S-CORP Clips | Week of December 12

A compilation of the business tax related stories that caught our eye

Hatch Tax Reform Report

For weeks, there had been K Street rumors of a “secret” tax reform plan being put together by in-coming Finance Committee Chairman Orrin Hatch (R-UT).  Apparently, the “Comprehensive Tax Reform for 2015 and Beyond” report released yesterday is it, although it’s not so much a plan as an analysis of the current code and the challenges policymakers will face in reforming it.  After a quick review, it’s obvious the Finance Republican staff spent an enormous amount of time and effort putting this together and it shows.  As our friends at Politico summarized:

Before lawmakers can reform the tax code, they need to understand it.

Towards that end, incoming Senate Finance Committee Chairman Orrin Hatch released a nearly 350-page report today on all-things tax reform.

It traces the history of the tax code, and efforts to reform it, as well as issues ranging from patent boxes to refundable credits to the case for moving to a territorial system, along with what, exactly, is a territorial system.

From the pass-through business community’s perspective, there’s lots to like here, particularly the report’s emphasis on integrating the corporate code with the individual code to eliminate the double tax on corporate income.  We’ve been advocating for corporate integration for years.

The report also advocates for comprehensive reform, another priority of the Main Street business community.  Here’s what it says:

Tax reform also needs to address the more than 90 percent of U.S. businesses organized as pass-through entities, such as partnerships, S corporations, limited liability companies and sole proprietorships. According to recent data, approximately 58 percent of all net business income in the United States is earned by pass-through entities.22 If real estate investment trusts and mutual funds are included as pass-through entities, then the percentage rises to 78 percent.23 Because of these numbers, it is important that we approach tax reform in a comprehensive manner, addressing both the individual and corporate tax systems. As the data show, both systems are intertwined and must be looked at in the whole.

On the other hand, the report does signal just how much work the pass through community has in educating policy makers on the importance of pass through businesses to jobs and investment.  The chapter on business tax issues is wholly dominated by corporate concerns, while the subchapter on pass through tax issues is only three pages long.  More on this to come. 

Inversions

Ryan Ellis of Americans for Tax Reform reminds us in his recent Forbes article that corporate inversions are driven by bad tax policy, not bad corporations.  He writes:

To say the least, the United States has not created a friendly tax environment for our largest employers.  They face the highest marginal income tax rate in the developed world (whether they are corporations with a 40 percent rate or flow-through firms with a nearly 50 percent rate).

…There should be a giant notice at the top of every business tax form released by the IRS which says, “Get out of our country, and take your jobs and capital with you.” Corporate inversions are a natural and a regrettable side effect of this treatment.”

Extender Recap

Last month, your S-Corp team was popping champagne corks when we learned that congressional leaders had reached an agreement to make permanent several of our priorities – including the five-year built-in gains holding period – as part of a broader extenders package.  We then had to put the corks back in the bottles (not easy) when a preemptive veto threat from the White House dismantled the deal.

We are now left with Plan B – an extension of expired provisions for tax year 2014 only.  The legislation, which was passed last week by the House, retroactively renews the provisions going back to the start of 2014 and would therefore expire just a few weeks after passage.  So starting January 1, we’ll be right back at it.

Charitable

This week the White House further demonstrated its aversion to permanent tax provisions when it issued a veto threat against legislation that would lock in three charitable provisions.  According to the Hill, the bill would “…permanently extend preferences for donations of excess food inventory; waive some limitations for donations of land to conservation easements; and make permanent a provision allowing tax-free donations from Individual Retirement Account funds.”  That package is now dead too.

 

S-CORP Clips | October 1-10

A compilation of the business tax related stories that caught our eye

 

Administration on Tax Reform

The President’s economic advisors have been unusually busy in recent weeks.  National Economic Council Director Jeffrey Zients was firm in his conviction that tax reform could get done in the new Congress, citing the “remarkably overlapping” approaches of Obama’s plan and the Camp draft.

It is true there are some common themes in the Camp and Administration proposals, but also there are major – and fatal – differences as well, including:

  • The Camp Draft is budget neutral while the Administration’s plan would raise revenue;
  • The Camp Draft adopts a territorial tax system while the Administration appears to strengthen our world-wide system; and
  • The Camp Draft is comprehensive while the Administration plan would reduce rates on corporations only – an approach rejected by Democrats and Republicans alike.

