Recap of a Busy Week in Tax Policy

Patent/Innovation Box

Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) unveiled their proposed “innovation box” legislation aimed at keeping intellectual property registered in the United States. The bill would lower the rate on qualified income from patents and intellectual property to 10 percent, but only for firms with domestic R&E expenses. Similar laws already exist in Europe, and there are signals that this could become part of a Ways and Means international tax package later this year. Here’s Chairman Ryan on the proposal:

The proposal from Reps. Boustany and Neal can help us stem the tide and protect good American jobs. It will also help ensure the United States continues to be the world’s leader in innovation. Their plan would allow American businesses to better compete with foreign companies and keep their research and development facilities here in the U.S. This is just one piece of international tax reform, but it’s an important one. I applaud Charles and Richie for their work, and look forward to refining the proposal as we move forward on a broader plan to make America more competitive and promote high-paying jobs.

Senators Rob Portman (R-OH) and Chuck Schumer (D-NY), who authored the Senate Finance Working Group report on international reform, were also supportive. You can read their respective statements here. With support in both chambers, it appears the innovation box will be a factor in international tax negotiations later this year.

As the proposal currently stands, it doesn’t appear as if innovative pass through businesses would be eligible for the innovation box. The sponsors have made clear that the legislative text released this week is a “draft” and that they are eager for input.  We will be working with the rest of the pass through community to coordinate our comments and make sure S corporations are well represented.

 

Highway Bill & Patent Boxes

Why release the patent box draft now, just before the long August recess? We believe the goal was two-fold.  First, it is a genuine effort to get feedback on the proposal, which is a new concept for the Ways and Means Committee and they’d like to get the policy right.  Second, it helps to keep the ball moving on Chairman Ryan’s two step plan to getting international tax reforms done this year – pass a short term highway extension now and follow it up with a bigger package of highways and international tax reforms this fall.  The innovation box idea is a key “sweetener” in the larger international package, so getting it out now helps to move the overall plan forward.

For the past year, Ryan’s goal has been to combine highways, international reforms, and tax extenders into one big package Congress would enact at the end of 2015.  He believes the general desire by both parties to get a highway bill done can help push his international package over the finish line.

Senate Majority Leader McConnell, on the other hand, thinks any plan to reform taxes with this President in office is doomed to fail and wanted to get highways done and off the table at least through the elections.  So McConnell proposed to do long-term highways now with little in the way of tax policy, while Ryan advocated for addressing highways in December with as much international reform as he can muster.

The three-month extension adopted by Congress this week represents a compromise between the two positions.  It means Congress will have to revisit the issue prior to December, but it also keeps alive Ryan’s international reform efforts.

 

Built-In Gains Relief Introduced in Senate! 

Good news!  Sens. Pat Roberts (R-KS) and Ben Cardin (D-MD) introduced legislation Thursday to provide a permanent five-year recognition period for built-in gains (BIG) assets.

We’ve been advocating on BIG for years and, even after all of the leadership changes in Washington, DC over the past several elections, built-in gains relief continues to receive strong bipartisan support in both chambers. We are glad that Congress has recognized the importance of such relief by continuing to extend temporary relief – as included in the tax extender package recently adopted by the Senate Finance Committee.  Permanent BIG relief, however, is the only way to offer business owners the certainty they need, so we’ll keep working to get the Roberts/Cardin bill across the finish line.

Also in the Senate this week, the Small Business Committee adopted a “Sense of the Committee” resolution endorsing legislation introduced by Committee Chairman David Vitter (R-LA) that includes “sting” tax repeal!  Eliminating the “sting tax” has been a priority of the S Corporation Association for years and it’s a key part of the S Corporation Modernization Act introduced by Representatives Reichert (R-WA) and Kind (D-WI) last month.

Fixing this particular passive income rule has been long overdue—in fact, the Joint Committee on Taxation recommended the repeal of this termination rule back in 2001!  As with permanent BIG relief, we plan to spend this fall pushing the tax writing committees to adopt Sting Tax relief as part of any tax legislation moving this year.

 

Hillary Clinton Proposes Tax Hikes on S Corps

In her bid to reform so-called “quarterly capitalism,” presidential candidate Hillary Clinton proposed this week to hike the capital gains tax on investments held less than two years to the top individual rate of 39.6% (plus the 3.8% net investment tax), or nearly double the tax today. Under her plan, the tax rate would gradually decline for investments held between two and five years, while investments held six years or longer would get the current 20% rate.

So while all of Washington, including the Obama Administration, is working on ways to reduce the tax on investment and encourage more companies to remain here in the US, candidate Clinton would increase the cost of domestic investment instead.  Clinton did add that capital gains would be eliminated for select long-term investments in small businesses. That doesn’t sound bad, but it begs a few questions. What is her definition of “small business”? How long would the investment need to be held?

Moreover, if lower capital gains for small businesses would stimulate long-term investment, why limit it to small businesses?  Why not reduce or eliminate the capital gains rate on all domestic investments, as Senator Rubio has proposed? As the Wall Street Journal points out, this proposal may do little more than distort investment decisions in the short-term and prevent the efficient allocation of capital:

A high and sliding tax-rate scale also harms the efficient allocation of capital by expanding what economists call the “lock-in effect.” If owners of capital must wait years to pay a lower tax rate, many will decline to realize their gains solely for tax purposes. This artificially reduces the mobility of capital.

Economic growth is enhanced when capital is able to efficiently find its highest return. “Buy and hold” often works well for individual investors in specific stocks. But no economic theory says one- or two-year investments are worse than 10-year, and sometimes they’re better.

