August 26, 2014
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m
Tax Policy Issues Prepare for a Rumble on the
Gridiron
By: Mary Burke Baker, Cindy L. O’Malley, Karishma Shah Page, Ryan J. Severson, Andrés Gil,
David A. Walker
The clock is running out on the 113th Congress. While the calendar says we are not quite at
the two-minute warning, with a truncated September congressional schedule and the
campaign season taking up much of the fall, the final whistle is closer than you may think.
This alert considers how the dynamics on tax policy have shifted since the beginning of
2014. Then, it examines how the tax agenda—including inversions, extenders, tax reform,
and the continuing demand for revenue offsets—fits into the legislative line-up for the rest of
the year and beyond.
Calling Audibles: Shifting Dynamics on Tax Policy
Since the beginning of the year, the dynamics on tax policy have been in flux. In the Senate,
Senator Ron Wyden (D-OR) succeeded former Senator Max Baucus (D-MT) as Chairman of
the Finance Committee. Almost immediately, Chairman Wyden shifted the Committee’s
focus from tax reform to tax extenders, proceeding with the mark-up of the Expiring
Provisions Improvement Reform and Efficiency (“EXPIRE”) Act (S. 2260) in April. However,
the Senate has not moved forward on the EXPIRE Act because of a disagreement over the
amendment process. Meanwhile, the House also has pivoted to tax extenders in recent
months. Retiring House Ways and Means Committee Chairman Dave Camp (R-MI) followed
up on February’s comprehensive tax reform discussion draft with several mark-ups and the
House passage of various bills making certain tax extenders a permanent part of the Internal
Revenue Code.
At the same time, interest in tax reform is re-emerging. For example, early this summer
Chairman Wyden and Ranking Member Orrin Hatch (R-UT) renewed their commitment by
announcing a series of hearings to set the stage for tax reform in the coming years. So far,
the hearings have focused on traditional tax reform issues like modernizing corporate
taxation and the international tax system, as well as issues that receive less media attention
like retirement and education tax incentives. These hearings may be an opportunity to refine
the framework proposed by former Chairman Baucus or develop a new playbook going
forward.
The recent focus on corporate inversions has also changed the game (see our alert,
Congress Turns Tax World Upside Down with New Focus on Corporate Inversions, for
additional detail). Several House and Senate members have introduced legislation aimed at
curbing inversions, and the Administration has announced it is exploring administrative
options to clamp down on the practice. Since there is strong interest in tackling inversions on
both ends of Pennsylvania Avenue, it is poised to remain a hot topic in tax policy moving
forward.
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Tax Policy Issues Prepare for a Rumble on the Gridiron
Moreover, the leadership transition in the House may have a significant impact on the tax
agenda in the months and years ahead. With the surprising defeat of Majority Leader Eric
Cantor (R-VA) and the election of his replacement, then-Majority Whip Kevin McCarthy (RCA), the path forward on tax issues may shift. Mr. Cantor had been instrumental in
determining which extenders being made permanent by the Ways and Means Committee
would make it to the floor for a full House vote. Mr. McCarthy has not been outspoken on tax
issues, so his position on taxes is less clear.
One constant throughout is the need to find revenues to offset the cost of legislation. A
recent example is the short-term extension of the highway trust fund, where several tax
provisions were in play as revenue raisers. There is no end in sight to the demand for
revenues, which keeps many popular tax deductions, credits, and accounting methods
perpetually close to the line of scrimmage.
September Session
Congress Seeks to Tackle Corporate Inversions
The hottest topic in tax policy is corporate inversions, and lawmakers already have several
approaches on how to address this issue when Congress returns in September. In addition,
the possibility of executive action looms over the inversions debate.
While there seems to be general consensus that the surge in inversions is a problem,
Republicans and Democrats are split on how to address it. Republicans, including House
Speaker John Boehner (R-OH), House Ways and Means Chairman Camp, and Senate
Finance Committee Ranking Member Hatch say the issue is best resolved as part of tax
reform, although Mr. Hatch has indicated he would be willing to consider a near-term,
prospective approach focused on incentivizing companies to stay in the United States that is
consistent with broader tax reform. In contrast, several Democratic members have taken
actions consistent with a retroactive deterrence policy that would limit the benefits of an
inversion. The Administration is also part of the huddle, with both the President and Treasury
Secretary Jack Lew stating they are considering what administrative actions might be taken
to stop the advance of inversions.
