Surviving the Cliff

As all eyes continue to be transfixed by the increasingly surreal American presidential election, tax experts view it as a mere distraction between the real cataclysmic showdown–the 2025 Tax Cliff.

Much of the 2017 Tax Cuts and Jobs Act is set to expire next year or shortly after, and extending it wholesale for 10 more years could cost as much as $5 trillion. Republicans will look at canceling the Inflation Reduction Act as a possible revenue source, while Democrats hope that tax increases on the wealthy could further fund their own priorities. Neither party wants to see the TCJA entirely expire, and the imposing deadline could force Congress to act.

Whatever legislation results, whether it’s a bipartisan “grand bargain” or something one party crams through, could be one of the most consequential tax measures ever.

And it will likely affect much of the international framework as well. If Democrats hold the White House and see gains in Congress, they’ll likely hope to implement the Organization for Economic Cooperation and Development’s Pillar Two 15% global minimum tax, a top priority for the Biden Administration. Republicans, meanwhile, would presumably like to reverse planned hikes in the tax on global intangible low-taxed income (GILTI) and on foreign-derived intangible income (FDII), while also making other taxpayer-favorable tweaks.

But while there were be changes, odds are there won't be a dramatic overhaul of the U.S. international tax code.

Both parties would like to tweak GILTI and FDII, and would probably like to scrap the unpopular base erosion and anti-abuse tax as well. But there’s no particular momentum to overhaul the basic structure–GILTI and FDII, tweaked or not, has good odds of staying.

As maligned as the TCJA’s international tax provisions may be in some corners, they’ve proven remarkably sturdy and durable. They could ultimately become as enduring to the U.S. tax code as Subpart F, enacted in the 1960s, or even the century-old foreign tax credit.

The party with the most incentive to change the TCJA’s provision is the Democratic Party, of course. They’ve been harshly critical of all aspects of the law since before it was passed, characterizing it as a giveaway to the wealthy at the expense of future taxpayers. Some Dems acknowledge that the bill includes safeguards meant to prevent abuse, but they claim those were ineffective window dressing that, if anything, hastened the flight of dollars offshore.

The participation exemption that puts most offshore income outside the reach of the U.S. Treasury encourages companies to shift income and actual jobs offshore, the Democratic critics claim. For that matter, the GILTI tax–which targets low-taxed “intangible” income through a formula based on the amount of tangible property the company holds–is also allegedly an ineffective deterrent for base erosion, as the GILT tax rate is half the overall rate. (The GILTI rate is 10.5%, while the corporate rate is 21%–presently.)

During the 2020 election, most of the Democratic presidential candidates argued for a return to worldwide taxation, decrying how the TCJA rewards companies the more they earn offshore. (Territoriality is supposed to be about avoiding double taxation and focusing on the manageable task of taxing only your own income–but such subtleties get lost on the campaign trail.)

While Biden also echoed these concerns, his actual proposals haven’t totally given up on territoriality.

This is partly because many of the basic design aspects of GILTI were included in Pillar Two, which Biden touted as a major accomplishment and a blow to international tax avoidance. Pillar Two doesn’t exactly mandate that countries apply a lower rate of tax to foreign income, but that’s kind of implied by the “minimum tax” concept.

Biden’s most recent budget request would increase both the overall corporate rate and the offshore rate–but maintain a disparity between them.

That budget also calls for implementing all of the legislative changes needed to fully implement Pillar Two. It makes sense that this would be the administration’s official position. But given how Congressional negotiations are invariably whittled down to only the bare necessities, few expect to see Democrats go that far. They’d be likelier to make select changes to GILTI–applying it on a country-by-country basis and increasing the rate–to be closer to the OECD model, and hope that this is enough for the rest of the organization to grant a grandfathering exemption.

(Democrats could also theoretically repeal GILTI’s formulaic carveout for tangible property, which they’ve long criticized as an incentive for offshoring. But this would also move away from the OECD model, so I doubt it.)

But even if Democrats decided to go with Pillar Two wholesale, that would still put in place an international system that looks an awful lot like the current one we have. GILTI would be effectively gone, but there would be a new tax on foreign profit in its place. BEAT would be gone, but they would enact the under-taxed profit rule, which bears some ancestral similarities. And a new domestic minimum top-up tax would be laid on top of the current corporate alternative minimum tax. (You can see why most find this unlikely to happen.)

