Last week, President Biden proposed a major change in the way some large corporations are taxed. These firms would be required to pay tax on the income they report to shareholders rather than their taxable income. What did Biden propose and how would it work?
What did the President propose?
His plan, which was introduced as legislation by House Democratic leaders, would impose a 15 percent alternative minimum tax on the adjusted financial statement income (“book income”) of large corporations. As a result, some large corporations would pay an amount by which their minimum tax exceeded their regular tax for the year. The minimum tax would allow a credit for a share of taxes paid in other countries.
How does the minimum book tax differ from the regular corporate income tax?
The 21 percent corporate income tax applies to income firms report to the IRS on their tax returns. The new minimum tax would apply to book income, with certain adjustments, which is reported in financial statements, such as 10-Ks. Because there can be large discrepancies between income reported in financial statements and on tax returns, the minimum book income tax may be larger than the regular income tax.
What are differences between financial statement and tax accounting?
Companies follow different sets of rules when reporting to investors and for tax purposes. This helps explain why some large profitable companies pay very little in federal corporate income taxes. Tax accounting is based on the Internal Revenue Code, which defines income and expenses for tax purposes. US book accounting is typically based on Generally Accepted Accounting Principles of the United States (GAAP).
Some differences between book and tax income are temporary while others are permanent. In 2020, for example, businesses could fully deduct for tax purposes the cost of many types of capital investments in the year they acquired those assets because of the 2017 Tax Cuts and Jobs Act. But when they report to shareholders, they must depreciate those assets over several years.
There also are permanent differences in the way the tax code and GAAP treat income and expenditures. For example, tax-exempt bond interest is recorded as income on financial statements but not for tax purposes.
Another major difference is the treatment of some forms of executive compensation, including different measurement concepts and principles for equity compensation. Similarly, business tax credits are excluded from financial statements. However, Biden’s plan would allow firms that are subject to the new minimum tax to continue to claim many of those credits.
What tax preferences would still be allowed under this proposal?
The bill retains the value of general business credits, and credits for research, green energy, and low-income housing. Companies with operating losses in previous years will be able to reduce their adjusted financial income by a maximum of 80 percent for the purposes of paying the minimum tax. And any minimum tax can be used to offset future regular tax liability.
How is this book minimum tax different from the global intangible low-tax income (GILTI) reform that the Democrats also are proposing?
The book minimum tax would be imposed on the financial statement incomes of very large US multinationals, no matter where they earn their income. Its goal is to raise revenues from large corporations with major discrepancies between their financial statement income and their taxable income. By contrast, GILTI is a minimum tax on active foreign earnings only of all US multinational corporations regardless of size. The Build Back Better Act includes a 15 percent minimum tax on the foreign earnings of US multinationals.
Which firms would pay the new tax?
Corporations with a 3-year average adjusted book income above $1 billion will be subject to the minimum tax. In 2019, about 455 US corporations reported net income before taxes above $1 billion. However, many of these firms would not be subject to minimum tax because they pay more in regular income taxes.
What are the pros and cons of this minimum tax?
Proponents of the minimum book tax say it would limit tax avoidance by large corporations and ensure that highly profitable companies pay substantial income tax. They also say it would make tax liability more transparent to shareholders. By focusing on big companies, it avoids raising taxes on most businesses and potentially alienating members of the business community and policymakers.
Opponents of book taxes say income differences usually arise from policies designed to encourage investment. They also argue that a better way to curb aggressive tax avoidance is by directly limiting or repealing specific tax incentives.