Democratic legislative proposals have two primary themes: to make it more difficult for an
inverted company to avoid being treated as a U.S. taxable entity and limiting interest
expense deductions by U.S. subsidiaries of inverted companies. The first approach may
include increasing the foreign ownership threshold or imposing a substantial management
and control test that would treat an inverted company as a U.S. taxable entity even if the
foreign ownership threshold is met. The second approach would limit the ability of a foreign
parent to load a U.S. subsidiary up with debt that would generate interest expense
deductions that would reduce the U.S. tax base. A recent proposal by Senator Charles
Schumer (D-NY) also would grant the Internal Revenue Service (“IRS”) broad new power to
regulate the transactions of inverted corporations by requiring the U.S. subsidiary to obtain
advance annual approval from the IRS on the “terms of their related-party transactions for 10
years immediately following an inversion;” this appears to apply retroactively. Notably,
Senator Carl Levin (D-MI) and his brother, Rep. Sander Levin (D-MI), have been on the front
line of Members introducing inversions legislation.
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Tax Policy Issues Prepare for a Rumble on the Gridiron
Senate Finance Committee Chairman Wyden responded to Senator Schumer’s proposal
with a statement saying he continues to seek a bipartisan solution with Ranking Member
Hatch and hopes to have a deal ready by September. Chairman Wyden said his approach
on inversions “includes discussion of tax and accounting rules, including . . . earnings
stripping, which is a key piece of any sound solution.”
Looming over this debate is the possibility of executive action to combat inversions. In early
comments reacting to the flare-up of inversions, Secretary Lew said that legislation was
necessary to fix the problem. However, later comments by the President and the Secretary,
in which they characterize inversions as a matter of patriotism, indicate the Administration is
exploring whether and how it could address the issue through administrative or executive
actions. The possibility of an administrative remedy has attracted a diverse reaction from
Congress, with Speaker Boehner saying the President lacks the authority to take any
meaningful action, while, on the other end of the field, Senator Bob Casey (D-PA) has written
to Secretary Lew asking for clarification about what the Administration might be able to do.
Since the chances of bipartisan congressional consensus in the near term on this issue may
be slim, throwing the ball to the White House to solve this problem is an option some
Members would like to consider. Among other Members, however, short-term, executive
action may trigger a backlash in Congress if it is perceived as exceeding the President’s
authority.
The inversions debate is expected to spill into the Lame Duck session and likely next year,
as well.
Watch Your Blind Side: Non-Tax Issues and Messaging Votes Could Have
Revenue Implications
Congress also has several non-tax proposals planned for consideration that could have
revenue implications in September, during the Lame Duck session, and in the next
Congress.
For example, in September, both the House and Senate are planning a number of
messaging votes in advance of the November elections that are likely to include tax
provisions. In August, newly elected House Majority Leader McCarthy sent a memo to his
House Republican colleagues laying out the chamber’s September agenda. It will include
votes on several bills that each bundle together various provisions with a common theme,
including energy, jobs, and health care—many of which have already been passed by the
House. The jobs package would include up to 40 previously passed bills aimed at reducing
regulatory burden, facilitating access to capital, and making several popular tax provisions
permanent, including the research and development credit and bonus depreciation. As
passed, these bills do not contain offsets; further votes could trigger pressure to find pay-fors
so the deficit is not increased as a result of making certain popular provisions permanent.
Senator Majority Leader Harry Reid (D-NV) is likewise planning a series of messaging votes
on issues like the internet access tax moratorium, an increase in the federal minimum wage,
student loan debt, and reauthorization of the Export-Import Bank, among others.
