How 'territorial' taxing of US foreign profit might work

US taxes

Passive income - for things like investments an owner is not actively involved in - is subject to immediate taxation under US rules, though there are ways around that as well.

In its purest form, a "territorial system" would mean repealing the deferral law and exempting all active foreign profits earned by US companies from taxation. Such a system would let US companies bring home foreign profits tax-free.

Previous actual proposals have been more limited, however, including one put forward by Congress's nonpartisan Joint Committee on Taxation, and one made in 2005 by a presidential tax reform panel assembled by the Bush administration.

Many countries have territorial systems, but they limit the amounts and types of foreign profit that are exempted from taxation, as the earlier US proposals did.

Critics of a territorial system say it would give US corporations a strong incentive to move even more income and jobs offshore. Backers say this problem could be addressed by lowering the corporate income tax rate to a level closer to other countries' rates and by making other adjustments.

REPEAL OF DEFERRAL. An alternative to the territorial system would be to end the law that allows deferral of US taxes on foreign profits. If this law were repealed, all active corporate profits - at home and abroad - would be taxed on a current basis at the full rate of 35 percent, minus credits for foreign taxes paid and other tax breaks.

PARTIAL REPEAL OF DEFERRAL. Another option might be to repeal deferral only partially, perhaps rolling it back only for tax-haven countries targeted by the government. Choosing which countries to target would be a process fraught with politics.

Obama has proposed this in past budget proposals. He may do the same again, as the White House is only likely to move away from that idea in the context of broader tax reform.

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