2704 and Family Businesses

Remember the Obama Administration’s family-business valuation rules?  They were proposed back in August and resulted in such a backlash from the family business community that Treasury received nearly 29,000 comments during the 90-day comment period.  That’s a record as best as we can tell.

So where do the rules stand now?  Here’s the latest.

Two weeks ago, President Trump signed an Executive Order calling on Treasury to review all “significant tax regulations” issued last year and 1) identify those that are burdensome, complex or exceed Treasury’s authority, 2) issue a report within 60 days listing those identified rules, and 3) issue an action plan within 150 days on what Treasury plans to do about them.  Here’s what it says:

Addressing Tax Regulatory Burdens.  (a)  In furtherance of the policy described in section 1 of this order, the Secretary of the Treasury (Secretary) shall immediately review all significant tax regulations issued by the Department of the Treasury on or after January 1, 2016, and, in consultation with the Administrator of the Office of Information and Regulatory Affairs, Office of Management and Budget, identify in an interim report to the President all such regulations that:

(i)    impose an undue financial burden on United States taxpayers;

(ii)   add undue complexity to the Federal tax laws; or

(iii)  exceed the statutory authority of the Internal Revenue Service.

This interim report shall be completed no later than 60 days from the date of this order.  In conducting the review required by this subsection, earlier determinations of whether a regulation is significant pursuant to Executive Order 12866 of September 30, 1993, as amended (Regulatory Planning and Review), shall not be controlling.

(b)  No later than 150 days from the date of this order, the Secretary shall prepare and submit a report to the President that recommends specific actions to mitigate the burden imposed by regulations identified in the interim report required under subsection (a) of this section.

The 2704 valuation rules easily fit within the EO’s description of targeted rules.  They are obviously burdensome, confusingly complex, and the case can be made that they exceed Treasury’s authority under Section 2704.  A trifecta worthy of Churchill Downs.

Meanwhile, Team Trump continues to press for full repeal of the estate tax.  As Trump’s lead at the National Economic Council Gary Cohn stated the other day:

We are going to repeal the death tax. The threat of being hit by the death tax leads small business owners and farmers in this country to waste countless hours and resources on complicated estate planning to make sure their children aren’t hit with a huge tax when they die. No one wants their children to have to sell the family business to pay an unfair tax.

So we expect 2704 to be on the target list released by Treasury in the next couple months and the action plan released later in the year.  Since the rules are merely pending and not finalized, the obvious action is for Treasury to simply withdraw them.  No action by Congress or the President is required, which makes this an easy win for the Trump Treasury team and a significant relief to the family business community across the country.  More on this to come.

 

Tax Foundation and the Kansas Straw Man

Our friends at the Tax Foundation are generally rock solid on tax policy, but they missed the mark in a recent Politico piece.  Several of their economists took a look at the situation in Kansas, where the Governor several years ago cut the pass through tax rate to zero, and applied those lessons to the pending Trump Administration proposal to cut tax rates on corporations and pass through businesses alike down to 15 percent.  According to them:

Small-business advocates have suggested that these proposals will help create tax rate parity between pass-throughs and C-corporations by taxing them at the same rate. But these arguments ignore that corporate income is taxed twice, at both the business level and the shareholder level—for a combined tax of more than 50 percent. Lowering the corporate rate and continuing to tax pass-throughs at the individual income tax would move the U.S. tax code closer to treating all income equally. Enacting a lower tax rate specifically for pass-throughs would do the opposite.

Problem is, none of this is true.  Neither the S Corporation Association nor the Parity for Main Street Employers coalition has endorsed the Trump plan, partly because we still don’t understand it and partly because it’s hard to see how the math works.

We don’t ignore the double tax on C corporations, either.  Our tax reform principles letter, signed by 120 national Main Street trade groups, has just three key principles, one of which is to eliminate the double tax on C corporations. Far from ignoring the double tax, we made its elimination one of our goals in tax reform.

And finally, that corporate tax of “more than 50 percent” belongs in the fiction section.  Yes, if you add the 35 percent corporate rate with the 23.8 percent shareholder rate, you get a combined rate that high, but very little business income is ever subject to the classic double corporate tax.  As we pointed out back in January, the Tax Foundation’s own numbers show that less than 10 percent of all business income is even potentially subject to the double tax.

So the Tax Foundation is fighting straw men.  To be sure, the Tax Foundation is not alone in raising these points.  The Tax Policy Center has published several posts on the tax rate parity issue – here and here, for example.  These papers suffer similar challenges – they ignore the economic harm of the double corporate tax, they take it on faith that C corporations pay more than pass through businesses, and they ignore the gaming opportunities C corporations will have under the new, low rate structure.

The simple fact is that the business community has largely abandoned the classic model of business taxation.  Most C corporation shareholders don’t pay taxes, most C corporations don’t pay dividends, and most business income is earned under the pass through structure.  Any reform pushing companies back into the harmful double corporate tax is a step backward, not forward.

The correct way to tackle tax reform is to tax all income once, tax it when it is earned, tax it at similar reasonable top rates, and then leave it alone.  The business community is already there and it’s time for the tax code, and our think tank friends, to catch up.

 

Treasury Nominee Disappears

What ever happened to David Kautter?  Wasn’t he going to be named to be the next head of tax policy over at Treasury?  Politico and other outlets reported that over a month ago.  Since then, nothing.  No announcements, no nominating papers, nothing.