Additionally, as noted above, before the August recess Congress passed legislation to
maintain a revenue stream for the Highway Trust Fund. Although the House proposal that
Congress ultimately enacted did not repeal or cut back on any popular tax expenditures,
further debate over the highway bill and funding sources is inevitable because the tax-writing
committees will need revenue for a long-term Highway Trust Fund proposal expected to
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Tax Policy Issues Prepare for a Rumble on the Gridiron
move forward in the Spring of 2015. As with corporate inversions, the risk to certain tax
expenditures through non-tax legislation will continue throughout the rest of the year and
beyond.
Lame Duck: Hail Mary on Tax Reform Unlikely, but Watch for Movement on
Other Issues
Short-Yardage Gains: Tax Extenders Provide Opportunity for Small Victories
before Tax Reform
In addition to corporate inversions, Congress is expected to consider tax extenders during
the Lame Duck session. The Senate’s EXPIRE Act would extend dozens of temporary tax
incentives, including the research and development tax credit (with modifications), numerous
energy tax incentives, the new markets tax credit, the work opportunity tax credit, bonus
depreciation, and others for two years (through December 31, 2015). Senate Majority Leader
Reid has indicated that the package will not be considered until after the elections—not
because of substantive objections, but rather because of disagreement on the amendment
process.
The House has taken a different approach to tax extenders. The House Ways and Means
Committee has marked up a select number of business, charitable, and education-related
tax bills that would make numerous tax extenders permanent, and the full House has
approved several of these, including small business expensing under section 179 of the
Code, reduced recognition period for built-in gains of S Corporations, bonus depreciation,
and several charitable-related tax provisions. Notably, these measures did not include
offsets, and Chairman Camp has said he is not looking to offset the cost of the bills—a
position that has received criticism from congressional Democrats and the White House.
Assuming the Senate passes the EXPIRE Act after the elections, this will likely trigger a tax
extenders conference during the Lame Duck session. Under this scenario, the House and
Senate would be starting from dramatically different positions, with the Senate supporting a
two-year extension of nearly all the tax extenders and the House supporting only the
permanent extension of a smaller number of provisions. Given the distance between the two
chambers’ positions in such a scenario, there is no clear outcome from conference
negotiations—indeed, it is possible that that some extenders would be made permanent,
others extended, and others allowed to remain expired.
Impending Substitutions: Impact of the Elections on Tax Policy in the Lame Duck
Session
This year’s elections could have a big impact on tax policy in the near, mid, and long term.
Although the elections are still several weeks away and much can change, at the time of this
writing, control of the Senate appears to be tilting in favor of Republicans. Four Democrats
(Senators Tim Johnson (D-SD), Max Baucus (D-MT), Jay Rockefeller (D-WV), and Tom
Harkin (D-IA)) have already retired or will retire at the end of this term, and at least five
Democratic incumbents (Senators Mark Begich (D-AK), Kay Hagan (D-NC), Mary Landrieu
(D-LA), Mark Pryor (D-AR), Mark Udall (D-CO)) face competitive races. Meanwhile, the
House will likely remain in Republican hands.
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Tax Policy Issues Prepare for a Rumble on the Gridiron
A flip to Republican control of the Senate could have immediate consequences on tax
extenders in the Lame Duck session—as well as tax reform in the long term. In particular,
Republicans would have a stronger hand at the bargaining table during the Lame Duck
session and may decide not to extend several tax provisions that are traditionally
championed by Democrats, such as incentives for renewable energy. Another possibility is
that Republicans defer action on extenders until early in the next Congress, when they
control the Senate. Similarly, the playbook on tax reform, inversions, and other tax issues
could undergo significant revisions if Republicans control both Houses of Congress.
Looking to Next Season: The Tax Policy Agenda in 2015
New Quarterback(s) at the Helm: New Committee Leadership Would Change the
Game
Leadership changes on the House Ways and Means and Senate Finance Committee could
have a dramatic impact on tax policy in the 114th Congress. If Republicans hold a majority in
the Senate, Senator Hatch is expected to become Chairman of the Finance Committee.
Senator Hatch would bring to the table dramatically different positions than current Chairman
Wyden on inversions, tax reform, incentives for renewable energy, and other issues; for
example, Mr. Hatch is on record as supporting a territorial international tax system, and his
position on inversions is discussed earlier in this report.
