Congress is currently considering, at the last moment, a minimum corporate income tax to help pay part of the reconciliation bill. The name of the tax sounds trivial, but it would be a terribly complicated law that would have many unintended consequences that would slow down the economy and hurt workers.
What is that?
The plan would enact a minimum 15% tax on “adjusted financial statement income” of companies that report more than $ 1 billion in profits to shareholders. An abbreviated way of saying it is that it would apply to the âbook incomeâ of a business. Right now, businesses pay taxes on their taxable income. The Biden administration plans to raise $ 150 billion over 10 years.
Financial accounting of accounting income and tax accounting are two entirely different concepts, and they should not be confused. The purpose of financial accounting is for companies to report their profits and losses to investors in a uniform and standard manner. This way, investors can gauge a company’s outlook and compare it to other companies in its industry and across industries. Reports are fully public.
Companies prepare tax accounts for the express purpose of complying with tax law. Tax accounting is not concerned with profitability as is financial accounting. Instead, its sole purpose is to obtain the taxable income of a business. as defined by Congress. Tax returns are completely private (or at least they are meant to be).
What is the problem?
Combining financial accounting with our federal tax laws just doesn’t work like mixing apples and oranges. Mixing them together will not only result in an impractical framework, but will also set a dangerous precedent.
This is dangerous because it would cede congressional authority over part of the tax code to unelected officials from agencies that set the rules for financial accounting. Accounting standards are based on general âprinciplesâ defined by groups such as the Financial Industry Regulatory Authority (FINRA), the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) to name a few. a few. The leaders of these groups are not elected and are not accountable to voters. FINRA and FASB are independent non-governmental organizations. Yet the decisions they make on accounting standards would impact the tax code. The Constitution is clear that Congress makes tax law, outside agencies do not. To cede this power would be a dangerous precedent.
A tax policy that crosses financial and tax accounting would be impractical because it would be too complex for companies to comply with. Without further details on the policy, here are some complications that the accounting firm PwC identified, which could all turn out to be major:
Determine how and if a business qualifies for the tax.
Synchronization issues between the financial statement year and the tax year.
How to deal with the substantial differences between fiscal and accounting accounting, such as amortization of spectrum licenses.
Issues for companies that are not part of a consolidated group and complications of dividends received.
How to account for the income of controlled foreign companies, ignored entities and foreign tax credits.
The treatment of carryforwards and net operating losses.
The effect of mortgage management rights.
These are just a few of the potential problems. As PwC states, âthe proposal [book minimum tax] would add significantly to the complexity of corporate tax compliance and administration. As drafted, the provision introduces several new concepts and raises important questions as to their interpretation. ”
If Congress passes the tax, these problems and many more will arise.
No more problems
A tax on books is also likely to have very negative consequences, including for those who are not subject to the tax. A major difference between accounting income and taxable income is the accelerated expensing / depreciation of capital investments like machinery. Accelerated expense recognition / depreciation reduces the immediate after-tax cost of the investment. An accounting income tax would recoup this reduction for some companies, thus increasing the immediate cost of a capital investment.
To understand how it works, our friends at the Tax Foundation have provided this helpful Example : A company with $ 100 million in gross revenue and $ 65 million in operating expenses wants to acquire $ 30 million in new equipment that could be immediately expensed. Under current law, their taxable income in the first year is $ 5 million. But because according to accounting rules, equipment depreciates over 5 years, its taxable income under the tax on books is $ 29 million.
As a result, the company can spend less on acquiring new equipment. The supplier of this equipment ends up bearing part of the economic cost.
Besides being a dangerous and impractical policy, it is ludicrous that Congress is considering the idea at such a late date. He’s doing it because he needs income offsets for all spending from the reconciliation bill now that it’s clear there are no votes to raise taxes in any other way, like increase the corporate tax rate. These policies are dead because it is widely believed that the economic damage that would ensue would be immense. There will be countless unintended consequences if Congress rushed the minimum book tax into law that would come to light through a normal legislative process, with hearings and public participation. In this mad rush, none of this work has been done. Thus, the risks of major tax-related problems, in addition to those listed above, are greatly increased.
Congress has already ditched the minimum book tax route with the adjustment to reported untaxed corporate profits, or ROT (no kidding), which he adopted in 1986 and quickly repealed. This tax was similar to the one currently under consideration. It turned out to be impractical, which is why Congress repealed it.
Rather than taking this same futile route again, Congress should eliminate the minimum tax on books altogether now. If it continues, it will be responsible for countless headaches to come.
About the Author
Senior Economist, United States Chamber of Commerce
Curtis Dubay is Senior Economist, Economic Policy Division at the United States Chamber of Commerce. He directs the House’s research on the US and global economies.