Big Picture on Pass-Through Taxation

Our expectation for 2013 is continued guerrilla warfare on specific tax hike proposals coupled with the looming threat of larger tax hikes when Congress next addresses the debt limit. Add in the determination of both tax-writing committee chairmen to pursue comprehensive reform, and you have a good understanding of how we’re going to spend our time over the next year:

  • Working with the tax committees to make their tax reform proposals as business friendly as possible;
  • Fighting the Administration’s efforts to turn tax reform into another opportunity to raise taxes on Main Street Employers; and
  • Fighting specific proposals to unfairly target S corporations and raise their taxes through discrete provisions like the payroll tax hike.

The President’s State of the Union address this week did little to change this outlook. In a world where 99 percent of policymakers agree that tax reform means lower marginal rates imposed on a broader base of income, the President’s view (illustrated by last year’s corporate reform proposal and his continued support of higher marginal rates) is just the opposite – higher marginal rates coupled with more special interest tax provisions. It’s the same anti-tax reform perspective offered by Senator Chuck Schumer late last year.

It’s this difference in perspectives that’s behind the pessimism over whether Congress will tackle tax reform this year. The gap appears just too large for Congress to find common ground and it would require a very, very large catalyst to bridge it.

Well, it’s possible that just such a catalyst is right on the horizon. The combination of sequestration cuts starting next month and the need for Congress to raise the debt limit before the August break is just the sort of ”rock and a hard place” scenario that could compel action.

Here’s why. The pain, political and otherwise, from the sequestration cuts will not be felt immediately but will instead grow over time. Each month will bring additional stories of how the cuts are adversely affecting Americans and US policy. Meanwhile, we know from experience that the House of Representatives will resist raising the debt limit without some sort of accompanying deficit reduction package.

So, starting this summer, Congress will be under tremendous pressure to revisit the sequestration cuts at the same time the tax-writers are talking tax reform and the House is insisting on additional deficit reduction. All while Congress is facing a deadline to extend the “must-pass” debt limit.

For these reasons, we’re taking tax reform seriously. The debt limit-tax reform scenario may play out differently, but the risk is simply too great to do otherwise.

We Are All for Comprehensive Reform Now

Two years ago, the S Corporation Association undertook the effort to combat “corporate-only” tax reform. We support cutting the corporate rate, but tackling the corporate tax code in isolation is bad policy and bad politics, and with the help of our E&Y study on the subject, we were able to quantify just how bad it would be for businesses organized as pass-through businesses…”$27-billion-a-year-in-higher-taxes” bad.

House Ways and Means Committee Chairman Dave Camp has always understood this challenge and has been a consistent advocate for comprehensive reform. Recent comments by Senate Finance Committee Chairman Max Baucus suggest he too understands the important role pass-through businesses play in jobs and investment – at 69 percent, his home state of Montana has the highest percentage of pass-through employment in the nation, after all.

With his comments in the State of the Union, it appears the President too has converted to the church of comprehensive tax reform. Here’s what he said:

Now is our best chance for bipartisan, comprehensive tax reform that encourages job creation and helps bring down the deficit. We can get this done.

Of course, he coupled that statement with a call for raising tax rates on high-income individuals, raising taxes on the overseas operations of multinational corporations, and for continued use of the tax code to target specific industries and taxpayers, so we’re not getting too excited here.

But the word “comprehensive” remains significant. Until somebody says otherwise, we’ll assume this means the President has backed away from his corporate-only proposal of last year. Let’s hope so.

Sequestration Highlights Threat to Pass-Through Businesses

Efforts to replace the sequestration spending cuts have highlighted the on-going threat S corporations and other pass-through businesses face this Congress.

For example, on Tuesday, Senators Whitehouse (D-RI) Levin (D-MI), Harkin (D-IA) and Sanders (I-VT) introduced two bills to offset the sequester with tax hikes. The first includes tax increases necessary to postpone the sequester until October 1, while the second would raise the taxes necessary to replace it entirely. As you can see, it’s the usual suspects list of LIFO and Carried Interest tax hikes, etc.

