These loopholes are bad policy even in the best of circumstances, but it would be unconscionable to allow them to continue if we can use revenue from closing them to avoid the devastating effect sequestration would have on national security, homeland defense, law enforcement, public safety, education and other important priorities
Amid last week's face-off between the White House and Congress over sequestration, Senators Carl Levin (D-MI) and Sheldon Whitehouse (D-RI) introduced the Cut Unjustified Tax Loopholes Act
, also known as the CUT Loopholes Act, or S. 268. The bill is aimed at curbing offshore tax abuses and strengthening tax enforcement, but also seeks to end excessive corporate tax deductions for stock options, close the blended tax rate loophole for derivatives, and end the carried interest loophole. These provisions are popular among American voters, but are sure to raise some eyebrows on Wall Street and in US board rooms.
The bill contains over a dozen provisions to expose offshore tax abuses and close offshore tax loopholes, including measures to:
- penalize offshore financial institutions and jurisdictions that impede U.S. tax enforcement;
- defer tax deductions for U.S. corporations moving jobs and operations offshore until the corporation repatriates the offshore profits from those operations and pays taxes on them;
- end transfer pricing abuses by taxing immediately excess income to foreign affiliates receiving U.S. intellectual property, limiting income shifting through U.S. property transfers offshore, and tightening the rules related to the valuation of “goodwill” and other intangibles;
- prevent corporations that renounce their U.S. residency despite their U.S. origins and operations from “earnings stripping” to avoid U.S. taxes;
- v. require foreign tax credits to be calculated on a pooled basis to stop the manipulation of those tax credits to dodge U.S. taxes;
- shift the burden of proof on establishing who controls an offshore entity;
- stop corporations managed and controlled in the United States from claiming foreign status;
- treat derivative payments made from the United States to offshore recipients as U.S. income;
- end vanishing companies by stopping “check-the-box” for foreign entities and “CFC look-through;”
- end loophole that allows corporations to avoid paying taxes on repatriated income by treating it as a loan; and
- require multinationals to disclose their employees, revenues, and tax payments on a country-by-country basis.
The bill also includes changes to the tax code that are sure to raise the hackles of many in the US corporate and financial sectors.
Taxation of Stock Options
Under the current tax code, corporations may claim a bigger deductions on their tax returns for stock options awarded to executives employees than the corresponding expense on their corporate books. Under this approach profitable corporations can report higher earnings to shareholders, while using the stock option deduction to reduce or eliminate those earnings on their tax returns and pay little or no taxes. The CUT Loopholes Act would ensure that:
- corporations take stock option tax deductions at the time, and in an amount not greater than, the stock option expenses shown on their books; and
- stock options compensation is subject to the same tax deductibility cap as other forms of compensation (at $1 million per executive).
Elimination of Blended Rates for Derivatives
The bill would end the blended rate for derivatives. Since 1981, profits from certain derivatives—including commodity futures— have benefited from a more favorable “blended tax rate.” Specifically, a short term capital gain from these derivatives is taxed, not at the short term capital gains rate, but at a rate which is 60% long term capital gains and 40% short term capital gains, even if the derivatives are held for seconds. Normally, investments have to be held for at least 1 year to get preferential long term capital gains tax treatment.
This so called blended rate loophole under the current tax code lowers the taxes on these derivatives by about 10%, which encourages commodity speculation (and high frequency trading) compared to investments in stocks, bonds, and other financial instruments subject to normal capital gains rules.
Elimination of the Carried Interest Tax Break
The bill also contains provisions that would end the carried interest tax break. If enacted, the bill would require that investment managers, such as hedge fund managers and venture capital firm partners, would pay ordinary income rates on all of their income from providing management services.