specifics include: allowing small businesses to expense up to $1 million under Code Sec. 179; allowing cash method accounting for businesses with up to $10 million in gross receipts (up from current law’s $5 million); doubling the amount of currently deductible start-up costs from $5,000 to $10,000; and expanding the health insurance credit for small businesses.

About 6:59 PM eastern time yesterday evening (February 22), President Obama signed the Middle Class Tax Relief and Job Creation Act (H.R. 3630) into law.  The bill extends the payroll tax cut and jobless benefits through the end of the year.

Payroll Tax Cut Extended Through End of 2012

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers—one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax). For remuneration received during 2011 the “payroll tax holiday period,” namely calendar-year 2011, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act, P.L. 111-312) reduced the employee OASDI tax rate under the FICA tax by two percentage points from 6.2% to 4.2%. Similarly, for self-employment income for tax years beginning in 2011, the Act reduced the OASDI tax rate under the SECA tax by two percentage points from 12.4% to 10.4%.

In December of 2011, when Congress couldn’t agree on how to fund a full-year extension of the payroll tax cut that applied for 2011, it passed the “Temporary Payroll Tax Cut Continuation Act of 2011” (the TTCA, P.L. 112-78), providing for a two-month extension of the payroll tax cut that applied for 2011, and a parallel extension of a lower SECA tax rate on self-employment income. More specifically, under the TTCA, the reduced employee OASDI tax rate of 4.2% under the FICA tax, and the equivalent employee portion of the RRTA tax, was extended to apply to covered wages paid in the first two months of 2012. For tax years beginning in 2012, the TTCA also provided that the OASDI rate for a self-employed individual remained at 10.4%, for self-employment income of up to $18,350 (reduced by wages subject to the lower OASDI rate for 2012).

New law. The Act provides that the “payroll tax holiday period” means calendar years 2011 and 2012. (Sec. 601(c) of the 2010 Tax Relief Act, as amended by Act Sec. 1001(a)) Thus, the 2-percentage point payroll tax reduction and the 2-percentage point reduction in the OASDI tax under the SECA tax for the self-employed will apply through Dec. 31, 2012. As a result, for 2012, employees will pay only 4.2% Social Security tax on wages up to $110,100 (wage base for 2012) and self-employed individuals will pay only 10.4% Social Security self-employment taxes on self-employment income up to $110,100.