I'm sure you're familiar with the ancient Chinese curse, "May you live in interesting times." Interesting times are usually uncertain times, and the unprecedented uncertainties we're now facing in our nation's tax policy are transforming this curse into reality. How is your tax department dealing with the uncertain tax situation today? Many tax directors tell us it's becoming more difficult to provide management with a forecasted effective tax rate or to determine how taxes will impact the hurdle rate for an investment. Meanwhile, non-tax executives within the company don't understand why the tax department can't provide a simple answer. You frequently hear the President and both sides of the aisle in Congress seeming to agree that the corporate income tax rate should be lowered, but are you ready to explain to your CFO or board of directors what this would mean for your company and how to increase the potential benefit and reduce the potential cost? How can we as tax professionals best anticipate our customers' (internal and external) needs given today's uncertain tax situation?
Tax Uncertainty Today
Uncertainty has arisen from the multiple roles the U.S. tax system is asked to play: stimulate the economy, reduce budget deficits, implement social policy, incentivize favored industries and activities, close loopholes for less favored industries and activities, and redistribute wealth. As a result, the U.S. tax system has become an unstable, increasingly provisional, and consistently manipulated set of rules. For example, since the Tax Reform Act of 1986, the U.S. Congress has enacted more than 40 tax acts ---- 17 of which have occurred only since 2005. Many of these tax provisions are enacted as temporary, subject to the political whim of annual "extenders," because increasing budgetary constraints or political posturing prevent their permanent adoption. The Joint Committee on Taxation's list of expiring temporary provisions is now 33 pages long. This has made tax planning difficult, as the U.S. tax system lacks policy consistency, even in areas that affect all corporate taxpayers, such as tax depreciation, and in areas that are crucial to future economic growth, such as research and experimentation.
Last-minute tax provisions enacted because of the Pay-As-You-Go (PAYGO) rules, used to fund non-tax legislation, deliver immediate budgetary relief but often wreak longer-term havoc from unintended (or not fully thought through) consequences. PAYGO tax provisions are regularly included in a bill without considering the full ramifications on the tax system and its administrative burdens. For example, the Foreign Account Tax Compliance Act (FATCA), enacted in 2010, was intended to combat offshore tax evasion through increased information reporting and withholding tax requirements and to help pay for the Hiring Incentives to Restore Employment (HIRE) Act. However, FATCA has significantly impacted the operations of both U.S. and non-U.S. companies.
Another factor leading to the growing uncertainty is the dramatic changes in the legislative process. Historically, tax policy was initiated by Congressional committees with full hearings, markups and business involvement, all of which created a rich legislative history for interpretation of the enacted tax law. Increasingly, tax policy has bypassed committees and lacked business involvement and, as a result, is often supported by weak legislative history. Additionally, because of party gridlock, substantive bills have been passed using reconciliation bills (i.e., requiring only up or down votes with no amendments allowed).
Several tax reform proposals have been introduced or circulated for discussion:
- Tax-Overhaul Plan from House Ways and Means (Chairman Dave Camp);
- President's National Commission on Fiscal Responsibility and Reform (Bowles-Simpson);
- Bipartisan Tax Fairness and Simplification Act (Sens. Ron Wyden and Dan Coats);
- Bipartisan Policy Center's Debt Reduction Task Force (Alice Rivlin and Pete Domenici);
- Roadmap for America's Future (Rep. Paul Ryan);
- Framework for Overhauling Corporate Taxes (Treasury Secretary Timothy Geithner); and
- President Obama just released his Administration's proposal for lowering the corporate income tax rate, promoting manufacturing and discouraging "accounting games to shift profits abroad."
While these tax reform proposals have been issued in response to growing budgetary pressures and in the hope of reducing tax uncertainty, in many respects, they have added additional uncertainty. Despite this, some commonality exists among the reform proposals. Nearly every proposal provides for a reduced corporate federal income tax rate while broadening the income tax base. Several of the proposals address tax policy related to foreign activity (i.e., territorial vs. worldwide tax system or a minimum tax on multinational corporations' foreign earnings).
Mitigating Tax Uncertainty
Despite the daunting tax uncertainty of our interesting times, tax directors and CFOs should begin taking steps now to mitigate the uncertain tax situation today. Proactive tax directors and CFOs have several options to consider.
Tax departments should develop awareness of the issues and legislative/policy proposals and become more active in the political process, either directly or through trade organizations and other business groups. After understanding the tax implications of proposed tax legislation, it is important to communicate these issues to your company. Communication may include regularly briefing and educating the CFO, discussing acceptable levels of tax risk, attending audit committee meetings, providing tax briefings discussing the potential implications to the company, and educating financial and operating management about proposed tax reform. Tax departments should also consider tax modeling, worst-case scenarios, and either developing or hiring key resources (e.g., cross-functional in tax accounting, forecasting and planning; skilled in tax processes and automation; and active within trade associations or key lobbying groups).
Tax departments also have opportunities to improve the outcome from the likely reduction of corporate income tax rates and the expansion of the tax base (e.g., elimination or reduction of the manufacturing deduction) that could be enacted as early as 2013. In anticipation of these changes, businesses should attempt to:
(1) Minimize deferred tax assets (DTAs);
(2) Maximize deferred tax liabilities (DTLs); and
(3) Maximize favorable permanent differences in 2012.
To minimize DTAs, businesses can trigger built-in gains to obtain a step-up in tax basis and use net operating losses (NOLs) at a higher tax rate (35 percent), maximize utilization of other tax attributes (e.g., foreign tax credits, research and experimentation credits) and accelerate deductions on existing DTAs (e.g., make payments to trigger deductions, accounting changes, bad debt deductions). DTLs may be maximized through accelerated tax depreciation (e.g., bonus depreciation, cost segregation), moving tax revenue to future periods (e.g., installment sales) and maximizing new deductions where tax is greater than book (e.g., transaction cost analysis). Favorable permanent differences may be found in meals and entertainment or domestic production activities deductions.
While these strategies are well known, tax departments may have so far delayed taking advantage of them because of the ever-present constraints of time, resources and budget. However, given the current consensus for a lower corporate income tax rate and a broader tax base, tax departments should re-evaluate these areas to increase the potential benefit and reduce the potential cost to the company.
Many of the proposed tax reforms focus on federal income tax, but the changes may have unexpected impacts on state income taxes as well. Since most states use federal taxable income as the starting point for calculating state taxable income, the broadened income tax base will also affect most state income tax calculations. Reductions in the federal rate will inversely increase the state effective tax rate, thus creating a state tax benefit. As a result of the potential additional state taxable income, companies may be required to re-evaluate their state DTAs and related valuation allowances.
Alvarez & Marsal Taxand Says:
Don't be caught unprepared! The current tax uncertainty should be no excuse for inaction. In fact, there are already some glimmers of future certainty among all of the current uncertainties. Take advantage during 2012 to best position your company to increase the potential benefits and reduce the potential costs of the tax changes that lie ahead in these interesting times.
For more information:
Charles Henderson IV
Managing Director, Atlanta
+1 404 720 5226
Managing Director, New York
+1 212 763 9760
Managing Director, Miami
+1 305 704 6688
Managing Director, Seattle
+1 206 664 8910
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the US., and serves the U.K. from its base in London.
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