Hopping On the Tax Reform Train

Many businesses in Illinois are looking forward to a friendlier tax environment. By Robert J. Derocher | Spring 2018



While many businesses in Illinois and across the nation say they’re looking forward to a friendlier tax environment, there’s plenty of cautionary flags among them.

The corporate crusade for competitive U.S. tax rates has gone on for nearly a century— so long, in fact, you could almost forgive corporate America for missing the tax reform train that whistled through Congress earlier this year, says Illinois CPA Society member and University of Illinois College of Law professor Richard Kaplan.

“The bill’s total gestation period was 10 days: They held no hearings and they had no expert analysis about what to do with pass-through entities,” Kaplan says. “Is this any way to run a railroad? The answer is no, but that train was moving. This is almost like the dog who caught the car: ‘Now what?’”

In fact, tax reform legislation was moving so quickly that Kaplan and other tax and business observers believe it will take several months or more to sort out all the implications of a bill that still had handwriting in the margins as lawmakers prepared to vote on it.

And while many businesses in Illinois and across the nation say they’re looking forward to a friendlier tax environment, there’s plenty of cautionary flags among them. After all, there’s still much to make sense of when accounting for a lower corporate tax rate and incentives for repatriating offshore profits and making advantageous business restructurings and capital investments.

ONE-WAY TICKET?

Launched in 1909 at 1 percent, the U.S. corporate tax rate raced as high as 52 percent in the early 1970s before leveling off at 35 percent in the 1990s. As one of the highest corporate tax rates in the world, it became the scapegoat for U.S. corporations looking for blame for stunted corporate growth. It’s also the reason why they’ve increasingly sought strategies for avoiding and deferring taxes — often by stashing trillions of dollars of profits in tax-friendlier nations.

But perhaps this is about to change. Known as the Tax Cuts and Jobs Act of 2017, the legislation slashing the U.S. corporate tax rate to 21 percent is being hailed in many corporate corners as a necessity for global competitiveness.

“People don’t realize how broken our corporate tax system was compared to the rest of the world,” says Rich Trapchak, corporate controller of Reynolds Group Holdings Limited in Lake Forest, Ill. “This change has really leveled us with the rest of the world and should drive more activity in the U.S.”

Indeed, every large U.S. corporation that generates vast amounts of foreign revenue, like Illinois’ Boeing, G.D. Searle, John Deere, and Navistar, has a lot to consider when weighing the reformed international provisions aimed at enticing corporations to repatriate offshore profits and earnings at the lower tax rate — a linchpin of the Tax Cuts and Jobs Act endorsed heavily by President Trump and congressional backers.

“Multinational companies now need to determine if international operations should be brought back to the U.S. Companies with offshore intellectual property must consider whether that IP is still best sourced to its current location,” explains Illinois CPA Society member Mark Wolfgram, CPA, senior tax manager for Bel Brands USA in Chicago. “Tax reform allows this to be an option, but will businesses take advantage of this opportunity?”

Another big question is whether the countries that have been home to so much corporate cash are going to idly sit by while the U.S. seeks to stimulate corporate expansion, hiring, wage increases, and economic growth by drawing that cash out of their economies. “You have to wonder if countries like Mexico are going to respond with new tax policies because they’re afraid that they’re going to lose revenue,” says Trapchak’s Reynolds colleague, Vice President of Tax Paul Moles. “The global tax landscape is very competitive. No tax jurisdiction wants to be the highest taxing jurisdiction.”

MULTIPLE TRACKS

Which ways companies travel in navigating tax reform for their competitive advantage remains to be seen, but the general feeling from the get-go is that, while tax reform was passed to make the U.S. tax code more pro-business, it was a missed opportunity for simplifying the tax code for corporations. In fact, some of the changes associated with the new tax law have only made tax planning more hectic in the early goings.

At Reynolds, an $11 billion packaging company that makes everything from aluminum foil and trash bags to Starbucks cups and bottle caps, Moles says tax planning has always been a complex process, and following tax reform, it remains a “monumental task” and “administrative burden” to compute and report its taxes to the IRS.

What’s more, corporate finance departments need to be more mindful than ever of their tax planning and reporting processes if they want to take immediate advantage of what tax reform entails.

