Handicapping Potential Effective Dates for Tax Reform Based on Historical Precedent
By Stuart E. Leblang, Michael J. Kliegman, and Amy S. Elliott
The stars are partially aligned for meaningful individual and business tax reform within the next 12 months with reform-motivated Republicans controlling both houses of Congress and the executive branch. Despite these positive conditions, meaningful tax reform remains uncertain given the fact that most fundamental reform creates winners and losers, and the many significant losers are highly motivated to suppress change.
Significant other challenges to fundamental reform exist including the fact that certain important Republicans believe that meaningful tax reform will only endure and stand the test of time if it is legislated on a bipartisan basis, which would be extremely difficult in the current polarized environment. A partisan approach utilizing the budget reconciliation process is the likely default for advancing tax reform, but utilizing budget reconciliation creates significant budgetary constraints and diminishes enthusiasm for radical reform ideas.
In addition, there remains significant disagreement among Republicans regarding the appropriate level of fiscal constraint necessary as part of the tax reform process and how to advance tax reform on a revenue neutral basis. Business opposition to any reform is generally tied to bottom-line impact, as fiscal frugality usually correlates to a loss of lucrative tax breaks with direct impact on whether a business entity is a winner or loser under tax reform.
Although currently there are unique forces in favor of tax reform, significant challenges mean that reform is not at all certain and final enactment by year’s end is quite speculative. While the chances for comprehensive tax reform may be better now than they’ve been in decades, they’re still relatively low. Our most optimistic handicap is just under 50 percent over the next 12 months.
If comprehensive tax reform stalls, the president and Congress could try to pass a smaller reform package with some meaningful corporate tax rate reductions coupled with a mild broadening of the corporate tax base. One factor that would propel this form of tax reform lite is the keen desire for Congress, the president and certain elements of the business community to enact tax changes that would induce U.S. multinationals to repatriate cash trapped in their non-U.S. subsidiaries. Of course the utilization of such repatriation revenues for corporate rate reductions or for an enhanced infrastructure spending program will be a policy point of significant contention.
While the substantive tax policy changes are of obvious critical importance, so are the issues of effective dates and transition rules. Effective dates and transition rules are provided on an ad hoc basis as a matter of legislative grace, but they could have a material impact on whether a taxpayer ultimately wins or loses under tax reform.
In general, tax changes are legislated on a prospective basis and are made retroactive only in cases of abuse or when beneficial tax changes are enacted close to the start of a calendar year.
House Speaker Paul D. Ryan, R-Wis., has indicated that the primary work on tax reform cannot occur until the spring. Based on this timetable, it is unlikely that a tax bill could be enacted before August 2017 at the earliest. If Congress remains focused on pursuing comprehensive tax reform that overhauls major individual tax provisions as well as significant U.S. corporate tax rules (such as the cash flow tax approach described in the House Republican Blueprint), an August enactment would be very optimistic given the amount of work that would be necessary to pass an administrable change in the law, including complicated transition rules, in both the House and the Senate, including a conference report to be ready for transmission to the President.
Whether in August or by year’s end, effective dates and transition rules will be very important to the tax reform process. To assist analysis and expectations in this regard, we have summarized the enactment dates and effective dates of major tax legislation dating back to 1980. Based on historical precedents, budget considerations and issues associated with tax administrability, we offer the following observations:
- The effective dates and transition rules for specific tax reform provisions will be decided de novo by the current Congress and its tax committees. Precedents and determinations by prior Congresses are in no way binding on the current Congress or tax committees.
- Favorable corporate tax rate changes associated with fundamental tax reform not enacted until August would likely be implemented prospectively starting in 2018, and those changes might be phased in over a number of years. This would also likely apply to taxes on imports associated with a border adjustment mechanism.
- Several caveats to the previous point. The first is that a retroactive change in rates (even if associated with fundamental tax reform) would become more likely if we happened to experience a recession over the next 6 months and tax reform became part of a broader economic stimulus plan. There is also a greater chance that provisions impacting a sale or purchase of specific types of assets (as opposed to a broader change in tax rates) could have retroactive effect to the date the provisions were first proposed in a bill or reported out of committee.
