S-Corp Submits Comments

The S Corporation Association submitted the following comments to the Senate Finance Committee today as part of the Committee’s request for input:

The United States is unique among developed countries in the emphasis it places on pass-through business structures – S corporations, partnerships (including limited liability companies), and sole proprietorships.  Pass-through businesses make up 95 percent of all U.S. businesses, they employ the majority of private sector workers, and they contribute the majority of business income to our GDP.

This reliance on pass-through businesses is not an accident or a byproduct of other priorities.  Rather, it was done purposefully by successive Congresses seeking to strengthen the role of private businesses in the American economy.  These deliberate actions date back to the creation of the S corporation structure in 1958 and they have worked to the benefit of the businesses themselves, the people they employ, and the communities they serve.  America has more jobs, higher wages, and a more diverse economy because of the strength of its pass-through business sector.

It is critical for Congress to understand this history as it seeks to tackle tax reform in the coming months.

One reason the pass-through business structure has been so successful is that it is, fundamentally, the correct way to tax business income.  If Congress were in a position to start from scratch, the pass-through treatment of business income, particularly how S corporations are taxed, would be the starting point.  As Eric Toder of the Tax Policy Center testified before the Senate Finance Committee:

I would.. note that the ideal way to tax business income is the way we tax S corporations.  We would like to attribute the income to the owners and the only reason we have a corporate tax is for large and frequently traded companies – very hard to do that and identify the owners who would pay the tax.  So where you can do that, we should do that, and that is the right treatment. 

For publicly-owned companies with thousands of shareholders, pass-through treatment is simply not feasible.  But for everyone else, allowing closely-held businesses to pay their taxes using the pass-through structure would be an improvement in tax administration and tax simplicity while helping to make U.S. business more competitive globally.  

Starting with the premise that S corporation taxation is the correct way to tax business income, we encourage the Senate Finance Committee to consider the following broad principles supported by 120 national business trade associations (see attached) as it considers how to best reform the tax code and tax business income:

  1. Tax reform needs to be comprehensive.  Most workers in the United States are employed at pass-through businesses that pay taxes at the individual rates, not the corporate rates.  To ensure that we avoid harming a large segment of American employers, tax reform needs to include both the individual and the corporate portions of the tax codes.  

  2. Congress needs to reduce the tax rates paid by individuals and corporations to similar, low levels. Excessive marginal rates discourage investment and hiring, while splitting business income and taxing it at significantly different rates encourages planning to circumvent the higher rates, ultimately resulting in wasted resources and lower growth.  To ensure that tax reform results in a more simple and competitive tax code, Congress needs to keep top tax rates low, and it needs to keep them at similar levels.  

  3. Congress should continue to reduce the incidence of double-taxing business income.  A 2011 study on tax reform by Ernst & Young made clear that the predominance of pass-through businesses in the United States, and the single layer of tax they face, results in higher levels of investment and employment in the U.S.  A key goal of tax reform should be to continue this progress towards taxing all business income only once.  

Read the entire submission here.

Business Community Rallies Behind 3.8% NIIT Repeal

The Business Committee came out in force today in opposition to the Obamacare 3.8 percent Net Investment Income Tax (NIIT) and, more to the point, in support of repealing this harmful tax as part of the on-going health care reform effort.

More than forty national trade groups joined the S Corporation Association in writing to Senate Majority Leader McConnell supporting NIIT repeal as a priority in health care reform. Since the beginning of the year, repeal of this tax had been a core part of Republican efforts to roll back the Affordable Care Act (ACA).  But in recent weeks a number of senators have argued to keep the tax in place even as health care reform moves forward.  As the Associated Press reported prior to the July 4th break:

Top Senate Republicans may try preserving a tax boost on high earners enacted by President Barack Obama in a bid to woo party moderates and rescue their sputtering push to repeal his health care overhaul.  The break from dogma by a party that has long reviled tax boosts — and most things achieved by Obama — underscores Senate Majority Leader Mitch McConnell’s feverish effort to yank one of his and President Donald Trump’s foremost priorities from the brink of defeat.  The money from the tax boost would instead be used to bolster proposed health care subsidies for lower-income people.

