After fifteen years of advocacy, one stimulus bill and three extenders, permanent built-in gains relief is just one short ride down Pennsylvania Avenue away from becoming law!
That’s because the Senate just voted 65-33 on passage of a tax extender bill that included numerous provisions important to the Main Street business community, clearing the way for it to go to the President’s desk, where he plans to sign it.
Getting these provisions made permanent is, to paraphrase Donald Trump, a HUGE deal, and should be the cause of celebration for businesses and tax professionals alike at holiday time. As Politico noted this morning:
Make sure to take extra notice of your surroundings, tax wonks. Because after today the world is likely to look a lot different, with so many of the more popular tax extenders removed, in some cases, from decades’ worth of a stop-and-go cycle.
“Stop-and-go” is an understatement. In just the past three years, key portions of the tax code, including small business expensing, the research and experimentation credit, our built-in gains relief, and dozens of other provisions taxpayers rely on have simply expired, twice, for the better part of an entire year, only to be reauthorized, retroactively and at the last minute, by Congresses eager to get home for the holidays.
We’re doing that again right now, only included in the package is language making the most important of these extenders permanent, so we won’t have to write this story next year! We’re confident you are as tired of reading it as we are of writing it.
Before we get to next steps, a note of thanks is in order for our terrific champions on the hill – including Representatives Reichert, Kind, Tiberi, Paulsen, and Neal and Senators Hatch, Cardin, Roberts, and Thune. In the trade world, we marched shoulder to shoulder with allies over at NFIB, ACEC, ABC, AGC, ICBA, the Beer Wholesalers, the Wine & Spirits Wholesalers, the National Grocers Association, the Multi-Housing Council, and others. It’s been a long road, and we’re ecstatic it’s coming to an end.
As for next steps, there are numerous ways to improve how S corps are taxed, including the rule prohibiting foreign investment in S corporations. That rule makes no sense, and precludes the S corporation community from an important source of capital. You can bet we’ll be up on the Hill pushing for relief from that restriction and others with the goal of making it’s easier for S corporations to raise capital, hire new employees, and succeed at their business.
We will also continue to press for tax reform that treats the pass-through community fairly! Cutting corporate rates while keeping rates on S corporations and other pass-through businesses high is not tax reform – it’s the exact opposite. So we’ll spend 2016 working with our allies in the business community to educate tax writers and make sure they understand just how important Main Street businesses are to jobs and investment in this country.
That’s it for now. Expect lots more from us in 2016 and beyond. Thanks to everyone for their support, and we sincerely hope everyone has the best of holidays in the coming weeks!
Negotiators agreed to a package of tax and a package of spending provisions last night, and the big news (pun intended) is that the 5-year recognition period for built-in gains (BIG) – something S-Corp has been championing for more than a decade – is made permanent in the tax package! We’re also happy to see that another priority, a basis adjustment to ensure S corporation owners can receive full charitable deductions on contributions, is also made permanent in this package!
The process from here is that the packages introduced last night will be held over for a couple days so members can review them, and then vote on them separately in the House. We understand that a vote on the extender package will occur tomorrow, and the spending bill on Friday.
Then, in a move not wholly unusual for this time of year, the House would combine the two packages into one “message” and send them to the Senate. The combo message accomplishes two things – it means there’s no debate on the motion to proceed (since messages from the House are privileged) and it means there’s only one bill to filibuster, not two.
As a result, the Senate could receive the bill on Friday and vote that day if everyone cooperates, or run the clock on cloture and vote on final passage Sunday or early next week if they don’t.
That’s the process. What’s in the package? As we reported several weeks ago, the tax extenders portion has been divided into three parts – those provisions made permanent (R&E tax credit, small business expensing, built-in gains, etc.), those extended for five years (bonus depreciation, CFC look-through, etc.) and those extended for 2015 and 2016 only (everything else). You can read the full list here.
We don’t do spending here at S-Corp, so we won’t bore you with those details, but both the tax and spending package include a number of extraneous provisions that may be of interest to the business community, including:
- Lifting the long-standing ban on oil exports;
- A two year suspension of the medical device tax, as well as the two year delay in the Cadillac tax and annual fee on health insurance providers;
- REIT-related provisions based on items included in Ways and Means Chairman Brady’s recent proposal, but with further modifications and a transition rule; and
- Technical changes to the recently adopted partnership audit rules.
Left out of the package were efforts to roll back the Labor Department’s pending fiduciary duty rule or to raise the SIFI threshold for regional banks. We expect a number of these provisions to raise concerns with specific groups, so it will be interesting to see how the leadership in the House and the Senate cobble together majorities for both the tax and the spending bills.
