Letter from Chairman Simmons

Dear S-CORP Member:

As the President of a multi-generation family business, the question Ibm often asked is bWhy has the McIlhenny Company stayed private all these years?bB Why, indeed.

We do face limitations as a family-owned S corporation.B We pay higher tax rates on our business income and we have limited access to the capital markets.B Unlike Apple, we canbt borrow money every time we pay a dividend.B Dividends come from earnings, or they donbt come at all.

But being a family business is part of our identity.B It means every decision we make is made here at the local level rather than at bcorporate headquartersb in another state or another country.B Selling Tabasco to a corporate interest would mean turning our backs on our community, its history, and its people.

Thatbs not just a McIlhenny story b itbs an S corporation story.B The S corporation was created by Congress 50 years ago to encourage closely-held and family-owned businesses and to diversify Americabs commercial sector.B Congress recognized the value of having economic decision-making spread across the country.B Diversification is good for investors, and itbs good for our employment base too.

The S corporation experiment has been an amazing success.B Five decades after their inception, there are more than 4.5 million S corporations, and they employ one out of every four private sector workers.B That means that every day, some 30 million Americans get up and go to work at a business where the decisions that affect their future are made by people working and living in the same community.

So the S corporation is more than just a tax structure for organizing your business.B It is a revolutionary means of helping closely-held businesses — and the communities they serve — thrive and grow in an increasingly competitive world.

One of the goals of the S Corporation Association is to ensure policymakers understand this history and the role S corporations play in todaybs economy.B Therebs a tremendous amount of misinformation out there, which is why S-CORP has invested in original research to help tell our story, including key facts like:

  • Businesses organized as S corporations and partnerships employ the majority of private sector workers.B Small business is bigger than big business in the United States.
  • S corporations pay the highest level of tax of any business structure b more than 30 percent!B Far from being btax freeb as the Wall Street Journal once charged, S corporations pay their fair share, and then some.
  • High tax rates on S corporations and C corporations alike cost Americans jobs b lots of them.B According to our research, the higher taxes imposed in last yearbs fiscal cliff will cost us more than 700,000 jobs in the coming years.

Armed with these facts, the S Corporation Association has led the charge to make certain policymakers in Washington, DC understand the important role private business ownership plays in job creation and business investment.B In recent years, S-CORP has:

  • Organized DC trade groups to be the voice of the pass-through business community during the tax reform debate;
  • Positioned our S Corp Modernization Act (H.R. 892) to be included nearly word for word into the Chairmanbs tax reform plan;
  • Championed the reduction of the built-in gains holding period to 5 years and moved the provision from an after-thought to an annual tax expenditure item;
  • Twice defeated efforts to expand payroll taxes on S corporations; and
  • Organized exporters and defeated efforts to repeal the IC-DISC benefit.

Pretty good stuff from a trade association named after part of the Tax Code.

Looking forward to 2014, we plan to build on this success by expanding our membership –the more members we have, the larger our voice — while increasing our advocacy efforts before Congress.B Like the mouse that roared, we will be heard on tax reform, extenders, and other tax issues important to our membership.

What can you do to help?

  • Renew your membership for 2014.B S-CORP is not flashy, and we donbt have lots of bells and whistles.B What we do have is great advocacy, and advocacy starts with our members.B Renew today!
  • Spread the word.B Our best ambassadors are our members.B Let other private businesses in your community know about S-CORP and the important work that we do.

Again, I am deeply appreciative of your support and look forward to working with you in 2014 to defend the greatest vehicle for private enterprise ever invented — the S corporation.

Sincerely,

Tony Simmons
Chairman, The S Corporation Association
President & CEO, The McIlhenny Company

 

To download Chairman Simmons’s letter, please click here.

Senate Finance Committee Shakeup

Yesterday we got word that Senate Finance Committee Chairman Max Baucus is headed to Beijing to serve as the next Ambassador to China. For tax policy, the move changes our outlook in the following ways.

First, it increases the focus on a possible extenders package early in 2014. Baucus made clear in his comments yesterday that he plans to spend the rest of his time as Finance Chair seeking to move an extenders package. It shouldn’t take more than a month or two for his nomination to move through the Senate, but that should give him time to get something started on that front. It’ll still be an uphill effort, but movement in the Senate would invariably increase the odds that something gets adopted.

