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House Republicans are seeking to remedy part of their tax reform plan that could result in higher taxes for many family farmers and other small businesses.
The potential change would allow small businesses to deduct net interest expense, a measure the House GOP tax plan would eliminate in exchange for the ability to immediately write off equipment purchases.
As it stands, many small businesses don’t need an overhaul of the tax code to be able to deduct the cost of machinery or software. Companies that buy less than $2 million worth of equipment in 2017 can fully deduct the first $500,000 under tax code Section 179.
“We don’t want to allow for much interest deductibility because it causes problems throughout the system,” House Ways and Means Committee member Devin Nunes (R-Calif.) told Bloomberg BNA. “There could be some low threshold amounts that are de minimis.”
But some Republicans on the Ways and Means Committee are looking for a way to save the tax benefits these companies already have without siphoning away too much revenue needed to cut business and individual tax rates. The House GOP plan would cut the corporate rate from 35 percent to 20 percent and the passthrough rate from a top rate of 39.6 percent to 25 percent.
The Republicans on the committee have mostly come to an agreement that there will be some sort of small business exception. They have decided there will be a carveout that mirrors Section 179 for land and small businesses, according to a former Hill staffer.
The details on how it will be structured or how large to make it have yet to be decided, Rep. Tom Rice (R-S.C.) said.
From a policy perspective, a small business exception makes sense, said Alan Cole, an economist at the right-leaning Tax Foundation, and Joseph Rosenberg, a senior research associate at the left-leaning Urban-Brookings Tax Policy Center.
“There are certain tax preferences that are probably undeservedly targeted toward small businesses, but the case here is that they would be worse off compared to where they are now,” Rosenberg said.
Small businesses don’t have access to equity markets, so they need debt financing to expand, Cole said. The House Republican plan seeks to take away the tax incentives for companies to rely on borrowing, but small businesses borrow out of a genuine need, he said.
The American Farm Bureau Federation is one of the loudest voices pushing for an exception in an overhaul of the tax code. About 95 percent of farm sector debt in 2015 was held by banks, life insurance companies and government agencies, meaning that losing the interest deduction would harm their liquidity and make it difficult to purchase land and production inputs, the group said.
The group is scheduled to testify at an April 5 House Agriculture Committee hearing on the need for an exception.
Sticking points could arise as the committee hashes out the details of the exemption and gets feedback from the Joint Committee on Taxation about how much revenue it would lose. Some committee Republicans are seeking a carveout that would go beyond Section 179-eligible companies and could be tailored to certain industries.
Rice said he is pushing for a “generous” exemption. Rep. Vern Buchanan (R-Fla.) is asking the committee to look into expanding the exemption for businesses—such as a tractor dealer—that have a lot of inventory paid for with loans or for startups that rely on capital from banks.
“There’s more work to be done,” Buchanan said.
“Not allowing interest deductibility could hurt valuations for small businesses,” said Randy Schwartzman, the Northeast Tax Regional managing partner at BDO USA LLP. Businesses are valued by looking at their future earning potential after taxes, so disallowing interest deductibility would hurt their cash flow and cause their valuation to decrease, he said.
Providing exceptions for certain industries or loans below a certain amount is likely to generate lots of lobbying activity as lobbyists push for the most favorable terms possible for their clients.
“We recognize that we are making fundamental changes with tax reform,” Rep. Tom Reed (R-N.Y.) said. “When you look at interest deductibility and what we put out in the blueprint, there are legitimate concerns with that.”
The committee is pondering how to configure transition rules to debt-intensive industries, such as utilities, Reed said. Private equity is another sector that has pushed for special considerations if the tax system were to shift.
“We are working on figuring out an exception for small businesses and farmers,” a House GOP aide said. “Large companies in the M&A space will need some sort of transition rules for existing debt. New debt and timing issues are all at play in the transition rules.”
Providing exemptions would further complicate the tax code, rather than simplify it, and runs counter to the stated goals of pro-growth tax reform, a spokesman for the Businesses United for Interest and Loan Deductibility (BUILD) Coalition, which lobbies to keep interest deductibility as part of the tax code, told Bloomberg BNA.
“If a small business exemption gets you to the preferred policy to hold those folks harmless to what they currently have, that’s just the cost of getting the legislation through,” Rosenberg said. “I guess at some point you have to draw the line or things start to unravel.”
Doubts have been cast on the House Republican plan to shift away from a corporate income tax system and toward a destination-based cash flow tax as opposition from the Senate and splinters within the Republican Party have become clearer. This new framework more closely mimics a value-added tax with border adjustments that taxes imports but not exports.
Many trade specialists have questioned whether the plan as written would comply with World Trade Organization rules. The main sticking point is that the plan allows for companies to deduct wages, something trading partners could view as a subsidy. But other carveouts, such as allowing some interest deductibility, could also create problems for the system on the international stage.
“Each time you eliminate one proposed feature of the features of the blueprint tax plan and move it toward the U.S. corporate income tax, the harder the case will be at the WTO,” Cole said.
To contact the reporter on this story: Laura Davison in Washington at lDavison@bna.com
To contact the editor responsible for this story: Meg Shreve at firstname.lastname@example.org
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