Worst of all, this would leave owners of pass-through businesses on the hook for corporate “quarterly capitalism.” Since many pass-throughs are family-owned through multiple generations, they’re already making the kinds of long-term investments that Clinton is looking to promote. Her campaign has said she is committed to producing a full tax plan, and we’ll be sure to analyze it when it becomes public.

S Corp Provisions on House Floor

Last Friday, longtime S-CORP allies Rep. Dave Reichert (R-WA) and Rep. Ron Kind (D-WI) introduced two pieces of legislation – H.R. 629 and H.R. 630 – to extend tax provisions critical to America’s 4.6 million S corporations.

The bills would make permanent the five-year built-in gains holding period as well as a basis adjustment fix for S corporations making charitable contributions.  They build off the momentum from last Congress when identical bills successfully passed the House with broad bipartisan support. These provisions are ones that we’ve championed for years, and go a long way towards making the tax rules for Main Street businesses fair and predictable.

In a joint press release, Rep. Reichert had this to say:

S Corporations are proven job creators and it is our job as legislators to make sure the tax code helps them to access the capital they need to grow, remain competitive and help get Americans back to work. I am pleased to introduce these bipartisan pieces of legislation with my colleague Congressman Kind, because our tax code should encourage growth rather than stifle it. I look forward to working with my colleagues to advance policies that help our small businesses create jobs and support families across the country.

Rep. Kind also added:

These commonsense, bipartisan bills will bring stability and simplicity to the tax code to make it easier for many small businesses to create good jobs and help sustain local communities. There are nearly 60,000 S Corporations in Wisconsin alone, so supporting these job creators is a top priority as we work to strengthen the economy in Wisconsin and across the country.

The broad support these provisions have garnered from the business community and lawmakers reflects the sentiment that these outdated tax rules just don’t make sense and permanent changes need to be made. H.R. 629 would allow S corps increased access to their own capital by providing for a permanent, five-year BIG holding period, rather than the current ten-year period these businesses must endure before they can dispose of appreciated assets without paying a prohibitive tax.  As S-Corp Advisor Jim Redpath testified before the Ways and Means Committee last year:

I find the BIG tax provision causes many S corporations to hold onto unproductive or old assets that should be replaced. Ten years is a long time and certainly not cognizant of current business-planning cycles. Many times I have experienced changes in the business environment or the economy which prompted S corporations to need access to their own capital, that if taken would trigger this prohibitive tax. This results in business owners not making the appropriate decision for the business and its stakeholders, simply because of the BIG tax.

H.R. 630 is another common sense reform that would encourage S corporations to give back by permanently ensuring S corporations are able to deduct the full value of the stock they donate to charity.  This provision would level out the tax treatment of such donations between S corporations and partnerships.

Improving and making permanent the rules for the businesses that drive our economy is critical and we applaud Reps. Reichert and Kind for once again introducing this legislation.  We are looking forward to seeing the bills considered and adopted by the House!

Highway Bill, Extenders, and the Tax Outlook for the Rest of the Year

The pending debate over highway spending has tax implications and the pass-through business community should pay attention.

The Highway Trust Fund will run out of money in the next couple weeks and both the Senate and the House are planning a two-step response — a short-term patch that will keep highway projects funded into next year and then longer bills that would establish highway policy for the next couple years.

How to allocate all those dollars for roads and bridges is always a complicated and politically charged affair.  So is how to pay for it.  Finance and Ways and Means both are expected to hold markups tomorrow on their respective plans.  Here are the offsets for each:

  • Ways and Means:  $11 billion in offsets from pension smoothing ($6.4 billion), customs user fees ($3.5 billion), and transferring funds from the Leaking Underground Storage Tank fund ($1 billion)
  • Finance:  No final deal yet, but it looks like they are shooting for $10 billion in offsets including mortgage reporting ($2.2 billion), extending the statute of limitations on overstatement of basis ($1.3 billion), and a host of other items.

Considering the alternatives — gas tax hike, tolls on interstate highways — this set seems pretty tame.  That said, the debate over the highway bill should serve notice to the business community that while tax reform may be on hold, Congress will continue to look to tax policy to offset some of its other priorities, so we need to be vigilant.

Meanwhile, action on extenders and related items continues at a low level.  This week, the House will take up a permanent 50 percent bonus depreciation bill.  While bonus depreciation is not really an “extender,” it does keep the focus on all those expired provisions, and it’s not bad policy either.  Coupled with the higher Section 179 limits, the bill goes a long way towards moving the tax treatment of business investment towards general expensing, something many economists have argued is good for the economy.  As the Tax Foundation noted:

We find that permanently extending this provision would boost GDP by over 1 percent, wages be 1 percent, and create 212,000 new jobs due to its effects on the cost of capital. It would also increase federal tax revenues by $23 billion after taking into account the increases wages and incomes caused by making bonus expensing permanent.

Extending R&E, Section 179, and built-in gains — either permanently or for several years — would be good for the economy too.  These provisions already expired at the end of last year (2013), so every day Congress waits is a day of benefit lost.  When Congress does act, it will make the extension effective back to January 1st, but it will be hard to argue that business investment increased in 2014 because of higher Section 179 limits that weren’t retroactively extended until this December, won’t it?  The behavioral effect will be lost.

Moreover, any extension that is less than two years (2014 and 2015) would require Congress to come back next year and perform the exercise all over again.  How Congress expects businesses to use these provisions to their advantage when they keep expiring is beyond our ability to explain, and one of the best arguments behind Chairman Camp’s push to make them permanent.

Despite the strong case for action now, any meaningful movement prior to the elections would be shocking.  There’s only seven or eight weeks of session left before Congress recesses for the elections, and with the extenders already expired, we can’t see a real catalyst out there that would compel the House and Senate to come together on a package.

That’s too bad, and is just one more reason why both the tax code and the policy making process that creates it appear wholly dysfunctional.