Second, Baucus’ early departure has implications for the tax reform discussion. Baucus had committed to taking up reform in 2014 and was in the middle of rolling out a series of discussion drafts outlining his approach. Changing Captains mid-stream can only as a set-back, at least in the short term. But a closer review suggests the move could enhance reform’s long-term prospects. As Roll Call observed yesterday:

The expected nomination of Sen. Max Baucus as ambassador to China will almost certainly diminish the near-term prospects for overhauling the tax code by removing one of the strongest proponents of a tax rewrite from the Senate. But the potential elevation of Sen. Ron Wyden to replace Baucus as chairman of the Senate Finance Committee may bring new impetus to the effort over the long haul.

Roll Call goes on to note that Senator Wyden of Oregon has a long history of producing bipartisan reform plans on big topics like health care and tax policy. He also has more support within his conference generally, and with Majority Reid in particular.

Attached is the Wyden-Coats plan he introduced last Congress, as well as a video of their rollout here. (It was the Wyden-Gregg plan two congresses ago.) We reviewed the plan back in 2011 and found it to be a mixed bag for S corporations. Eliminating the individual AMT is helpful, but separating the top rates on pass through businesses and corporate income is not. For now, however, our key takeaway is less about the details and more about the fact that Wyden has the ability to craft plans that are both bipartisan and interesting conceptually. It’ll take something like that to see any progress in the Senate.

Finally, the move increases the odds Democrats retain the Senate next year. If Wyden does take over Finance, then Senator Mary Landrieu would take his place as Chair of the Energy & Natural Resources, which can’t hurt her reelect effort in Louisiana, while Senator Mark Pryor (D-AR) likely would take over the Small Business Committee leadership, which can’t hurt his reelection efforts in Arkansas. These are marginal items no doubt, but with the Senate majority in play next November, every little adjustment makes a difference.

Built-In Gains Introduced in the Senate

Finally, many thanks to our S-CORP Senate allies Ben Cardin (D-MD) and Pat Roberts (R-KS) for an early holiday present! They’ve reintroduced their bipartisan legislation, S. 1855, to retain the shorter holding period for built-in gains (BIG).

As many of our readers know, the 5-year holding period for built-in gains expires at the end of the year along with the rest of the tax extenders, so that beginning next year, S corporations would need to hold onto appreciated assets for 10 years before selling them, or face a punitive level of tax.B S. 1855 would retain the more reasonable 5-year holding period and make it permanent.

Senators Cardin and Roberts have been instrumental in moving this important reform forward throughout the years, and we hope the introduction of this legislation will help build momentum for the provision to get extended again early next year.

By our estimate, the expiration of the 5-year holding period will lock up the assets of thousands of S corps across the country next year – resulting in them having less liquidity to make new investments and create jobs. Under the rules, if they do sell these appreciated assets within the 10 year window next year, they will face a punitive tax of around 60 percent of any gain they realize. Most companies in this position choose to simply hold on to the asset, resulting in the locked-in effect which is particularly detrimental to privately-held businesses like S corporations with limited access to the public markets.

So thanks for the holiday treat! We’ll be pressing hard for this important reform to get considered in the New Year!

Tax Reform Rehash

The release of Finance Committee tax reform discussion drafts on cost recovery and international tax have laid bare a reality that’s been hiding just below the surface for two years now the visions for reform embraced by the key House and Senate tax writing committees are dramatically different and move in opposite directions.

The international drafts are a good example. The Ways and Means draft would move the tax treatment of overseas income towards a territorial system, while the Baucus draft would move towards a more pure worldwide system by largely eliminating deferral. Here’s how the Tax Foundation described it:

Of the 34 most advanced countries, 28 use a territorial tax system, while only 6, including the U.S., use a worldwide tax system with deferral. No developed country imposes a worldwide tax system without deferral, though some have tried it with near disastrous effects.

Exactly how the two committees could bridge these broad differences in vision is unclear.

For pass-through businesses, the differences are just as stark. Neither committee has released details on overall rates or the treatment of pass-through businesses, but both have made clear the general direction they plan to take.

The Ways and Means Committee seeks comprehensive reform where the top rates for individuals, pass- through businesses, and corporations would be lowered and the differences between them reduced, helping to restore the rate parity that existed from 2003 to 2012. Other provisions in Chairman Camp’s draft would seek to close the differing treatment of partnerships and S corporations, creating a stronger, more coherent set of pass-through rules.

Finance Chairman Max Baucus, on the other hand, appears to actively oppose rate reductions for individuals and pass-through businesses even as he constructs his reform package around a core of cutting rates for C corporations. The inherent inconsistency of lowering corporate rates to make US businesses more competitive while simultaneously defending significantly higher rates on pass-through businesses is stark. The Baucus draft does make a vague reference to “considering” the impact on pass-through businesses, but it is clear that consideration amounts to nothing more than increased small business expensing or something similarly limited.