- Retroactive rate reductions would also be more likely if the effort to effect fundamental change is abandoned, and a simpler bill involving rate reductions and mild base broadening is enacted. Even in this context, it would be unusual to have a retroactive rate reduction if enactment is delayed until August or the fall. The chance of a retroactive rate reduction back to January 1, 2017, would increase if tax reform is enacted earlier than August or is part of a stimulus package.
- Significant base broadening provisions in either fundamental tax reform or a lighter tax bill would likely be phased in over several years and are usually accompanied by beneficial transition rules.
- Specified anti-abuse rules are sometimes timed to go into effect as of the first public notice of the change (either when the bill was first announced[1]or when the bill was first voted on by the House Ways and Means Committee, which has primary jurisdiction due to a rule that tax bills should originate in the House.)[2]Even so transition relief is generally provided for binding contracts.
- House Republicans are working to repeal all Affordable Care Act taxes, including the 3.8 percent net investment income tax, retroactive back to Jan. 1, 2017. Our best estimate is that such a repeal is highly likely,[3]which would make achieving revenue neutral tax reform somewhat easier. However as previous ACA repeal bills would have prospectively repealed the related taxes, that’s also a possibility.
- No matter its effective date, a tax law change can have immediate financial reporting consequences. For example, if a corporate rate cut was enacted on day 1, but does not go into effect until day 500, companies would have to take a hit on their earnings statements for the reduced value of their deferred tax assets (e.g., net operating losses) for the current quarter not the quarter in which the change goes into effect.[4]
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ATRA extended expiring tax provisions and provided a short-term delay of the sequester budget cuts with Congress punting on an increase to the debt limit and other fundamental fiscal sustainability concerns. Individual changes: Raised taxes retroactively (by 2 days) • Created a new top rate of 39.6% (not 35%) on incomes over $450k (joint), effective for tax years beginning after 2012. • Created a new top capital gains of 20% (not 15%) on incomes over $450k (joint), effective for tax years after 2012. • Made the AMT patch, which had expired, permanent retroactively (for tax years beginning after 2011). • Extended 2012 marginal rates on incomes below $450k (joint), effective for tax years beginning after 2012. • Inflation adjusted the dollar amounts in the tax brackets, effective for tax years beginning after 2013. • Reinstated personal exemption phase-out on income over $300k (joint), effective for tax years beginning after 2012. • Increased top estate tax rate from 35% to 40%, effective for individuals dying after 2012. Business changes: Lowered taxes retroactively • Extended (retroactively for 2012 and prospectively for 2013) many traditional extenders that had expired. • Extended bonus depreciation for property acquired and placed in service before Jan. 1, 2014. |
Passed House: |
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Patient Protection and Affordable Care Act (PPACA) of 2010 (P.L. 111-148) |
Became law: March 23, 2010 |
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PPACA is also referred to as the Affordable Care Act (ACA) or Obamacare. Portions of it were amended seven days later by the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152). Individual changes: Raised taxes prospectively • Added 3.8% net investment income (NII) tax, effective for tax years beginning after 2012. • Added the individual mandate, a ($95 or 1% initially) payment for failing to maintain health coverage effective in 2014. Business changes: Raised taxes prospectively • Added the employer mandate, a payment ($2,000/employee) for failing to provide coverage, effective in 2014. • Added 40% excise tax on high-cost employer-sponsored “Cadillac” health insurance plans, effective starting in 2018. • Added 2.3% excise tax on medical devices, effective starting in 2013. • Added 10% excise tax on indoor tanning services, effective July 1, 2010. |
Passed House: |
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Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312) |