Add to those differences the fact that the Administration’s draft landed with a thud when it was released back in 2012 and has barely been discussed since, and the idea of House Republicans and the Obama Administration coming together on tax reform in the next Congress seems laughably remote.

Meanwhile, Council of Economic Advisers Chair Jason Furman spoke in New York the other week on tax reform, offering additional context to the Administration’s tax reform proposal and addressing some of the concerns that have been raised.  We’ll have more to say about this later, but this paragraph caught our eye:

On the economic merits, it is important to remember that C corporation income is partially taxed at two levels while pass-through income is only taxed at one level. As a result, today C corporations face an effective marginal rate that is 6 percentage points higher than that on pass-through businesses. Although the President’s Framework would cut and simplify taxes for small business, including small pass-through entities, for larger businesses we should be moving towards greater parity—with the goal of equal effective rates on an integrated basis, a goal that would not be served by parallel reductions in individual and corporate tax rates.(Emphasis added)

That’s not exactly true.  Recall that our study on effective tax rates released last year found that S corporations face the highest effective tax rate of any business type.  Those estimates were based on real businesses and actual tax returns.

The numbers Jason is referring to are based on hypothetical future investments.  They can be found in a three-year-old Treasury analysis under the heading of “Effective Marginal Tax Rates on New Investment.”  Jack Mintz authored a comprehensive critique of these estimates for the Tax Foundation last February, some of it pretty damning.

For our purposes, we will just point out that Treasury’s analysis, correctly done, would be appropriate if you wanted to measure the tax burden on marginal investment decisions – should we build that new facility, should we buy that piece of equipment, should we use debt or equity? – but it doesn’t support the notion that C corporations today pay a higher effective rate than pass-through businesses.  You need to estimate average effective tax rate to make that claim, which is what our study does.

Jason is right to point out that the double tax on corporations hurts US competitiveness.  That’s the reason the pass-through business community advocates for its reduction as an essential goal of tax reform.  There’s little point in reforming the tax code if the result doesn’t reduce the tax on investing in the United States, and the best path to achieving that is to tax business income once at reasonable rates and then leave it alone.  That’s how S corporations are taxed today, and real reform would move C corporations in that direction.

 

Ryan on S Corporations

Contrast the Administration’s approach with that of Representative Paul Ryan (R-WI), a leading contender to take the gavel as the next Chairman of the Ways and Means Committee.  He recently gave a speech at an event hosted by the Financial Services Roundtable in which he made clear the importance of improving the tax code for all businesses, including S corporations and other pass-through businesses. Here’s what he had to say:

“Tax reform is one of those things that we don’t know if we’re going to be there at the end of the day, because we want to make sure that, as we lower tax rates for corporations, we do the same for pass throughs.

You know, a lot of people in the financial services industry – banks – are subchapter S corporations.

Where Tim [Pawlenty] and I come from, “overseas” is Lake Superior, and Canadians are taxing all of their businesses at 15 percent. And our subchapter S corporations, which are 90 percent of Minnesota and Wisconsin businesses, are taxed at as high as a 44.6 percent effective rate.

So we have to bring all these tax rates down, but we have a problem with the Administration being willing to do that on the individual side of the tax code.”

We’ve been beating the “comprehensive tax reform” drum for three years now and it’s nice to see key policymakers embrace the message.

 

American Progress on S Corp Payroll Taxes

Meanwhile, Harry Stein of the Center for American Progress is out published a report with broad recommendations on how to best reform the tax code. Among its suggestions is one to close the “Edwards-Gingrich loophole,” an issue we’ve covered extensively in the past. On that subject, the S Corporation Association has developed the following position:

  1. We don’t support using the S corporation structure to avoid payroll taxes.  We represent businesses that comply with the law, not sneak around it.
  2. It’s not a loophole, its cheating.  This issue is often described as a loophole, but that’s not accurate.  Underpaying yourself in order to avoid payroll taxes is already against the rules.
  3. The IRS has a long history of successfully going after taxpayers who abuse the S corporation structure.  The current S corporation rules on this have been in place since 1958.
  4. Any “fix” needs to improve on the current rules.  That means they need to be easier to enforce and they need to target wage and salary income only.  Employment taxes should apply to wages only, not investment (including business) income.