In the House, Ways and Means Chairman Camp is retiring at the end of the year. House
Budget Committee Chairman Paul Ryan (R-WI) and Congressman Kevin Brady (R-TX) have
indicated their interest in the House Ways and Means Chairmanship and are undoubtedly
considering tax reform. Presumed Chairman Ryan has said tax reform is his top priority, and
he would begin his tax reform efforts with a clean slate. His budgets, however, provide little
insight into what shape his views would take, other than to lower rates, broaden the base,
and eliminate unidentified tax loopholes.
A change in Ways and Means leadership to Congressman Ryan, in particular, could
potentially bring a new level of cooperation between the House and Senate moving forward.
Senator Hatch and Chairman Ryan have a history of closely working together on issues such
as health care reform. Even if Democrats retain control of the Senate, Chairman Wyden and
Chairman Ryan have collaborated on policy issues in the past, such as entitlement reform.
Chasing the Elusive Title: Congress to Continue Work on Tax Reform
Tax reform is widely expected to remain a major topic in tax policy in the 114th Congress.
Although the new Ways and Means chairman will want to develop his own plan, Chairman
Camp’s discussion draft, the Tax Reform Act of 2014, may serve as a starting point for future
tax reform efforts in the House (see our alert on Chairman Camp’s Tax Reform Discussion
Draft for additional detail). The discussion draft provides a comprehensive blueprint for
reforming the Code and revamping current individual, business, and international tax rules.
Although there was general support and positive recognition for the difficult work leading up
to the draft, many stakeholders were uncomfortable with the hard choices Chairman Camp
made in order to lower tax rates. Nevertheless, Mr. Camp’s proposal is respected as a
serious and principled attempt to revamp the tax code.
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Tax Policy Issues Prepare for a Rumble on the Gridiron
In the Senate, Chairman Wyden is also committed to reforming the tax code in 2015. The
Senate Finance Committee has already held several hearings on tax reform since Chairman
Wyden took over the Committee. While it is unclear if more hearings will be held this year,
there seems to be an increased pressure on reforming the tax code next year due to the
recent increase in corporate tax inversions. Chairman Wyden could build off his previous tax
reform proposals while incorporating ideas from discussion drafts during Senator Baucus’
tenure as Chairman of the Committee or even from Chairman Camp’s tax reform discussion
draft (see our alert on Chairman Wyden’s Tax Reform History for additional detail).
Additionally, Ranking Member Hatch’s recent comments about the need for tax reform in the
context of the inversions issue, including a Wall Street Journal op-ed, demonstrate his
interest in pursuing tax reform if he becomes Chairman in 2015.
Although the President has advanced several discrete tax reform proposals in his budgets
and other initiatives, mostly business related, the White House has not taken a strong lead in
the tax reform debate. Many stakeholders believe this lack of political pressure, coupled with
the upcoming presidential election in 2016, significantly reduces the chances of meaningful
tax reform next year. This does not rule out, however, that Congress would take up a more
targeted piece of tax reform, such as corporate tax reform or international tax reform, since
the Administration has previously supported these scaled-down efforts.
Post-Game Recap: Putting it All Together
There are many tax issues in play as this session of Congress wraps up. The outcomes are
yet to be determined due to many variables and potential changes in the line-up, including
possible interference with congressional action due to turbulent world events that could
supersede a domestic agenda. This uncertainty makes it particularly important to stay alert
and not take your eye off the ball as Congress considers a busy tax agenda before the clock
runs out.
Authors:
Mary Burke Baker
Government Affairs Advisor
mary.baker@klgates.com
+1.202.778.9223
Karishma Shah Page
Associate
karishma.page@klgates.com
+1.202.778.9128
Cindly L. O’Malley
Government Affairs Counselor
cindy.omalley@klgates.com
+1.202.661.6228
Ryan J. Severson
Associate
ryan.severson@klgates.com
+1.202.778.9251
Andrés Gil
Associate
andres.gil@klgates.com
+1.202.778.9226
David A. Walker
Government Affairs Coordinator
dave.walker@klgates.com
+1.202.778.9346
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Tax Policy Issues Prepare for a Rumble on the Gridiron
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