Sanders Calls on Obama, Lew to Close 6 Corporate Tax 'Loopholes'

Sanders identified several actions that the White House could take to prevent corporations from using offshore tax havens and other tax dodges and to prevent wealthy individuals from avoiding income and estate taxes.

"Since the Republican-led Congress has refused to raise revenue by asking the most profitable corporations to pay their fair share, I would hope that the president could take executive action to remedy some of the most egregious loopholes," Sanders said. "We have got to demand that companies like Apple, Hewlett-Packard, and General Electric stop engaging in legalized tax fraud that limits our ability to invest in the future."

"At a time when this country has a $18 trillion national debt and a huge amount of infrastructure and social needs it is absurd that major profitable corporations pay nothing in federal taxes," added Sanders, who last week issued a new detailed report on the extent of offshore tax havens by major American companies that have been most engaged in lobbying for new tax breaks and cuts to important programs for middle class families, such as Social Security, Medicare and Medicaid.

The six tax breaks that Sanders wants Obama and Treasury Secretary Jack Lew to eliminate are:

• The check-the-box loophole allows multinational companies to characterize their offshore subsidiaries in different ways to different governments so that their profits are untaxed.

• The Hewlett-Packard loophole allows American corporations to use short-term loans from their subsidiaries circumvent the requirement that they pay U.S. taxes on their offshore profits when those profits are brought to the U.S.

• The corporate inversions loophole allows an American corporation to merge with a (usually much smaller) foreign corporation and then reincorporate as a foreign company to avoid U.S. taxes even as it continues to operate and be managed in the U.S.

• The carried interest loophole allows hedge fund managers to characterize their compensation (which they earn for managing other people's money) as capital gains, which is subject to lower personal income tax rates than other types of income. Tax experts have pointed out that the Treasury Department has the authority under existing law to determine how this income is taxed.

• Valuation discounts are restrictions placed on small business property given to family members (to keep the business in the family, for example) which are often meaningless but are claimed to dramatically reduce their value for estate and gift tax purposes.

• The real estate investment trust (REIT) loophole allows private prisons, billboard companies, casinos and other companies claim that they are making money from rents to avoid paying the corporate income tax.

Contact: Vince Morris (202) 224-3728

Several problems with our tax code could be addressed through executive action to start the process of tax reform. Current tax laws authorize the Administration to issue regulations that would likely address several of the most egregious loopholes.

I. Summary

Check-the-Box Loophole

Carried Interest Loophole

Corporate Inversions

Valuation Discounts that Reduce Estate and Gift Taxes

Corporate Offshore Tax Avoidance Using Short Term Loans

Real Estate Investment Trust Loophole

II. Details

Corporate Offshore Tax Avoidance Using Check-the-Box Rules

In 2013, Senator Carl Levin held a hearing of the Homeland Security and Government Affairs Permanent Subcommittee on Investigations on Apple's use of offshore tax havens. Senator Levin and the subcommittee's ranking member John McCain issued a report explaining that Apple used this loophole and recommended that Congress close it.

Businesses are generally allowed to deduct expenses like interest paid on debt from their gross income when calculating taxable income. Without rules to prevent abuse, some corporations would arrange financial transactions in which they make large interest payments to their offshore subsidiaries and use the deductions to wipe out their income for U.S. tax purposes. Our tax rules generally try to prevent this by taxing interest (and certain other types of income) when it is earned by of offshore subsidiaries of American corporations.

But corporations can circumvent these anti-abuse provisions by using check-the-box rules. For example, a subsidiary of an American company in Germany could make an interest payment to another subsidiary in a tax haven country, and tell the German government it is entitled to a deduction because it made an interest payment to another corporation. But then it tells the American government that the tax haven company is just a branch of the German company so the payment was an internal company payment, meaning there is no profit to tax. In reality, that payment is a profit that is not taxed anywhere.

The Clinton Administration proposed rules to address the problem -- which were withdrawn after Congress threatened to legislatively lock the check-the-box rules in place.

This problem demands particular attention because the OECD, through its Base Erosion and Profit Shifting (BEPS) project which the U.S. has been heavily involved in, has called on countries to end the tax avoidance associated with hybrid entities created through check-the-box. If Congress refuses to act, the Administration arguably must act alone to implement the OECD's recommendations and cooperate with the BEPS project.

President Obama proposed in his fiscal year 2010 budget to address the international tax avoidance associated with check-the-box through legislation. JCT estimated that the President's proposal, which included several complex exceptions, would raise $31 billion over a decade. A simpler version of this proposal from Senator Levin was said to raise $78 billion over a decade. This presumably means that $78 billion is the outer limit on the possible revenue savings from addressing this problem through executive action.

