With the inauguration of President Donald Trump and Republicans in control of the House of Representatives and the Senate, it is likely that a combination of Trump's campaign tax proposals and House Republicans' tax proposals will come together in a legislative package in 2017. Consequently, many tax professionals are eager to learn how the expected tax reform package will affect their own taxes and those of their clients.
At the top of the list of tax reform proposals is a substantial reduction in corporate tax rates and a reduction in the individual tax rates applied to business income from flowthrough entities. Another anticipated reform concerns the business tax structure. In addition to lowering business tax rates, other anticipated changes include the repeal of the corporate and individual alternative minimum taxes and the elimination of many business tax expenditures.
A common tactic used in tax reform to offset revenue lost from tax rate reductions is to broaden the tax base by eliminating certain "special interest" tax breaks. This means there are, inevitably, winners and losers as credits and incentives that benefit certain industries are reduced or eliminated. Following is a discussion of several popular tax credits and incentives and their potential future in light of the latest tax reform proposals.
Sec. 41: Research and development tax credit
The research and development (R&D) tax credit is a federal incentive that encourages businesses to invest in technological innovation for products or processes developed within the United States. Businesses engaged in qualified research activities can use the credit to offset their regular federal tax liability, as well as state tax liabilities if the qualified research is performed within states that offer similar incentives. Currently, 38 states offer research credits, many of which are similar to the federal R&D tax credit.
While Trump and many Republicans in Congress favor reducing corporate tax expenditures, the R&D tax credit is one provision that does not seem to be in danger of elimination. Both Trump and House Republicans have stated that they would maintain the R&D tax credit.
With a Republican administration in place, many believe the R&D tax credit may be in line for expansion or improved efficiencies. Enhancements to the credit may include:
- Increasing the alternative simplified credit rate from 14%;
- Increasing the qualified research percentage of contract research expenses from 65% to correspond to the reduction in the corporate tax rate;
- Increasing the general business credit limitation to enable an offset against the full regular tax liability instead of the current excess of regular tax over tentative minimum tax for businesses with average gross receipts of $50 million or more for the prior three years; and
- Other potential changes to reduce IRS controversy and improve administration of the R&D tax credit.
Sec. 199: Domestic production activities deduction
The Sec. 199 domestic production activities deduction (DPAD) is a federal incentive established by the American Jobs Creation Act of 2004, P.L. 108-357. The deduction is offered to certain businesses engaged in the following domestic activities:
- The lease, rental, license, sale, exchange, or disposition of:
• Products manufactured, produced, grown, or extracted by the taxpayer within the United States;
• Qualified film productions; or
• Electricity, natural gas, or potable water produced by the taxpayer within the United States;
- The construction of real property in the United States; or
- Engineering or architectural services related to the construction of real property.
As outlined in House Republicans' "Better Way" blueprint, Congress is expected to take the position that "the domestic production ('section 199') deduction would no longer be necessary" (A Better Way: Our Vision for a Confident America, Tax, June 24, 2016, p. 27). The move away from the Sec. 199 deduction would be for simplicity, as the deduction calculation is often complex and a frequent issue in IRS examinations. The blueprint also notes that the effective tax incentive from the deduction would be included in the lowered corporate tax rates.
While the elimination of the Sec. 199 deduction would remove a major incentive for corporations to manufacture domestically, the expectation is that a reduced overall corporate tax rate would encourage increased production. All other things being equal, manufacturers may receive less of an overall benefit from tax reform than other industries because they would lose a deduction that could be as much as 9% of taxable income.
Alternative fuel tax credits
The federal fuel tax applies to the sale or importation of gasoline (other than for aviation), diesel, kerosene, and special fuels into the United States. The applicable tax rates per gallon of fuel currently range from $0.0925 to $0.244.
Until Dec. 31, 2016, Sec. 6426 allowed tax credits for the sale or use of certain alternative fuels, including:
- $1.00 per gallon for biodiesel mixtures used in a motor vehicle;
- $0.50 per gallon for alternative fuels (e.g., liquefied petroleum gas, liquefied natural gas, compressed natural gas, liquefied fuel derived from biomass) used in a motor vehicle; and
- $0.50 per gallon for alternative fuel mixtures (mixture of alternative fuel with gasoline, diesel, or kerosene) used in a trade or business.
The biodiesel mixture and alternative fuel credits were refundable in that the excess of the credit over the amount of excise tax paid could be claimed as an additional refund payment under Sec. 6427. Alternatively, taxpayers could claim the excess credit as an income tax credit under Sec. 34. The alternative fuel mixture credit was limited to the excise tax paid.
All of these fuel tax credits expired for periods after Dec. 31, 2016. The Republican-controlled Congress did not act on an extenders package in the lame-duck session, preferring to address expired tax expenditures as part of overall tax reform. Although nothing specific has been mentioned in tax reform discussions, Trump's support of the fossil fuel industry seems to indicate that tax credits for alternative fuels could fall by the wayside in tax reform legislation.
Renewable energy credits
Many changes are expected regarding emission levels and green initiatives as a result of the election. While there are many advocates for a nationwide tax on the emission of greenhouse gases, they are likely to face opposition from a Republican Congress and EPA Administrator Scott Pruitt.
The Trump administration will likely make significant changes to tax incentives for the production of energy within the United States. As mentioned above, the reforms are expected to trend toward reduced tax expenditures. The renewable electricity production tax credit (PTC) for wind energy was extended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113, and is being phased out by incremental credit rate reductions through 2019. Similarly, the energy investment tax credit (ITC) for solar energy is undergoing an incremental credit rate reduction from 30% through 2019 to 22% after 2021. The PTC and ITC for all other types of renewable energy expired for any projects where construction began after 2016, including hydropower, biomass, and geothermal. It appears unlikely that any of these expired energy credits will be reinstated under tax reform.
As a result of the 2016 elections, tax professionals and taxpayers should expect significant changes to the current tax system. The modifications to both the individual and corporate tax rates would affect many aspects of financial and tax planning. Businesses performing the above-mentioned activities are also likely to be affected by the elimination of various credits and incentives and the expansion of others.
Mindy Tyson Weber is a senior director, Washington National Tax for RSM US LLP. Trina Pinneau is a manager, Washington National Tax for RSM US LLP.
Unless otherwise noted, contributors are members of or associated with RSM US LLP.