Some tax scholars have put together an important report detailing loopholes in the current tax bills that Congress should close, as well as numerous other issues. In general these problems will tend to cost the government more revenue than expected as people shield their money from taxes in unanticipated ways, but there are some unintended tax increases as well.
A handful of the biggies:
Our tax system is “poorly equipped to address a scenario in which corporations are taxed at a much lower rate than individuals,” and the new corporate rate is significantly below the top individual rate. In theory, corporate income is supposed to be double-taxed — once at the corporate rate and again when it goes to shareholders as a capital gain or dividend — but that second layer of tax is avoidable or mitigable in various ways. As a result, a taxpayer could gain from investing “through a corporation so her investment income accrues at the lower corporate rate,” from “simply setting up a corporation (or checking the box so that a partnership or other entity is treated as a corporation for tax purposes), and having their income accrue in the form of corporate profits,” or (for shareholder-employees) from “reducing their wages paid out by the corporation, thereby increasing the corporation’s retained profits.”
The Senate’s new tax advantages for “pass-through” businesses (whose profits are “passed through” to their owners and taxed through the individual income tax) might also be gamed. Law-firm associates might be able to become “partners in Associates, LLC — a separate partnership paid to provide services to the original firm.” The self-employed might “either mischaracterize or rearrange relationships to be independent contractors rather than employees.” The House’s provision, meanwhile, encourages owners to reduce their involvement in their businesses (as it’s targeted toward “passive” owners), and to acquire capital in the firm they don’t really need (such as when lawyers or doctors buy the buildings they work out of).
Both bills limit the deductibility of state and local taxes, which is supposed to raise a ton of money. But in response, states could shift their revenue efforts to other sources that will still be deductible. The bills allow a $10,000 deduction for property taxes, so states could set up “circuit breaker” policies allowing taxpayers to pay less in income taxes but more in property taxes. They could also tax income through payroll taxes on employers, which will still be deductible. Since the charitable deduction will stay, states could even allow residents to “donate” to the public coffers and count it against their state income tax.
Technical aspects of the corporate reforms could encourage companies to “locate real assets and investment offshore,” and could violate our treaty commitments.
Numerous provisions create opportunities for tax arbitrage, where deductions are taken against high tax rates and income is generated at low rates. I’ve written before about how delaying the corporate rate until 2019, but allowing businesses to fully deduct equipment purchases immediately, should encourage a lot of investment in 2018. The authors point out it could also encourage companies to buy equipment in 2018, deduct it against a 35 percent tax rate, and then just turn around and sell it again in 2019, when the tax rate will be 20 percent.
As Jibran Khan has noted, Congress’s tax pros made a serious last-minute screw-up regarding the corporate Alternative Minimum Tax that will hit corporations far harder than intended, though this is already a known issue.
Please, congressional Republicans — let’s find out what’s in this thing, and fix it, before we pass it.