Carried Interest Loophole

The general idea behind the lower rate for capital gains is that people who invest money should pay a lower rate on the return from that investment. This idea has never made much sense, but it is even worse when a loophole like this one is used to obtain the lower tax rate for income that is not a return on investment but is actually compensation paid for work (for the services provided by fund managers). Income in the form of carried interest can run into the hundreds of millions (or even in excess of a billion dollars) a year for individual fund managers, raising the question of why this particular group needs a special tax break.

Victor Fleischer, a tax law professor at the University of San Diego who first drew Washington's attention to the carried interest loophole, has written that the Administration has the authority under existing law to close this loophole. He points out that section 707(a)(2)(A) of the tax code authorizes the Treasury Department to issue regulations addressing the extent to which partners in a business are paid for compensation or paid returns on investments they have made -- and Treasury has not done so in the 30 years this has been on the books. Treasury can simply define fund managers as service providers so that carried interest is taxed as earned income.

Corporate Inversions

Congress needs to close the loophole allowing these corporations to claim that they are foreign companies for tax purposes. Until Congress acts, regulatory action can help by tightening the rules and blocking some of the tax dodges that are available to inverted companies. This would eliminate much of the motivation for corporate inversions.

In July of 2014, former Treasury official and Harvard Law scholar Stephen Shay published an article arguing that the Administration could act to block the two main tax dodges that become available to corporations after they invert. The first involves "hopscotch" loans, which inverted corporations could use to effectively shift offshore profits back into the U.S. without paying taxes on them. The second major tax dodge available to inverted corporations is "earnings stripping." In September of last year, the Treasury department issued a notice effectively addressing the first tax dodge (hopscotch loans) but only hinted that it would eventually address the second tax dodge (earnings stripping).

Corporations claiming to be based abroad (and corporations that really are based abroad) are able to use earnings stripping techniques to make profits earned in the U.S. appear to be earned in countries where they will be taxed more lightly or not at all. Earnings are stripped out of the U.S. when a foreign-owned U.S. corporation (which an inverted company technically is) borrows money from its foreign parent corporation, to which it makes large interest payments that wipe out U.S. income for tax purposes. The loan is really an accounting gimmick, since all the related corporations involved are really one company that is simply shifting money from one part to the other. The interest payments made by the American corporation in effect shift the profits that are really earned in the U.S. to the foreign country for tax purposes.

Shay's article explained that the Treasury Department could issue regulations under section 385 of the tax code that would limit earnings stripping for inverted corporations. That section of the law essentially allows Treasury to issue regulations to determine whether an interest in a corporation is treated as debt or equity (stock). Regulations could, Shay explains, reclassify excessive debt taken on by an inverted American company from its (ostensible) foreign parent company as equity. This would mean that any interest payments made by the inverted American corporation would be reclassified as dividends paid on stock, which, unlike interest payments made on debt, are not deductible. Shay proposes specific calculations for Treasury to use, but there probably are several ways that it could define excess indebtedness that would be reclassified as equity.

Valuation Discounts that Reduce Estate and Gift Taxes

In its analysis of the President's proposals in 2009, JCT commented that it seemed that Treasury was about to issue regulations addressing this issue and suggested that legislation was not even necessary.

Corporate Offshore Tax Avoidance Using Short Term Loans

Section 956 of the tax code is designed to prevent this. Section 956 treats such loans from offshore subsidiaries to their American parent corporations as a "deemed repatriation" that would be subject to U.S. taxes. The problem is that Treasury regulations created exceptions to these rules that greatly weaken them.

Those regulations essentially say that section 956 does not apply if loans from offshore subsidiaries are outstanding for less than 30 days each and the total loans for the year are outstanding for less than 60 days. The Permanent Subcommittee on Investigations explained that Treasury then turned this exception into a bigger loophole by declaring that it would not count any loan that was not outstanding at the end of a quarter and that these limits apply separately to each subsidiary of a corporation.

As a result, HP was "borrowing" billions from several offshore subsidiaries, mainly one in the Cayman Islands and another in Belgium, using this money to fund its U.S. operations while officially holding less than a billion in the U.S.

Stephen Shay, the same international tax law scholar whose article on corporate inversions prompted the Treasury Department to act on that issue, testified before the subcommittee that Treasury has additional powers under existing law, under both section 956 and section 7701(l) to prevent this type of tax avoidance.

This seems straightforward. Section 956(e) says the "Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this section, including regulations to prevent the avoidance of the provisions of this section through reorganizations or otherwise." Section 7701(l) provides that "The Secretary may prescribe regulations recharacterizing any multiple-party financing transaction as a transaction directly among any 2 or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent avoidance of any tax imposed by this title."