Became law: Dec. 17, 2010 |
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The Act, sometimes called the Middle Class Tax Relief Act of 2010, contained a 2-year extension of the 2001 and 2003 Bush tax cuts for all brackets plus extensions of various economic stimulus measures and a payroll tax cut for employees. Individual changes: Lowered taxes retroactively • Extended estate tax exemption of $7 million (joint) and top rate of 35%, effective for individuals dying after 2009. • Extended for 2 years the reduced rates and the itemized deduction/personal exemption phase-out lifting, starting in 2011. • Extended for 2 years refundable child tax credit, starting in 2011. • Reduced temporarily the employee payroll tax by 2 percentage points for 2011, designed as a fiscal stimulus measure.[5] Business changes: Lowered taxes retroactively (but see*) • Provided 100% expensing for certain property placed in service after Sept. 8, 2010, *the date President Obama made a speech in Cleveland, Ohio, proposing that “businesses should be allowed to write off all the investment they do in 2011.”[6] • Extended through 2011 the 1603 renewable energy grant program for solar and wind. |
Passed House: |
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American Recovery and Reinvestment Act (ARRA) of 2009 (P.L. 111-5) |
Became law: Feb. 17, 2009 |
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ARRA contained nearly $300 billion in tax cuts, the centerpiece of which was the making Work Pay Tax Credit, designed to help individuals and businesses during the financial crisis. Individual changes: Lowered taxes retroactively • Provided a refundable Making Work Pay tax credit of $800 (joint) in 2009 and 2010, also designed as a fiscal stimulus measure. Business changes: Lowered taxes retroactively (but see*) • Extended the net operating loss carryback period from 2 to 5 years for 2008 and 2009. • Increased the limitation on new markets tax credit investments for 2008 and 2009. • Made Notice 2008-83 inapplicable effective as of January 17, 2009 (*a Ways and Means press release announcing the proposed repeal of the notice as part of the larger economic recovery legislation was issued on January 16, 2009, although the release said the bill would repeal the notice prospectively).[7] |
Passed House: |
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American Jobs Creation Act (AJCA) of 2004 (P.L. 108-357) |
Became law: Oct. 22, 2004 |
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Among other things, AJCA replaced export subsidies that violated international trade rules with a new deduction aimed at U.S. manufacturers while limiting the tax benefits of some corporate inversions retroactively by more than a year. Business changes: Lowered taxes prospectively (but see*) • Gradually repealed the foreign sales corporation (FSC) extraterritorial income (ETI) regime, which was found to violate World Trade Organization rules, allowing businesses to claim 80% FSC/ETI benefit in 2005 and 60% in 2006. • Added the section 199 domestic production activities deduction, starting at 3% in 2005, then 6% in 2007, and 9% in 2010. • Extended higher $100k threshold for small business expensing through 2007, instead of reverting to $25k. • Increased the number of shareholders permitted in an S corporation from 75 to 100, effective for tax years after 2004. • Enacted rules limiting the tax benefits of corporate inversions completed in tax years ending after March 4, 2003, *the date of the first Ways and Means Committee hearing, grandfathering inversions that were substantially completed before then. |
Passed House: |
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Jobs and Growth Tax Relief and Reconciliation Act (JGTRRA) of 2003 (P.L. 108-27) |
Became law: May 28, 2003 |
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Also called the 2003 Bush tax cuts, JGTRRA accelerated the rate reductions set forth in EGTRRA (below). Individual changes: Lowered taxes retroactively (but see*) • Reduced the top rate on capital gains to 15% (from 20%) for taxable years after May 6, 2003, (*the Ways and Means mark-up and vote occurred May 6, 2003) with transition rules for taxable years that span May 6, 2003. • Accelerated rate reductions scheduled for 2004 and 2006 to apply in 2003 (27% down to 25%, 30% down to 28%, 35% down to 33%, and 38.6% down to 35%). Business changes: Lowered taxes retroactively • Increased bonus depreciation deduction from 30% to 50% for property placed in service after May 5, 2003. • Required corporations to pay only a portion of their third quarter (Sept. 2003) estimated taxes so that the balance due Oct. 1, 2003, falls in the government’s next fiscal year (a gimmick allowing lawmakers to satisfy revenue neutrality requirements during the budget window). |