That said, the tax package represents a major step forward for tax policy and how S corporations are treated. It gets the business community off the extender rollercoaster we’ve been on for the past three decades while setting the table for broader tax reform in 2017. We’ve been asking for permanence for years, and now it appears we’re just a couple of days away from getting it. You can bet S-Corp and our allies will be on the Hill with a message of just how important it is for Congress to enact this package.
Ahead of the extender deadline, S-Corp was on the Hill testifying yesterday that Congress needs to act to end the extender roller coaster and make permanent these provisions, including the built-in gains relief that affects so many of our S corporations. At a hearing hosted by the House Small Business Committee entitled “Tax Extenders and Small Businesses as Employers of Choice” S-Corp was represented by Tom Nichols, Chairman of our Board of Advisors.
Tom opened his remarks by highlighting the important role pass-through businesses play in employment and job creation, and then focused on a number of specific actions Congress could take this month to ensure they continue in this role, including making permanent the shorter, five-year holding period for the built-in gains tax. As Tom noted:
Delaying confirmation of the five year built-in gains tax period has similarly destructive consequences. In the past several years, small business owners have asked me repeatedly whether the five-year or ten-year period will apply. The only response I could give them is that the final built-in gains period will “probably” be five years, but that they can’t count on it.
This has created a number of excruciatingly difficult situations for my clients. For example, several of my farming clients were attempting to sell agricultural land – either to raise capital or to finance their pending retirement – while farmland prices were at their peak. Unfortunately, for those in the critical 6 to 10-year “limbo” period, this uncertainty constituted a huge stumbling block, and now it appears that the optimal time for selling is gone.
I had another client who wanted to sell his business, but could ill afford to do so if the double-tax built-in gains regime was applicable. I recommended that he and the buyer reach agreement and have all the documents prepared, but wait until actual passage of the extenders legislation to sign and close the deal. His response was that he was in poor health and may not be able to wait.
As with expensing, a five-year period for the built-in gains tax is well supported by policy considerations. The built-in gains tax was originally enacted in the Tax Reform Act of 1986 and was intended to prevent C corporations from converting to S Corporation status and selling some or all of their business subject only to the single-tax S Corporation regime. To be honest, I have never understood why paying only one tax upon the sale of a business was considered a loophole to be closed. Regardless, it is generally recognized that a ten-year waiting period is much longer than necessary in order to achieve the initial policy goal. Given the uncertainties and vagaries of conducting business, business owners are extremely unlikely to elect S Corporation status with concrete plans to sell after waiting for a period of five or more years.
You can read Tom’s written analysis here. Small and closely-held businesses play an invaluable role in creating jobs where they are most needed, despite all of the unnecessary obstacles imposed on them by Washington. But it doesn’t have to be so difficult. Failing to make business extender items like built-in gains permanent is a wholly unforced error that this Congress has the ability to fix. Talks are going on right now. Let’s hope they come to a happy conclusion.
Pass-Through Tax Rates
More on the effective tax rates pass-through employers pay. Sitting next to Tom at yesterday’s hearing was Todd Kriegel, the CEO of Global Precision Parts. Todd’s company has a profile that many S-Corp members will find familiar—a family-owned, S corporation manufacturer with 200 employees split across three locations in Indiana and Ohio.
Also familiar to S-Corp readers is how the Fiscal Cliff resulted in a massive tax hike on Todd’s business:
GPPs current federal effective tax rate is 39.4%, far higher than our C-Corp counterparts, not to mention the Chinese companies who we really are competing against. In 2008, we had a 28.07% effective federal tax rate with the Alternative Minimum Tax. That 11.33% jump in our tax liability cost us hundreds of thousands of dollars we could have used to hire more workers for the machines we would have purchased.
Just last April, S-Corp Board member Dan McGregor of McGregor Metalworking gave similar testimony on how the effective rate on his metal-working business jumped from 33 to 42 percent as a result of the fiscal cliff!
Following the resolution of the fiscal cliff, the top tax rate on my shareholders increased to approximately 41.4 percent due to the higher 39.6 percent marginal rate plus, where applicable, the new 3.8 percent Affordable Care Act tax and the effect of the reinstatement of the Pease limitation on itemized deductions. As a result, today we have to distribute approximately 42 cents of every dollar earned so our shareholders can pay the federal, state and local S corporation tax.
Dan and Todd employ hundreds of well-paid manufacturing workers in communities — like Springfield, Ohio and Wabash, Indiana — that desperately need jobs. And they are being forced to compete not only with Chinese companies that play by an entirely different set of rules, but also with domestic C corporations that enjoy significantly lower tax rates. The CEO of Pfizer complains about his 25 percent effective rate? We’re guessing Dan and Todd would swap with him in a second.
Any reform of how we tax business income needs to begin with Main Street businesses.