 

New Finance Committee Chair

February 14, 2014

Senator Ron Wyden (D-OR) took the helm of the Finance Committee this week.  What does this mean for tax policy?  Here’s what the press has to say:

  • The Hill tells us he blames Republicans for gridlock on tax reform;
  • Roll Call says he’s the “most liberal [Finance Chair] ever”;
  • Forbes says he wants to level out rates on ordinary and investment income; and
  • Politico observes he has a “penchant for big ideas.”

Beyond that, a couple consistent items do stand out.  First, it appears the new chairman is with us on the need for comprehensive, rather than corporate only, reform.  As the Hill writes:

But Wyden also appeared to break with many Democrats on some areas of tax policy. Wyden suggested it would be “a challenge” to reform just the corporate code, as Obama has suggested, because of the businesses that pay taxes as individuals.

Here’s Politico Pro:

But Wyden said the proposal put forward by President Barack Obama to reform just the corporate side of the code, a plan Republican critics say ignores small business that file as individuals, has “challenge[s].”  “We’ll look at that, but here’s the challenge. Most businesses are not what are called C corporations, which is where the concern has been. Most of them are sole proprietorships, hot dog stands, barber shops, partnerships, so it is very hard to bite off just one piece of it,” he said.

Another area of consistency in the reporting is Wyden’s short-term focus on moving an extenders package.  As readers know, a grouping of more than fifty tax provisions, collectively called the tax extenders, expired at the end of last year, including key provisions like the R&E tax credit, 179 expensing, and the shorter built-in gains holding period.  Wyden has made clear moving an extenders package is his first priority.

Finally, mostly liberal or not, the press is in agreement that Wyden has a long history of working across the aisle and crafting big, bipartisan reform bills.  As Forbes put it:

That makes Wyden sound like a standard progressive Democrat. But his record is much more complex. For instance, Wyden has bucked his own party’s leadership by reaching across the aisle to lawmakers such as House Budget Committee Chairman Paul Ryan (R-WI) on Medicare reform.

Wyden likes big ideas, but he is also a pragmatist. His challenge as the new chair of the Finance Committee will be to mix the ambitious with the realistic. That’s what Bob Packwood, the last Finance Committee chair from Oregon, did when he helped pass the Tax Reform Act of 1986.

S Corporation Numbers Hit Record High

The growth rate of the S corporation community has slowed in recent years, but it is growing nonetheless.

According to the IRS, there were 4.6 million S corporations in 2012, up from 3.3 million ten years ago. These numbers come from the agency’s data book that tracks the total number of tax returns filed and breaks them down by type.  The 4,579,669 subchapter S returns filed for 2012 are the most in the fifty years of S corporations.

Looking at past reports, a couple of interesting points pop out.

The top location for S corporations is California, right?  Nope – it’s Florida with nearly 600,000.  California is a distant second at 443,000.  Other states with lots of S corporations include Texas, Illinois, Pennsylvania, and Georgia.

California might catch up to Florida if its growth trend keeps up, however.  Over the last decade, its S corporation population has grown by 84 percent – the fastest in the country – while Florida has grown at a more typical rate of 37 percent.  The slowest S corporation growth has been in the business hostile Northeast (New Jersey lost 6 percent of its S corporations) and, surprisingly, the Midwest (Indiana and Ohio saw just 7 percent growth).

It is obvious the financial crisis took its toll on S corporation creation, just like other forms of businesses.  There were 4,440,001 S corporations in 2008, but only 4,579,669 million three years later, a growth rate of just thirty-five thousand per year.  Compare that to a growth rate of 300,000 to 400,000 per year a decade or so ago.

Where do all these new S corporations come from?  Some are existing businesses that convert from C corporation status, and some are new business formations.  Back in 2003, the IRS broke down the growth rate thus:

For Tax Year 2003, some 342.9 thousand corporations elected subchapter S status for the first time. Of these, 252.8 thousand were newly incorporated businesses. The remaining 90.1 thousand elected to make the conversion from a taxable corporation to an S corporation.

So of the 34,000 new S corporations for 2012, how many were new and how many converted?  We don’t know, because for some reason the IRS stopped doing detailed reports on S corporations back in 2003.  So the top lines numbers in the Data Book are all we have.  That, and 4.6 million S corporations!

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