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.
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 (R-CA), 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.
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.
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 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.
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.
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.