Passed House: |
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Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 (P.L. 107-16) |
Became law: June 7, 2001 |
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Also called the 2001 Bush tax cuts, EGTRRA reduced individual tax rates but the reductions expired within the 10-year budget window. The cuts are believed to have alleviated the subsequent recession, reducing the need for more stimulus.[8] Individual changes: Lowered taxes retroactively • Reduced the top tax rates (39.6%, 36%, 31%, 28%) by half a percentage point in 2001 and a full point in 2002 and 2003. • Created a new, lowest tax bracket at 10%, effective for tax years beginning in 2001. • Provided marriage penalty relief, effective for tax years beginning in 2005. • Increased over time the child tax credit from $500 in 2001 to $1,000 in 2010. • Repeals the estate tax in 2010 and reduces it for individuals dying after 2002 and before 2010. |
Passed House: |
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Community Renewal Tax Relief Act of 2000 |
Became law: Dec. 21, 2000 |
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This Act provided incentives for businesses to revitalize distressed neighborhoods. It was incorporated into the Consolidated Appropriations Act of 2001 (P.L. 106-554). Business changes: Lowered taxes prospectively (but see*) • Created the New Markets Tax Credit program for investments made after 2000. • Contained an anti-abuse provision designed to prevent taxpayers from duplicating a loss by assuming encumbered property in a nonrecognition transaction where the basis of the property exceeds the fair market value, giving rise to a deduction. The antiabuse provision was made effective for liability assumptions after Oct. 19, 1999, *the date that the Tax Court struck down a similarly abusive corporate tax shelter using the economic substance doctrine (Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. No. 21 (Oct. 19, 1999)). |
Passed House: |
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Tax Relief Extension Act (TREA) of 1999 |
Became law: Dec. 17, 1999 |
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TREA was contained in title V of the Ticket to Work and Work Incentives Improvement Act of 1999 (P.L. 106-170) and also contained provisions that were originally part of the REIT (Real Estate Investment Trust) Modernization Act. Business changes: Lowered taxes retroactively (but see*) • Extended the research and experimentation tax credit for 5 years, effective for amounts paid or incurred after June 30, 1999. • Provided for the creation of taxable REIT subsidiaries (TRSs) that could earn non-qualifying income and still be wholly owned by the REIT without disqualifying it as long as the REIT’s aggregate TRS ownership doesn’t exceed 20 percent of the REIT’s assets. • Modified the basis rules to prevent a partnership from distributing stock to a corporate partner to wipe out the corporate partner’s gain in its partnership interest, effective for distributions after July 14, 1999 (*the outline of a staff discussion draft mark to be offered by Senate Finance Committee Chair including a mention of this provision was released July 15, 1999).[9] |
Passed House: |
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Taxpayer Relief Act (TRA) of 1997 (P.L. 105-34) |
Became law: August 5, 1997 |
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Among other things, TRA excludes from gross income up to $500k in gains from the sale of a residence and limited basis recovery in the context of some stock redemptions characterized as extraordinary dividends. Business changes: Lowered taxes retroactively (but see*) • Excluded from tax up to $500k (joint) gain from the sale of a principal residence for sales occurring on or after May 7, 1997. • Contained an anti-abuse provision (known as the Seagram-DuPont provision) applicable to distributions after May 3, 1995, with a transition rule for distributions made pursuant to a binding contract or tender offer in effect or outstanding on May 3, 1995. *May 3 is the date that a bill (H.R. 1551) that first included the so-called Seagram-DuPont provision was introduced. In introductory statements upon the bill’s introduction, lawmakers explained that the bill is targeted at transactions similar to the one planned by DuPont and Seagram, with news reports indicating that “investment bankers and other advisors are actively marketing this potential transaction.” |