That’s a really bad idea – not only would it keep the harmful NIIT in place, it would also bake the NIIT’s revenues into the budget baseline for tax reform, making it even more difficult to reduce rates on pass through businesses to competitive levels.  The entire business community has rallied around the idea of treating Main Street businesses fairly in tax reform.  Failing to repeal the NIIT as part of health care reform threatens that goal.  As the letter states:

The NII tax was enacted as part of the ACA and sold as both a “tax on the rich” and as a means of shoring up the Medicare trust fund.  The tax has no connection to Medicare, however, and its burden falls on many middle class families and Main Street businesses.  The surtax imposes an additional 3.8 percentage points of tax on investment income, including capital gains, dividends, interest, as well as certain S corporation and partnership income, for families making as little as $200,000 a year.  Furthermore, because the ACA failed to index the NII tax to inflation, millions of additional taxpayers will be subjected to this tax in the future due to “bracket creep.” 

S corporations in particular are affected by the NIIT.  The tax targets passive ownership – read “savers” — so S corporation shareholders who don’t work at the business would have to pay the tax.  But S corporations are only allowed a single class of stock, which in practice means that all distributions have to be pro rata to the ownership interest.  The result is that S corporations with passive shareholders must increase their tax distributions for all their ownership, increasing the distributions and draining capital from the company.

The bottom line for the NIIT is that it’s a tax on the majority of taxable savings in the United States – savings we need to provide the capital for the future.  As S-Corp wrote when the tax was first announced:

Finally, while the tax has been described as applying to the “unearned” income of only a few taxpayers, it is actually a direct tax on the majority of taxable savings in this country.  In 2007, households with incomes exceeding $200,000 accounted for 47 percent of all interest income, 60 percent of all dividends, and 84 percent of all capital gains reported on tax returns.     

The $200,000 threshold is not indexed for inflation, so these numbers have only gotten worse since 2010.  The result is the tax is a significant drag on employment and wages.  According to the Tax Foundation:

Repeal would raise employment by 133,000. The economy would be 0.7 percent larger, and wages about 0.6 percent larger. The income gains would be spread over all income levels. After-tax incomes in the bottom 80% of the income distribution would be about 0.65% higher than with the tax in place. They would share in the gains.

So the NIIT was enacted without debate or any public review, it raises the cost of capital throughout the U.S., it taxes middle class families and Main Street businesses, and it reduces jobs and wages.  It needs to go, and it needs to go as part of health care reform.

S-Corp Testifies

S-Corp President Brian Reardon testified yesterday before the Senate Small Business Committee in a hearing entitled “Tax Reform: Removing Barriers to Small Business Growth.”  As Inside Sources reported:

The hearing primarily focused on ensuring small businesses are considered in the current push to lower corporate tax rates. The Small Business Administration found that small businesses make up a sizable portion of the national economy at 49.2 percent of private-sector employment.

“As we all know, our tax code is in need of reform,” New Hampshire Democratic Sen. Jeanne Shaheen, the ranking member of the committee, said at the start of the hearing. “As Congress considers tax reforms, we need to make sure small businesses are at the table.”

The S-Corp testimony focused on themes familiar to S-Corp readers, including the fact that pass through businesses like S corporations employ the majority of private sector workers, so that any effort to reform the tax code should start with those businesses in mind.

Testifying

You can watch the full hearing here

In addition to tax reform, the testimony touches on other important consistent S-Corp priorities like the S Corporation Modernization Act and the withdrawal of Treasury’s proposed 2704 regulations.  Asked about how we ended up with one of the worst tax codes in the world, Brian made the case for action:

Back in 1986, when we last reformed the code, we brought the corporate rate down from the high 40s down to 35 percent. At the time that was one of the lower tax rates in the developed world. I think the average for the OECD at that time was about 44 percent. Today the average for the OECD is down in the low 20s while we’re still at 35 percent. 

So we’ve been sitting still, both on rates and also this idea of a worldwide tax system. We tax our businesses on their earnings wherever they are made. Most countries in the last 10-15 years have moved to a territorial system. England did. You know, 10 years ago, England (UK) had the same problems we did — they had inversions, companies were moving overseas, they were losing to other countries…they completely revamped their rates, they cut the rates down, they moved to territorial, and now companies are moving to the UK not away from the UK.

You can read Brian’s full written remarks here.

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