The 2017 Tax Reform Act reduces the corporate federal income tax rate from 39% to 21%. Every corporation should be rejoicing, yet the large corporations are not. Why? According to the GAO, the large corporation’s effective federal tax rate already averages 16.9%. On the surface, the tax reform equates to offering discounts on snowmobiles to someone who lives in Florida.
Many large corporations have built an intricate web of perfectly legal internal methods to defer or avoid certain taxes. The methods require hiring accountants and attorneys to build tax shelters of which middle market businesses could never afford. The previous tax code gave large businesses a competitive advantage over middle market businesses.
Now the tables have turned.
Large organizations have moved more than $2.5 trillion overseas to take advantage of lower international corporate tax rates, according to the Citizens for Tax Justice. Prior to Tax Reform, the U.S. corporate tax rate averaged 38.91% while that of other developed countries averaged 22.96%. GE and Microsoft have each saved more than $100 billion overseas. Middle market businesses could not afford the expense of opening overseas bank accounts, offices, and the associated legal fees. Moving the corporate rate to 21% will lead many large corporations to repatriate and make investments that create business for middle market companies. Exxon announced plans to invest $50 billion in the United States partially due to tax reform. In the long term, the tax reform will benefit the larger corporations, saving millions by eliminating unnecessary cost supporting a complex tax structure.
The Tax Reform Act has eliminated a host of corporate tax credits and deductions. The corporate deductions include manufacturing, local lobbying, fines paid to governments, and dividends received deductions. Many of the tax deductions were offered to incent larger company behaviors and have been specifically eliminated or limited to where the larger organization cannot benefit. On the flip side, minimum revenue requirements for cash-based accounting have been raised from $5MM to $25MM. The requirement helps fast growing companies reduce administrative accounting and tax burdens. Longer term, larger corporations will begin to look for ways to shed certain internal entities designed to enable the tax credits.
Small businesses employ 49.2% of all private sector employees in the U.S. Many small businesses are organized as s S-Corporations where the profits are taxed against the owner’s personal income instead of at the corporate level. The incentive for small businesses to organize as S-corporations has virtually been eliminated under the new tax law. Once S-corporations begin to migrate to traditional C-corporations, investment opportunities will increase along with the significant reduction in tax liability. This transition will result in a significant number of small businesses growing into the middle market category with new investors and more cash on hand.
Many of the incentives for large corporations have been eliminated and the new corporate rate is now on par with other countries. Large corporations can no longer justify the tax havens, and middle market businesses are now able to compete on a level playing field when it comes to corporate income taxes.