Which is too bad, because not only does Treasury need the help, but Kautter appears to understand the importance of Main Street businesses to jobs and economic growth.  In 2014, he testified as an expert to the Small Business Committee at a hearing on “The Biggest Tax Problems Facing Small Businesses.” You can read his entire written testimony here, but his section on the need for a single layer of taxation for business is worth highlighting:

“As part of the process of broadening the tax base and lowering the corporate tax rate, I believe the time has come for Congress to consider a single tax rate schedule for all business income no matter what legal form a business uses to conduct business. Given the importance of small businesses to our economy, it makes little sense that income earned by unincorporated businesses (which tend to be small businesses) is subject to tax at the higher individual rates while income earned by corporations is taxed at lower corporate rates.”

He concludes with this:

“In short, what is needed is “business tax reform” not simply corporate tax reform. A single business rate schedule would move us toward a more comprehensive system of business taxation – one that applies to all businesses equally across the board. If done right, it could ease the tax burden of small businesses while increasing simplicity and fairness. And ultimately, that could provide small businesses with some of the relief they need in order to compete and thrive.”

Couldn’t have said it better ourselves.  Now if we could just find him.

2704 Comment Period Closes Big

The official comment period on the proposed Section 2704 regulations closed yesterday, with nearly 10,000 comments filed!  You can review those comments here, but a cursory review this morning made clear they were nearly unanimous in their opposition to the Treasury action.

Eventually, all the comments submitted will be accessible at the regulations.gov website, but until then, here are some of the more significant comment letters we’ve seen.  Definitely worth a read if you have clients or businesses affected by the proposed rule:

The Small Business Administration’s Office of Advocacy also weighed in on the regulations. The Advocate is an independent office charged with representing the small business community before Congress and the federal government, particularly through the application of the Regulatory Flexibility Act (RFA).  According to the Advocate:

The Regulatory Flexibility Act (RFA)… gives small entities a voice in the rulemaking process.  For all rules that are expected to have a significant economic impact on a substantial number of small entities, federal agencies are required by the RFA to assess the impact of the proposed rule on small entities and to consider less burdensome alternatives.

In certifying that the 2704 rules would not impact small businesses, Treasury argued that “any economic impact on entities affected by section 2704, large or small, is derived from the operation of the statute, or its intended application, and not from the proposed regulations in this notice of proposed rulemaking.”  It also argued that the rules would “affect the transfer tax liability of individuals who transfer an interest in certain closely held entities and not the entities themselves.”

The former argument represents a novel legal approach that would effectively gut the RFA by exempting all regulatory implementations of statutes, while the latter argument is simply a hoot—we’re just taxing the owners of small businesses here, not the businesses themselves.  We don’t buy it, and neither does the Office of the Advocate.  They recommend Treasury go back and conduct a proper economic assessment like they were supposed to.

Meanwhile, the Ways and Means Republicans released a letter today expressing their strong opposition to the rules.  24 committee members signed the letter, which states:

These proposed regulations as drafted represent a dramatic change from past practice and history and are not consistent with congressional intent. In order to avoid immediate and substantial economic harm to family-owned businesses and the jobs they create, these regulations should be withdrawn. Any new proposal in this area should be clearly defined and narrowly targeted within the reach of the applicable statutory rules.

With Congress returning for a Lame Duck session in two weeks, the Ways and Means letter will help us rally House members in opposition to the rule.

Looking forward, the IRS is hosting a public hearing on December 1st where we expect dozens of business representatives to come speak out against the rule.  S-Corp will be there, together with many of our allies.  Following that, the official comment period is over and Treasury will need to wade through all of the comments and address them fully, either by stating clearly why they disagree or by redrafting the rules to address the suggested changes.

Can this all be accomplished prior to the end of the Obama Administration?  Treasury officials argue no, while the political people at Treasury and the White House are less reassuring.  The White House has embraced a policy of getting as many rules out the door as possible, so we continue to operate with the possibility that these 2704 rules are part of the last-minute rush.  We hope that’s not the case, but it’s just too important to take chances.

S-Corp Submits Valuation Comments

Yesterday, the S Corporation Association submitted its formal comments to the IRS on the pending Section 2704 valuation rules.  You can read all 15 pages of comments here, but the basic message of the submission was that Treasury should discard this effort and start over.  As the comments conclude:

Promulgation of the Proposed Regulations in their current form and scope will generate significant uncertainty and constitute a significant impediment for the continuity of family-controlled businesses.  The Proposed Regulations inappropriately and illegally discriminate against family controlled businesses in form and effect.  If Treasury is inclined to promulgate regulations to address perceived abuse, those regulations should be targeted in scope, capable of reasonable application and administration, and consistent with Congress’s intent, as set forth in § 2704 and the legislative history of Chapter 14.  The Proposed Regulations do not satisfy any of those conditions.

The comment period for these proposed regulations doesn’t end until November 2nd, but already Regulations.Gov reports there have been more than 3200 comments submitted, with many more expected prior to the deadline.  The NFIB-NAM letter to Treasury Secretary Jack Lew had more than 3800 signatories, so this issue is getting people’s attention.

Meanwhile, Treasury Officials continue to speak to groups and make the following two points:

  • The proposed rules are not nearly as far-reaching as what outside experts have reported; and
  • It is highly unlikely that the IRS and Treasury will be able to finalize these rules prior to the end of the Obama Administration.

We take these points seriously, but are still left with the reality of what Treasury proposed back on August 2nd.  As our comments make clear, what Treasury printed in the Federal Register is a very broad proposal that would largely eliminate the consideration of control and marketability for a wide swath of family businesses when valuing them for gift and estate taxes.  The result goes well beyond what Congress enacted back in 1990 and would be a significant hike in taxes on those family businesses, leading to fewer family businesses and a further consolidation of economic power with large, publicly-traded companies.

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