Real Estate Investment Trust Loophole

The problem is that companies engaging in all types of activities claim to earn profits from their real estate in order to conduct the business through REITs and avoid the corporate income tax. The New York Times has reported that these companies now include "Corrections Corporation of America, which owns and operates 44 prisons and detention centers across the nation," and "Penn National Gaming, which operates 22 casinos, including the M Resort Spa Casino in Las Vegas." They also include "Lamar Advertising, an outdoor advertising firm, and Equinix, a data center operator."

IRS administrative rulings basically allow these businesses to claim that their income is generated by the land and buildings that they are using and therefore qualify as REITs. Under this standard, it is not clear what would stop a fast food restaurant chain, a major chain retailer or any company with real estate assets from claiming that it can convert to a REIT in the same way and avoid the corporate income tax. The Treasury Department should issue regulations that undo the effect of these administrative rulings.

I am writing to call on the Administration to close six of the most egregious loopholes in our tax code through executive action to begin the process of tax reform. Legislative proposals to close these loopholes have been estimated to raise over $100 billion over a decade, and acting through executive action could have a similar impact.

America needs tax reform that raises revenue in a progressive way to fund investments like infrastructure improvements that will create jobs and boost economic growth. One way to accomplish this is by closing tax loopholes that allow large, profitable corporations and some of the wealthiest people in our country to avoid paying their fair share.

Our nation has never, in the past five decades, balanced a budget with revenue levels as low as they are projected to be. The loopholes in our tax code have become so outrageous that some middle-class Americans are paying higher effective tax rates than huge, profitable corporations and multimillionaire Wall Street hedge fund managers.

The Republicans in Congress have made it clear that they will not address these problems. Therefore, the Administration should act on its own to close, at a minimum, the following six tax loopholes. The first three were created through regulation or administrative ruling rather than legislation, leaving no doubt that they can be repealed by regulation. The rest can be closed by the Administration under specific tax provisions that give the Secretary of the Treasury the power to issue regulations carrying out the purposes of our tax laws.

1. The check-the-box loophole allows multinational companies to characterize their offshore subsidiaries in different ways to different governments so that their profits are ultimately taxed by no government at all. Senators Carl Levin and John McCain issued a hearing report in 2013 explaining that Apple used this loophole and recommended that Congress close it. A proposal included in the President's first budget plan to close this loophole was estimated to raise $31 billion over a decade, while a simpler version of this proposal incorporated in the Stop Tax Haven Abuse Act was estimated to raise $78 billion over decade. Executive action to address this could potentially raise similar amounts.

2. The Hewlett-Packard loophole allows American corporations to circumvent the requirement that they pay U.S. taxes on their offshore profits when those profits are brought to the U.S. Companies like Hewlett-Packard have offshore profits that they have circulated to the U.S. by a continuous series of short term "loans" from subsidiaries in tax havens like the Cayman Islands.

3. The real estate investment trust loophole allows private prisons, billboard companies, casinos and other businesses to claim that they are making money from rents and thus structure themselves as real estate investment trusts (REITs), which do not pay the corporate income tax.

4. As you know, corporate inversions allow an American corporation to merge with a (usually much smaller) foreign corporation and then reincorporate as a foreign company to avoid U.S. taxes even as it continues to operate and be managed in the U.S. While the loophole allowing this can be closed only by Congress, the Administration has the authority to block the tax avoidance strategies that become available to corporations after they invert, which are the main motivation for most inversions. The Administration rightly acted in September of 2014 to block one such tax avoidance strategy known as "hopscotch loans" but has not yet acted on another, known as "earnings stripping." The Treasury Department estimates that the President's legislative proposal to address inversions would raise $13 billion over a decade, and executive action could potentially raise a similar amount.

5. The carried interest loophole allows wealthy hedge fund managers to characterize their compensation (which they earn for managing other people's money) as capital gains, which is subject to lower personal income tax rates than other types of income. This can result in millionaires and even billionaires who manage these funds paying lower effective tax rates than many middle-class families. A proposal in the President's budget to close the carried interest loophole was estimated to raise $17 billion over a decade, and executive action to address this could have a similar impact.

6. Valuation discounts are restrictions placed on small business property given to family members (to keep the business in the family, for example) which are often meaningless but are claimed to dramatically reduce their value for estate and gift tax purposes. The Treasury Department estimated that the legislative proposal in the President's fiscal year 2013 budget plan to close this loophole would raise $18 billion over a decade. Executive action to address this loophole could raise a similar amount.

There are undoubtedly more tax loopholes that the Administration could close on its own. This list is not intended to be exhaustive but rather to illustrate that if Congress fails to act, the Administration can act to resolve some of the problems with our tax code.