Thursday, May 5, 2011

Another Stinker: New Corporate Tax Proposal Lurks in Halls of Congress

Legislative analysts are buzzing about a new corporate tax proposal coming soon to a Congress near you. The proposal will center around the taxation of "pass-through" entities (like S corporations) that have revenues of more than $50 million.

It involves reducing the corporate tax rate to 28% (the median corporate effective tax rate for companies in the "Russell 3000" was around 32% last year) and eliminating certain deductions (i.e., reducing the rate and broadening the base much in the way the state of Texas did with the so-called "margin" tax). This proposal would presumably be extended to MLPs and LLCs.

The eliminations or changes would include: (i) modification of accelerated depreciation, (ii) elimination of the domestic production deduction, (iii) taxing foreign earnings on a current basis, and (iv) other Obama Budget proposals.

Who would be most adversely affected by the proposal if it becomes law? Low cash and low effective tax rate companies, which will actually see an increase in their taxes due to a loss of available deductions. According to Standard & Poor's and Bloomberg, the energy sector had an overall cash tax rate of 12% and an effective tax rate of 32% last year. This places energy companies within the "middle" of this scenario. However, the possible impact on cash flow and funding could be significant on an indirect basis even for non-pass through companies since many funding sources are pass-throughs.

On the surface, lowering tax rates seems like a good idea. However, it is the elimination of deductions which will make life difficult for many companies, especially those in capital intensive businesses.

The U.S. combined corporate tax rate is over 39%, making it the second highest in the world (second only to Japan)! We must go much further than lukewarm tax reduction! This is the reason literally billions remain unrepatriated outside the U.S. (it seems the new proposal might contain a repatriation holiday but this is just a patch on a broken system).

When are the folks in Washington going to learn that U.S. companies cannot continue to remain competitive with such high rates?

Energy companies desperately need their cash to reinvest in new technology, exploration and rising costs. When combined with the impact on prices due to restrictions on domestic production, Congress is simply restricting the growth of domestic energy jobs and forcing Americans to pay more for their energy. Even if not directly impacted by the proposal, the indirect impact will be felt by many companies through funding sources and increases in the cost of many services.

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