Rate Debate Update

The rate debate continues. Last week, the Senate failed to extend all the current tax rates and policies by a vote of 45-54. Two Republicans voted against the measure because of a refundable credit issue and one Republican missed the vote due to illness, but even if you adjust for those votes, the Senate still came up short of a majority for not raising taxes on employers during a period of severely high unemployment.

Very disappointing and something pass-through businesses and the markets should pay sharp attention to.

We expect better results today and tomorrow when the House votes on two related bills. One, H.R. 8, would extend through 2013 all the current Bush tax cuts. The other, H.R. 6169, would create an expedited process for Congress to consider tax reform next year.

To help with the vote, the S Corporation Association and our allies drafted and helped circulate the following business community letter in support of the legislation. As the letter states:

Business owners in this country crave clarity. They do not know what the tax laws will be moving forward and this uncertainty is having a material and negative impact on investment and job creation. 

Absent action, the Congressional Budget Office has made clear the combination of higher taxes and lower spending will send the economy into a tailspin starting early next year. Our members report that the prospect of the country going over the fiscal cliff is discouraging them from making investment and hiring decisions right now, slowing our already sluggish economy.

To address this uncertainty, Congress needs to act quickly on tax legislation that would accomplish two critical goals. First, the legislation must shrink the fiscal cliff and provide employers with a clear sense of the tax rules for 2013 by extending all of the expiring tax provisions for one year. 

Second, because it is long past time for comprehensive reform to create a pro-business, pro-competitiveness and pro-jobs tax code, the legislation should outline exactly how and when Congress will consider a comprehensive rewrite of the individual, corporate and international tax codes. This legislation should instruct Congress to broaden the tax base while lowering overall rates, and include rules for expedited consideration of the legislation to prevent delay or filibuster to provide the long-term certainty our economy needs to flourish.

This letter has been signed by more than 100 business trade groups, which should send a strong signal to policymakers in both chambers that the employer community needs to see action. The House plan is the most responsive to the needs of our members, and we hope Congress will adopt it.

Finance Hearing on Pass-Through Businesses

The Finance Committee held a hearing on tax reform and business entities today. Entitled “Reform: Examining the Taxation of Business Entities,” the goal of the hearing was to:

“…explore the different taxation of business entities structured as corporations versus pass-throughs, and to consider proposals to alter those rules. Baucus and the witnesses will explore the history of the two-tiered corporate tax system, compare the U.S. taxation of pass-throughs to the systems of other countries and consider whether the current system distorts business decisions in ways that hurt job creation and economic growth.”

This topic is obviously of great importance to S corporations and we submitted some excellent testimony from S-Corp Advisor Tom Nichols that outlines our views on tax reform and entity choice. His testimony is consistent with last fall’s trade association letter signed by 47 major business organizations that outlines three key priorities pass-through businesses would like to see under tax reform:

  1. Reform needs to be comprehensive and include the individual and corporate codes;
  2. The top rates for individuals, pass-through businesses, and corporations should stay the same; and
  3. Congress should continue to reduce the double tax on corporate income.

The final priority here is particularly important. If the goal of tax reform is to improve incentives for domestic job creation and investment, it needs to address the burden of the double tax on American corporations. Congress has proactively worked to reduce this burden for the past three decades, and that progress should continue in any future tax reform. As our Ernst & Young study authors observed in the report they did for us last year:

In addition, the flow-through form helps mitigate the economically harmful effects of the double tax on corporate profits, in which the higher cost of capital from double taxation discourages investment and thus economic growth and job creation. Moreover, double taxation of the return to saving and investment embodied in the income tax system leads to a bias in firms financing decisions between the use of debt and equity and distorts the allocation of capital within the economy. As tax reform progresses, it is important to understand and consider all of these issues with an eye towards bringing about the tax reform that is most conducive to increased growth and job creation throughout the entire economy.

We’re grateful that a number of today’s witnesses sounded the same theme, but remain concerned that Finance Chairman Max Baucus continues to suggest that large pass-through businesses should pay taxes as C corporations. From his opening statement:

While a valuable tool for small businesses, we should examine if the use of pass-throughs have disrupted the level playing field for larger non-public companies and their public competitors.

Ideally, our tax code should cause as few distortions in business as possible. Businesses should plan and organize based on growth and job creation - not the tax code.

One of my main goals of tax reform is to make the system more competitive, but also keep it fair.

These comments build on remarks he made last year, stating that, “We’re going to maybe, have to look at pass-throughs, and say they have to be treated as corporations if they earn above a certain income.”

As we said, most of the witnesses and Members supported the notion that tax reform done right would reduce the double tax on corporate income, not increase. As the Chairman’s remarks make clear, however, that goal is not universally agreed to and the pass-through community needs to be on watch.

Good News on BIG!

In other Finance news, the Committee announced last night that it would mark up tax extender legislation tomorrow. You can read the description of the bill here, coupled with the score by the Joint Committee on Taxation. Major provisions in the legislation include:

  • A one year extension of the AMT patch (2012);
  • A two-year extension of the R&E tax credit (2012 and 2013); and
  • Higher limits under Section 179 expensing (2012 and 2013).

The highlight for the S corporation community is the two-year extension of the shorter, five-year holding period for built-in gains.  Extending the five-year period has been one of our priorities for the past year. The current, overly long ten-year holding period prevents companies from accessing their own capital at a time when capital is scarce. What make more sense than extending the more reasonable five-year period?

The bill announced yesterday does not include 18 provisions that had been previously extended by Congress, and more provisions could potentially be added or deleted tomorrow during the mark-up. So, there’s still a lot of work to do before important built-in gains relief is enacted into law.

Fortunately, we have plenty of allies in the Senate on this provision from both sides of the aisle — Senators Cardin, Snowe, Hatch, Landrieu, Grassley, and Roberts have been key advocates on this issue through the years — and we’ll be working closely with them to get this provision across the finish line! Stay tuned.

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