Democrats have also vowed to repeal FDII, saving hundreds of billions of dollars currently going, in large part, to tech companies that have chosen to keep their valuable intellectual property in the U.S. In its place, the Biden Administration has promised to enact vague research & development incentives. This might be the biggest potential change, although how it would fit into the larger picture could be complicated.

If Republicans have the upper hand, their game plan would no doubt prioritize protecting GILTI, FDII, and the rest of the TCJA. Aside from ensuring that GILTI keeps its current 10.5% rate, they might make further taxpayer-friendly changes to it, allowing for net operating losses and foreign tax credit carryforwards. (Which some Democrats have proposed, and which could make it into a Democratic 2025 bill as well.)

In 2017, when Republican tax-writers prepared to enact a long-anticipated overhaul, American corporations held trillions of dollars offshore, allowed by the bizarre deferral feature of the pre-TCJA system. That was an enticing amount of revenue for both party’s policy agendas, and it ended up helping to pay for the TCJA’s slash in the U.S. corporate rate.

That money’s now gone. There still is income held offshore by U.S. companies, for various reasons, but the amount that the U.S. could grab for new initiatives is uncertain and probably small compared to what will be needed next year. There is some talk of using new international taxes (or “closing tax loopholes”) to fill those gaps, but Congress will likely find that the account is almost drawn.

That’s not to say that everyone, inside the U.S. and out, shouldn’t pay close attention to how Congress proceeds on this. (Yeah, it’s in my interest to say this–but seriously, they should!) It’s going to be an unpredictable year, and even slight changes could end up having massive consequences.

But like it or not, the TCJA’s international features have better-than-not odds of sticking around.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• It’s a bit outside our usual area of coverage, but important nonetheless: The Republican-controlled U.S. House of Representatives Committee on Ways and Means (the one that does the tax business) passed Tuesday a measure of disapproval of Biden Administration regulations which allow, the measure claims, Chinese government-affiliated individuals to benefit from electric vehicle credits enacted by the Inflation Reduction Act. This has been a key area of controversy in the IRA implementation, although the Biden Administration and Democratic defenders claim its safeguards are enough to prevent the Chinese government from benefiting, even indirectly. The tension between the IRA’s “Buy American” protections and its mandate to ramp up clean energy production as fast as possible–which means using materials from wherever they can get them–is a fascinating and important topic. This latest measure is under the Congressional Review Act, which allows Congress to knock down a regulation from the executive branch. Because the president has to sign a CRA resolution for it to go into effect, it’s only ever been used to rescind regulations passed by a prior administration after there’s a change in party at the White House. The window for a future President Trump to sign CRA measures on Biden Administration regulations is now open, so there will be plenty of these coming down the pike.
• The Republican Party’s 2024 platform has gotten some notice, even though party platforms typically have little to do with actual political agendas. For whatever reason, Trump has put a lot of effort into changing the document to reflect his priorities–probably mostly to put his stamp on the party. The recently amended platform includes promises to enact “baseline” tariffs on all foreign-produced goods, reflecting Trump’s promise to enact 10% tariffs on virtually everything coming into the U.S. Even if you believe this is unlikely to come to pass–expect retailers to vigorously oppose this, just as they did the DBCFT in 2017–it shows how much the GOP has turned away from the free trade principles that used to define its approach to globalization. With the Biden Administration also more protectionist than prior Democrats in office, this is an important sea change in how the U.S. approaches the world economically.
• I haven’t been including regular updates on countries’ implementation of Pillar Two, because there have just been too many. But this one seemed worth a mention–Australia’s Treasury announced last week that it was finally introducing legislation to implement the global minimum tax. They’re a bit late to the party, partly because of how difficult translating the OECD guidelines into local tax codes can be. The enthusiastic introduction from the Australian government is a reminder that while the policy is controversial in the U.S., many countries around the world view it as a political winner.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

This unnamed, Union Jack-wearing caped hero appeared on covers of "Weekender," beginning in 1945, but was never in the magazine--which only included reprints. From his costume and "V" on his belt, the Public Domain Super Heroes Database has dubbed him Jack Victory.

Contact the author at amparkerdc@gmail.com.