S-Corp Mod Bills Introduced! 

Good news on a hot day in July!  The 2016 version of the “S Corporation Modernization Act” has been introduced the House and the Senate.  Led by Senators Thune (R-SD) and Cardin (D-MD) and Representatives Reichert (R-WA) and Kind (D-WI), the bill includes a half-dozen provisions designed to improve the rules that govern S corporations.

  • You can see the entire bill here
  • You can see the section-by-section analysis here
  • You can see the S-Corp press release here

Yesterday’s introduction of companion bills is the first time in a while that the S corporation community has had this important legislation being championed in both bodies, and we really appreciate the hard work the members and their staffs put in to get the provisions just right.

Of particular note is the fact that Senator Thune is taking on the leadership of the bill from Finance Committee Chair and longtime S corporation advocate Senator Orrin Hatch (R-UT).  South Dakota has a ton of S corporations and ranks second nationally in pass-through employment, so this effort is important to Senator Thune and his state and we look forward to his enthusiastic leadership.  As he noted at the introduction:

Family owned small businesses are the backbone of the U.S. economy and can be located in every corner of the country.  Small towns and rural communities are oftentimes the ideal location for these small- and medium-sized businesses, which is why making these common-sense reforms to S corporations is so important to South Dakota.

Senator Ben Cardin added:

S corporation businesses are critical to the well-being of the Maryland economy and account for more than half of our state’s private-sector workforce.  Unfortunately, our federal tax code has not kept up with the increasingly important role that these types of companies play,” said Cardin.  “The S Corporation Modernization Act contains much-needed changes to the tax treatment of S corporations, allowing them to better attract capital, create jobs, and make charitable investments in their communities.

Key changes in this version relative to past efforts include:

  • Dropping the two provisions – BIG and charitable – that were made a permanent part of the Tax Code last December
  • Moving the Nonresident Alien provision up to the top slot – it is time for direct foreign investment to be available to S corporations; and
  • Including the new internal basis adjustment provision to ensure that S corporation assets receive similar treatment as partnerships.

So your S-Corp team has a new bill, new champions, and new priorities to accomplish in the coming months and years.  The legislative outlook is uncertain, with Congress preparing to break for the party conventions and then, after a short fall session, the November elections.  That doesn’t leave us much time, but as always we will be looking for opportunities to get something done.  With a terrific bipartisan set of advocates on the Hill, we are in a good position to do just that.

 

S-Corp Concerns Dominate 385 Comments

The comment period is closed and the verdict is in – just take S corps out.  That’s what numerous trade associations and other groups recommended to Treasury regarding the pending section 385 regulations.  Here’s what the National Association of Manufacturers had to say:

The proposed regulations also significantly impede the ability of businesses organized as subchapter S corporations to utilize their cash effectively. In particular, the bifurcation rule in the proposed regulations, which allows the IRS to treat a debt instrument as part debt and part stock, could cause a subchapter S corporation to lose its S status and become taxed as a C corporation.

In order to qualify as an S corporation, an entity must have only one class of stock (identical rights to distribution and liquidation proceeds) and must be owned only by eligible shareholders (examples of ineligible shareholders include C corporations, foreign corporations, partnerships, insurance companies and non-resident aliens). The reclassification to stock, or part stock, could inadvertently create an ineligible S corporation shareholder (e.g., if the debt reclassified to stock was held by a C corporation, the C corporation would become an ineligible S corporation shareholder); and/or the reclassification to stock could create a second class of stock via preferred return consideration on the debt instrument….

The proposed regulations do not apply to corporations filing a consolidated tax return. S corporations under common ownership, however, are not permitted to file a consolidated tax return and thus, the proposed regulations apply to commonly-owned S corporations, even those with solely domestic activity. The NAM strongly recommends that subchapter S corporations be exempted from the final regulations.

Other groups made similar arguments and their conclusions were just as strong.  Here’s just a sample:

American Bar Association

Exclude S corporations from the expanded group.

National Retail Federation

We recommend that S corporations be exempted from the application of the regulations.

American Institute of Certified Public Accountants

Provide exceptions to ensure that S corporations do not inadvertently terminate their status when debt is reclassified as equity.

Florida Bar

The rules should exempt S corporations which clearly cannot be a focus for the issues of concern regarding the Proposed Rules.

KPMG

Exclude S corporations, as well as certain other entities, from the ambit of the proposed regulations (i.e., revise Prop. Treas. Reg. § 1.385-1(b)(3)(i)(A) so that it only “turns off” paragraph (3) of section 1504(b)).

The IRS is holding a public hearing on the proposed rules today.  Of the 18 speakers listed, many of them are from groups that support excluding S corporations from the rule.  We’ll be watching closely to what, if any, reaction there is from the Treasury and IRS officials in attendance.  More to come.

Thune Files S-CORP Amendment

More good news on the tax front.  Senator John Thune (R-SD) has filed an amendment making permanent two key S corporation reforms.  Joined by Senators Ben Cardin (D-MD) and Pat Roberts (R-KS), the Thune amendment would make permanent the shorter, five-year recognition period for built-in gains as well as an improved basis adjustment for charitable contributions by S corporations.

The text of the amendment is identical to the text of H.R. 4453 and H.R. 4454, legislation sponsored by Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) that passed the Ways & Means Committee earlier this month and are due to be considered by the House of Representatives in coming weeks.