Wolfgram points out that it has been an all-out rush for corporate tax planners to figure out how to capitalize on one-time tax savings moves, like accelerating deductions and expensing capital assets for the 2017 tax year, while deferring income to the 2018 tax year.

To illustrate, Wolfgram says a corporation that accrued a year-end $10,000 bonus would typically pay that bonus on April 15, 2018, and then take the deduction for that bonus on its 2018 return. But if the corporation paid the bonus on March 15 and moved the deduction to 2017, it would reduce its 2017 tax bill on the bonus by $3,500 (35 percent) compared to only $2,100 (21 percent) in 2018.

“Paying the bonus 30 days earlier netted the corporation a $1,400 permanent tax savings. That may not sound like much,” Wolfgram says, “but add a few zeroes to the simple example: At $1 million, this is a $140,000 benefit; at $10 million, this is a $1.4 million benefit.”

Mark Denzler, vice president and COO of the Illinois Manufacturers Association in Springfield, points out that even the potential long-term benefits of the new tax law are stirring up immediate — and positive — reactions.

“The manufacturing sector is often the canary in the coal mine, and manufacturers are optimistic about what’s happening nationally and globally,” Denzler says, noting that he’s hearing of more companies planning expansions or acquisitions on the heels of tax reform.

What Denzler is hearing in Illinois also has merit nationally. According to a National Association of Manufacturers quarterly outlook survey conducted just after the new tax law was signed, more than 94 percent of manufacturers reported a positive outlook, up from 64 percent a year earlier.

One boon to U.S. manufacturers is a new provision allowing the full expensing of new and used property and equipment, which will help them invest in their facilities. “If companies are inclined to go on an equipment-buying spree, they can do that. With this provision, they can reduce their taxable income to a point that the change in the tax rate is an afterthought,” Kaplan says. “If John Deere wants to buy more manufacturing equipment to make more of their tractors, now might be the time to do that. Maybe they can even zero out their taxable income.”

It’s not just the large corporations that have different accounting and tax tracks to consider in the wake of tax reform. Smaller companies need to consider the implications of changing their corporate structures based on new, potentially lower tax rates for C Corporations versus so-called passthrough entities and other business formations.

“This is the new kid on the block that everyone is having to figure out,” Kaplan says.

CURVE AHEAD

In fact, “figuring it out” is becoming a familiar phrase when it comes to tax planning thanks to the whirlwind move to pass tax legislation before the end of 2017 — just ahead of the 2017 tax filing season.

“It was mildly reckless in terms of how tax reform was legislated, but that’s not up to the IRS. Now they have to administer what was enacted,” Kaplan says.

“This is going to be a transitional year in the tax world,” Trapchak states. “You can pretty much expect a ton of interpretative guidance and clarifying memos to come from the IRS, and that’s going to take some time.”

Once the IRS starts issuing guidance, Wolfgram predicts some of the biggest questions will then turn back to the businesses themselves. “For many large businesses, the availability of cash was not an issue before, so some people are skeptical that any tax savings will trickle down to employees and/or new investments,” he says. “Others will argue that tax reform makes U.S. business operations more enticing for the money that was on the sidelines. If you’re a smaller business, perhaps this is the economic trigger you’ve been waiting for to make a new investment in plants, machinery, and/or employees.”

Moles also questions just how much some companies will have at their disposal for potential economy boosting activities, such as business expansions, stock buybacks, greater shareholder dividends, and bonuses and higher wages for employees.

And never mind the uncertainty brought about by a rollicking stock market, a learning-on-the-job IRS, or a new tax world order. One of the biggest wildcards, the one underpinning the American economy, is the average American taxpayer. Just how much they benefit from tax reform, and what they do with any extra income, will be closely watched in the months and years ahead.

The common train of thought is “when consumers have more money in their take-home pay, they’re going to spend more and that stimulates the economy,” Denzler notes.

In fact, with an estimated 75 percent of the U.S. economy being consumer based, “how consumers feel is going to be huge,” Kaplan adds. “What people are going to be looking for is, literally, ‘What’s in my paycheck?’ This is a fascinating national experiment.”