Passed House: |
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Tax Reform Act (TRA) of 1986 (P.L. 99-514) |
Became law: Oct. 22, 1986 |
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The last time Congress undertook a significant overhaul of our tax system – as it applies both to individuals and businesses – was when it adopted the Tax Reform Act of 1986. Individual changes: Lowered taxes prospectively • Lowered the top rate from 50% to 28%, effective for tax years beginning in 1988 with blended rates for 1987 returns. • Increased the standard deduction from $3,670 to $5k (joint), effective Jan. 1, 1988. • Repealed a provision allowing 60% of long-term capital gains to be free of any tax, effective after 1986. Business changes: Lowered taxes prospectively (but see*) • Lowered the top corporate rate from 46% to 34%, effective July 1, 1987 with blended rates for 1987 returns. • Extended depreciation schedules (e.g., 3-year property now depreciated over 5 years) effective Jan. 1, 1987. • Repealed investment tax credit (up to 10% of property placed in service) *effective Jan. 1, 1986, with some transition rules. |
Passed House: |
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The Economic Recovery Tax Act (ERTA) of 1981 (P.L. 97-34) |
Became law: Aug. 13, 1981 |
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ERTA, also referred to as the Kemp-Roth Tax Cut, reduced rates across the board and adopted the accelerated cost recovery system (ACRS). Individual changes: Lowered taxes retroactively (but see*) • Phased in rate cuts for all brackets (1.25% in 1981, 10% in 1981, 19% in 1983, 23% in 1984). • Lowered the top rate from 70% to 50%, effective for tax years beginning in 1982. • Enacted a top rate on long-term capital gains of 20% for sales occurring after June 9, 1981, *the date that a related bill (H.R. 3849) was introduced in the House. Business changes: Lowered taxes prospectively (but see*) • Lowered the 17% rate to 16% (in 1982) and 15% thereafter, and the 20% rate to 19% (in 1982) and 18% thereafter. • Replaced old depreciation system with ACRS for most non-real property placed in service after Dec 31, 1980. • Increased the charitable contribution deduction limitation from 5% to 10%, effective in 1982. • Created a 25% tax credit for certain research expenditures *made after June 30, 1981. |
Passed House: |
[1] Steuerle, Gene, 1993, Some Notes On ‘Retroactive’ Income Tax Increases (http://www.taxhistory.org/www/econpers.nsf/Web/128D83352B83E89E852566DB0063DAB0?OpenDocument).
[2] Martin, Keith, 2012, Retroactive Taxes, Chadbourne & Parke LLP (https://www.chadbourne.com/In_Other_News_Retroactive-Taxes-11-01-2012_Projectfinance).
[3] Lawmakers may decide that they need more revenue to serve as a down payment on replacing the ACA, depending on the size and scope, in which case it’s possible some effective dates would be Jan. 1, 2018.
[4] Elliott, Amy S., 2010, The Role of Deferred Tax Assets in Corporate Tax Reform, 128 Tax Notes 911; 2015, Global Tax Accounting Services Around the world: When to account for tax law changes, PricewaterhouseCoopers LLP (http://www.pwc.com/us/en/tax-accounting-services/publications/assets/pwc-around-the-world-when-to-account-for-tax-law-changes.pdf).
[5] Gravelle, Jane G., 2010, Tax Cuts and Economic Stimulus: How Effective Are the Alternatives?, Congressional Research Service, 2010 TNT 245-18.
[6] Obama, President Barack, 2010, Remarks on the Economy – As Prepared for Delivery Wednesday, September 8th, 2010, in Cleveland, Ohio, 2010 TNT 174-24.
[7] Beck, Matthew, 2009, Memo to reporters and editors, House Ways and Means Committee, 2009 TNT 11-137.
[8] Beattie, Andrew, A Concise History Of Changes In U.S. Tax Law (http://www.investopedia.com/articles/tax/10/concise-history-tax-changes.asp).
[9] Outline of Draft of Finance Chair Roth’s Tax Bill Mark, 1999, 1999 TNT 136-20.
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