As with the Reichert/Kinds bills, a large coalition of business organizations wrote in support of the Thune amendment.  The letter, signed by the American Trucking Association, the Associated Builders and Contractors, the S Corporation Associations, and twenty-one other organizations, closes, “On behalf of America’s Main Street business community, we respectfully ask that you support the Thune amendment and permanently extend the 5-year recognition period for built-in gains.”

The Thune/Cardin amendment would makes changes to the tax extenders package currently being considered by the Senate, That package already includes two-year extensions of the BIG and charitable provisions, but it faces an uncertain future.  Earlier reports suggested Republicans would vote en bloc against closing out debate to protest their on-going inability to offer amendments on the Senate floor.

The latest news, however, suggests that Republicans may support closing debate in order to ensure that the extender package keeps moving through the legislative process.  As National Journal reported earlier today:

Usually when Majority Leader Harry Reid prevents Republicans from offering amendments, GOP senators block the underlying bill. At least, that was how Republicans handled the recently dispatched energy-efficiency bill, which went down earlier this week.

“There’s probably a lot more support among Republicans for tax extenders than there perhaps was for energy efficiency,” said Sen. John Thune of South Dakota, the chamber’s No. 3 Republican.

The difference, according to lawmakers, is that some of the roughly 60 provisions in the tax-extenders package benefit constituents in some way. Thune also said that members view extending current tax policy differently than they do enacting new energy legislation.

“I just think you’re talking about tax policy,” Thune said. “You’re talking about extending tax policy. And many of them are things that our members are supportive of.”

The tax provisions that expired at the end of 2013 are extremely popular with the business community and, now that tax reform has been set aside, the only real opportunity to see them extended would be for the House and the Senate to come together on a package and send it to the President.  With strong leadership in both the House and the Senate, these two S corporation provisions are well positioned to be part of that package.

Moving on Extenders

Extenders are back in play in the House and Senate.  Finance Chairman Ron Wyden (D-OR) plans to release his package Monday, with amendments due on Tuesday and markup to begin on Wednesday.

Details of the Wyden plan are not available, but early indications are that his package will include most of the tax provisions that expired at the end of 2013 and that they will be extended for both 2014 and 2015.  It doesn’t appear that the Chairman plans to offset the revenue loss of the package unless there are more modifications to the language than a simple date change.

Meanwhile, on the House side, Ways and Means Chairman Dave Camp (R-MI) sent a letter to his colleagues outlining his plan for addressing extenders.  As the letter states:

As such, beginning in April, the Committee will continue its work by going policy by policy to determine which extenders should be made permanent.  That process will include both hearings and markups. Specific dates and topics will be forthcoming.   

Reading between the lines, it appears the Ways and Means Committee will hold hearings on extenders beginning in April to examine the provisions more closely, followed by the introduction of an extender package and consideration by the Committee.  After the examination, we should expect a package that focuses on permanent extensions – keeping in line with the principle of tax reform.

For S corporations, there are a couple items at play here.  First is the extension of built-in gains (BIG) relief, which expired at the end of 2013.  With the expiration of the 5 year BIG holding period, thousands of S corporations that have converted from C corporation status now have to hold on to their appreciated assets for an entire decade or face the BIG corporate-level tax. This causes a prohibitive tax burden where the applicable federal, state and local shareholder taxes exceed 60 percent in many states.   This punitive tax effectively forces these businesses to “lock-up” their assets and capital, inhibiting future investments in the business and employees, as well as potential job creation.

Our Senate champions, including Sen. Ben Cardin (D-MD) and Sen. Pat Roberts (R-KS) who recently introduced legislation together to permanently extend the 5 year recognition period (S. 1855), are steadfast in their support and have called for BIG relief to be part of any extender package that moves forward.  As the snap-back to 10 years is an excessive amount of time to reasonably ask a company to hold a particular asset, Congress has agreed to extend the 5 year period several times and we have had strong bipartisan support for this important relief for many years.

The second item is the extension of the basis adjustment to stock of S corporations making charitable contributions of property, a provision that also expired at the end of last year. With flow-through entities, charitable deductions flow through to the individual tax returns of partners or shareholders.  Prior to the Pension Protection Act (PPA) of 2006, however, if an S corporation made a contribution of appreciated property to charity, its shareholders’ deductions were limited to their basis in the S corporation.  To encourage more charitable giving by S corporations, the PPA temporarily removed this limitation, allowing shareholders to take into account their pro rata share of charitable deductions for contributions of appreciated property.  The provision has been extended with bipartisan congressional support ever since.  It brings consistent treatment of charitable contributions between flow-through businesses, and would allow for America’s S corporations to be more active and supportive of needed charitable activities.

Permanent extensions of these provisions have, of course, been included as part of the S Corporation Modernization package for several congresses – most recently introduced by Reps. Dave Reichert (R-WA) and Rep. Ron Kind (D-WI), as H.R. 892 in the House last year.

Both permanent extensions were included in Chairman Camp’s tax reform discussion draft, along with other S Corporation Association priorities.  The draft would also increase access to capital by extending ownership of an S corporation to non-resident aliens through an electing small business trust (ESBT), ensuring payment of tax at the trust level (at the highest individual tax rate), easing punitive restrictions that apply to converted S corporations regarding passive income limitations, and punishing the unwary with S corp status termination.  Lastly, the draft would encourage philanthropy from S corporations by conforming the rules applicable to ESBTs and individual shareholders of an S corporation.

We plan to keep a close eye on this extender process – particularly our S Corp priorities – and look forward to seeing Chairman Wyden’s package on Monday.

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