US Congress: tax reform emerging as major 2016 campaign issue – financial industry a prime target

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Tax reform is emerging as a major issue in the 2016 US presidential campaign, and in the growing wave of populist anger at the establishment elite in Washington and Wall Street, the financial industry has become a prime target of tax reform proposals from candidates in both political parties.

Candidates from both side of the aisle – among them Jeb Bush, Donald Trump, Hillary Clinton and Bernie Sanders − have offered specific proposals to raise taxes on the financial industry. They have pledged that tax reform would be a top legislative priority and that they would act on their proposals in 2017 if elected.

These tax proposals would impact hedge funds, private equity firms and real estate partnerships, and include taxing carried interest, limiting the corporate interest deduction and ending the deferral for like-kind exchanges.

Taxing carried interest as ordinary income:  The Obama Administration and Congressional Democrats have been going after carried interest for years, with no success. However, the push to raise tax rates on carried interest has gained considerable support with the endorsements of Donald Trump and Jeb Bush to tax carried interest as ordinary income. Democratic candidates Hillary Clinton and Bernie Sanders also support taxing carried interest. In addition, Senator Chuck Schumer (D-NY), a long-time defender of carried interest, has announced his support of proposals  to increase taxes on carried interest. Schumer has noted the “wealth of bipartisan support” for taxing carried interest, and urged Congress to act on the proposal as soon as possible. However, the Bush proposal to tax carried interest was included in his comprehensive tax reform plan, and any real threat to carried interest will likely be in a comprehensive tax reform bill.

Eliminate the deduction for corporate debt:  One of the most significant proposals in the Bush tax reform plan is his proposal to end the “favorable tax treatment” of debt financing over equity financing by eliminating the deduction for corporate debt. According to the proposal, “the deductibility of interest for businesses subsidizes debt, discouraging equity, and thereby threatening long-term prosperity.” This proposal would stop government from “subsidizing corporate and Wall Street debt.”  A tax reform plan by another presidential candidate, Senator Marco Rubio (D-FL), would also eliminate the corporate deduction for debt. These proposals mirror the plan outlined by the Obama Administration in its corporate tax reform plan to reduce the bias towards debt by reducing the deductibility of interest for corporations. The New York Times has said that these proposals would “have a profound impact on almost every industry, but would especially affect private equity and real estate.”  Standing alone, this proposal has little chance of passing. However, members on both side of the aisle see it as way to pay for a substantial corporate tax reduction in a major tax reform bill. 

Repeal the deferral for like-kind exchanges:  There is also bipartisan support for proposals to limit or eliminate the deferral for like-kind exchanges. The tax reform plan proposed by former House Ways and Means Committee Chairman Dave Camp (R-MI), who has since retired from Congress, would have repealed the deferral of gains on like-kind exchanges, as would the tax reform discussion draft offered by the Senate Finance Committee. The President’s budget proposes to limit the deferral to US$1 million a year. The comprehensive tax reform plan proposed by Jeb Bush most likely includes like-kind exchanges. Although not all the details have been released, the plan does call for the elimination or phase-out of most tax expenditures.

Comprehensive tax reform has stalled in Congress.  Congressional Republicans and President Barack Obama have been unable to resolve their stark differences over individual tax reform. However, there is widespread agreement in Washington that tax reform is needed to fix the broken tax code, and that the next best opportunity for action on a major tax reform bill will come when a new President takes office in 2017.

Accordingly, the major elements of the next tax reform plan will be fleshed out over the next 12-15 months. That is how long that hedge funds, private equity firms and real estate partnerships have  to make the case against any proposals now aimed at them by presidential candidates.

While comprehensive tax reform will have to wait until 2017, a number of key issues are on the tax agenda for the rest of the year.

House Ways and Means Committee Chairman Paul Ryan (R-WI) intends to move an international tax reform plan this fall, one that aims to shift to a territorial tax system with a one-time tax on accumulated foreign earnings to help fund the highway trust fund and adopting an innovation box regime. The committee is also expected to add an extension of expiring tax provisions to the international tax reform plan.

Congressional Democrats are likely to continue to press the carried interest issue in the coming weeks and months, particularly if the outcry against Wall Street and inequality continues to grow as an issue in the presidential campaigns.

Although Republicans in the House and Senate are expected to continue to defer action on carried interest and other loophole closers to comprehensive tax reform, interested parties need to continue to monitor developments and voice opposition to these changes to policymakers.

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