So the Finance Committee would cut corporate rates and ask S corporations and other pass through businesses to help pay for them. In the end, C corporations would pay a top rate of 28 or 25 percent, while pass-through businesses would pay rates 13 to 20 percentage points higher.

How do they justify this disparate treatment? The double tax on corporate income is often raised as leveling factor. As the Washington Post recently reported, “Today, the Treasury estimates, as much as 70 percent of net business income escapes the corporate tax.”

But “escaping” the corporate tax is not the same as escaping taxation. The simple fact is that pass through businesses pay lots of taxes, and they pay those taxes when the income is earned. The study we released earlier this year found that S corporations pay the highest effective tax rate (32 percent) followed by partnerships (29 percent) and then C corporations (27 percent on domestic earnings).

These findings include taxes on corporate dividends, so some of the double tax is included. They do not include capital gains taxes due to data limitations. Including capital gains would certainly close the gap between C and S corporations, but enough to make up 5 percentage points of effective tax? Not likely. Meanwhile, the study focused on US taxes only, so it doesn’t attempt to capture the effects of base erosion or the ability of C corporations to defer taxes on foreign income for long periods of time.

All in all, the argument against pass through businesses is based on some vague notion that these businesses are not paying their fair share. The reality is just the opposite. By our accounting, they pay the most. That means that, all other things being equal, today’s tax burden on S corporations makes them less competitive than their C corporation rival down the street.

Real tax reform would seek to make all business types more competitive by lowering marginal rates while also helping to level out the effective tax rates paid by differing industries and business structures. That’s the basis behind the three core principles for tax reform embraced by 73 business trade associations earlier this year: reform should be comprehensive, lower marginal rates and restore rate parity, and continue to reduce the double tax on corporate income.

These principles are fully embraced by Chairman Camp and the Ways and Means Committee. They appear to have been rejected by the Finance Committee. Which begs the question: What exactly is the goal of the Finance Committee in this process? Is it just to raise tax revenues? You don’t need “reform” to do that.

Whatever their goal, the gap between the House and the Senate is enormous, and unlikely to be closed anytime soon. Chairman Camp continues to press for reforms that would improve our tax code, but he’s going to be hard pressed to find common ground with what’s being outlined in the Senate.

Extenders

With the timeline for tax reform being pushed back, there is a bit more discussion of what to do about tax extenders. The whole package of more than 60 provisions expires at the end of the year and to date there’s been little discussion regarding how or when to extend them. As the Tax Policy Center noted this week:

It isn’t unusual for these mostly-business tax breaks to temporarily disappear, only to come back from the dead a few months after their technical expiration. But this time businesses are more nervous than usual. Their problem: Congress may have few opportunities to continue these so-called extenders in 2014. This doesn’t mean the expiring provisions won’t be brought back to life. In the end, nearly all will. But right now, it is hard to see a clear path for that happening.

While the future is murky as always, a few points of clarity do exist:

  • Nothing will happen before the end of the year. The House will recess this weekend and not return for legislative business until mid-January. Even if it took up extenders promptly after returning, which is highly unlikely, the soonest an extender package can get done would be February or March.
  • Coming up with $50 billion in offsets to replace the lost revenue will also be a challenge. Congress is tackling a permanent Doc Fix right now, which requires nearly three times that level of offsets. Coming up with an additional $50 billion will not be easy.
  • The lack of an AMT patch also is hurting urgency for the package. Congress permanently addressed the Alternative Minimum Tax earlier this year, which is good news, but that action also removed one of the most compelling catalysts for moving the annual extender package. Annually adopting the AMT patch protected 20 million households from higher taxes. That incentive is now gone.

All those points suggest that the business community has a long wait before it can expect to see an extender package move through Congress.

Or does it? One of the most popular extenders is the higher expensing limits under Section 179. This small business provision allows firms to write-off up to $500,000 in capital investments in 2013, as long as their overall amount of qualified investments is $2 million or less.

Beginning in 2014, these limits will drop to $25,000 and $200,000 respectively.

You read that correctly. Starting January, business who invest between $25,000 and $2 million in new equipment will no longer be able to write-off some or all of that cost in year one. Talk about an anti-stimulus. Coupled with the loss of bonus depreciation, the R&E tax credit, and the 5-year holding period for built in gains, and the expiration of extenders will have a measurable effect on the cost of capital investment for smaller and larger businesses alike.

This reality is beginning to sink in both on Main Street and the investment community, where certain industries rely on these provisions as a core part of their business plans in coming years. It’s too soon to see how much momentum the loss of these provisions will generate in coming months, but cutting the expensing limit from $500,000 to $25,000 in one year is bound to attract somebody’s attention.

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