Tax Plan may Hurt Insurers, REITs, Foreign Companies

[bigpoppanils]

Senate Republicans Scale Back

Dividend-Tax Plan After a Day

By JOHN D. MCKINNON and GREG HITT

Staff Reporters of THE WALL STREET JOURNAL

WASHINGTON -- A Senate Republican proposal to temporarily repeal the dividend tax turned out to have a short life of its own. A day after its unveiling, Republican tax writers scrapped it in favor of a more modest, longer-term benefit.

In an agreement announced as the Senate Finance Committee prepared to take up the tax-cut package Thursday, lawmakers would create a $500 exclusion from dividend taxes, which would grow by 10% in five years and additional 20% five years after that until 2013, when the tax would be reinstated on their full amount. Trying to please President Bush, who wants full repeal, Senate leaders had proposed phasing out the dividend tax over three years, then reinstating it in 2006. But even some Republicans dismissed the temporary benefit as a gimmick and party leaders sought a compromise, fearing the provision wouldn't make it through the committee.

The new Senate bill carries an estimated cost of $430 billion over 10 years. Because the Senate's 2004 budget plan allows it to pass no more than $350 billion of tax cuts, Republicans have to scrounge for ways to raise revenue to make up the difference. Those so-called offsets, along with the House and Senate dividend proposals themselves, threaten to hurt some businesses, and potentially could adversely affect thousands of Americans living overseas.

Life-insurance companies, commercial real-estate interests and foreign-based corporations found themselves left out of the version of the tax package approved Tuesday by the House Ways and Means Committee, and were scrambling to find a way to share in the benefits.

To offset the cost of its proposed dividend-tax cuts, the Senate is considering raising taxes or toughening rules on other industries and individuals. Senators may eliminate deductions for certain types of popular "hybrid" securities that look like tax-deductible debt for some purposes but not for others, and for civil settlements paid by corporate wrongdoers and their executives who overstate earnings.

Perhaps the most controversial idea being floated in the Senate would end a substantial tax break that U.S. nationals living overseas receive as a way to offset the taxes they pay to their host country. Currently, couples can exclude as much as $160,000 in income, as well as receive other tax breaks for foreign housing, meaning many Americans living abroad can avoid U.S. tax liability altogether. Eliminating the break would generate $34 billion for federal coffers -- but would be sure to draw howls of protest from Americans living overseas.

All the congressional infighting promised to drag out the process of passing an economic package even longer than expected. "The tough road is very much ahead of them," said Clint Stretch, director of tax policy for Deloitte & Touche, the big accounting firm.

The biggest clear losers so far appeared to be the growing number of foreign corporations that do business and trade their shares in the U.S.

The Ways and Means package would drop the top tax on dividends and capital gains to 15%, from the current 38.6% for dividends and 20% for most capital gains. But it specifically applies only to "domestic corporations." That means U.S. shareholders of foreign-based companies, such as Finland's Nokia Corp. or Canada's Nortel Networks Corp., couldn't get the reduced rates on the dividends and capital gains they receive from those shares.

"We're very concerned," said Todd Malan, executive director of the Organization for International Investment, a Washington group that represents foreign companies in the U.S. He said the bill would "eliminate any incentive for Americans to diversify their portfolios."

This provision also could make it harder for U.S. stock exchanges to attract foreign companies to list their shares -- a big priority for U.S. markets in the increasingly globalized securities business. Shares of foreign companies are widely traded through American depositary receipts, which trade and pay dividends in dollars.

The life-insurance industry is objecting that the House bill leaves unchanged the income-tax burden on annuities, while greatly reducing taxes on stock dividends and capital gains. Radio advertisements funded by the American Council of Life Insurers are highlighting recent financial-market gyrations and contending that "now is not the time to penalize those who chose to secure their retirement with an annuity."

The industry wants annuities, which are periodic payouts to investors that now carry a top tax rate of 38.6%, to be taxed at the level provided for dividends and capital gains in the House bill.

Real-estate interests complain that the House bill leaves unchanged the current 25% capital-gains rate that applies to sale of many commercial properties. The 25% levy in effect allows the federal government to "recapture" the value of depreciation-tax breaks already taken on the property. The industry supports the "bonus" depreciation changes already incorporated in the House bill, but wants the "recapture" tax lowered to about 19%, in proportion with the adjustment made to the regular capital-gains tax.

Write to John D. McKinnon at john.mckinnon@wsj.com and Greg Hitt at greg.hitt@wsj.com

Updated May 8, 2003