Another list posted by Politico reported the other day includes even more items:

POSSIBLE SENATE DEM SEQUESTER REPLACEMENTS - These ideas are making the rounds:

1) closing off a variety of “offshore tax shelters”;

2) ending preferential tax treatment for many private equity and hedge fund managers;

3) taxing the exercise of stock options more heavily

AMONG THE REVENUE ESTIMATES

1) Closing Carried Interest (14 billion);

2) Closing Corporate Jet (4 billion);

3) Closing Oil & Gas Credits (21 billion)

4) Farm Direct Subsidies (5 billion);

5) Closing S Corp pass Through (76 billion);

6) New Sen. White House Tax Proposals;

a) Set Min Rate for Millionaires;

b) higher rates for Oil & Gas;

c) SubPart F changes: Focus on Passive Income, Transfer Pricing & Loans to Parent Co.

Again, it’s the usual list, but what is this?

5) Closing S Corp pass Through (76 billion);

Closing S corporations? $76 billion? That’s a new one, and the description is just vague enough that it could be anything. That said, the only S corporation tax item out there with $76 billion attached to it that we know about originates with a Congressional Budget Office report from December entitled, Taxing Businesses Through the Individual Income Tax.

Here’s the key sentence:

The Congressional Budget Office (CBO) estimates that if the C-corporation tax rules had applied to S corporations and LLCs in 2007 and if there had been no behavioral responses to that difference in tax treatment, federal revenues in that year would have been about $76 billion higher.

In other words, if Congress repealed the current tax status of around 7 million private companies and subjected them instead to the double corporate tax, the CBO says you might raise some money. But $76 billion a year?B Not likely:

Behavioral responses-for example, owners of S corporations might have reduced those corporations’ taxable income by reporting larger amounts for their compensation (which would have raised payroll taxes and lowered corporate income taxes relative to CBO’s estimate)-would have changed the amount of additional tax revenue that would have been collected. Furthermore, the estimate does not account for interactions with other tax provisions, such as the alternative minimum tax.

Later in the paper, the CBO makes clear such a policy would result in less investment, lower wages, and more debt:

Nevertheless, the trend toward pass-through entities’ accounting for a larger share of business activity has some positive aspects. For example, it has probably reduced the overall effective tax rate on businesses’ investments, thus encouraging firms to invest. (The effective tax rate combines statutory rates with other features of the tax code into a single tax rate that applies to the total income generated over the life of an investment.) The shift in activity toward pass-through firms has also reduced at least two biases associated with the current corporate income tax that influence what businesses do with their earnings and how they pay for their investments:

  • The bias in favor of retaining earnings rather than distributing them, which results from taxing dividends immediately but deferring the taxation of capital gains; and
  • The bias in favor of debt financing, which results from allowing businesses, when they calculate their taxes, to deduct from their income the interest they pay to creditors but not the dividends they pay to shareholders.

It’s clear to us that whoever added this idea to the list likely had no clue what they were proposing, but it’s also in indication of just how desperate some in Congress are for revenue that they would even list something like this.

Forcing 7 million businesses into the double corporate tax is simply bad policy. It moves the tax code in exactly the wrong direction – we should be reducing the double tax, not increasing it. That’s the way to reduce the cost of capital and make American businesses more competitive.

Tax Outlook

The conventional wisdom in the press is that the agreement on the fiscal cliff killed tax reform. By making permanent so many tax policies — including the AMT treatment and estate tax rules — the deal deprived policymakers of catalysts for doing something big on taxes later this year.

That view may prove correct, but there remain several good reasons to believe taxes will be a big part of the policy conversation moving forward, including:

  • Debt Limit: The debt limit fight hasn’t been avoided, just delayed. Congress will need to raise the limit prior to the August break, setting up a redo of the 2011 negotiations that resulted in $2 trillion in deficit reduction over ten years.
  • Budget Season: By delaying the debt limit fight, Congress put the focus back where it should be — on budgets and the long-term fiscal imbalance. The House, Senate, and White House will all need to produce their vision for federal spending and taxes this spring, helping to set the table for the debt limit fight to follow.
  • Sequestration: The odds of sequestration will take effect as written beginning March 1st ($85 billion in total cuts this year with $43 billion from defense and $11 billion from Medicare) are rising every day. Republicans are determined to keep the focus on spending, and alternatives that replace some or all of the cuts with tax hikes stand no chance in the House. That said, one or two months of sharp cuts to defense spending may be enough to convince Congress that it needs to replace the across-the-board cuts with more targeted ones.
  • The CR: And finally, Congress needs to extend funding for the government when the current continuing resolution expires on March 27th.

Congress will have to deal with each of these items, either individually or in some combination, before the start of summer, which begs the question: How does Congress get past all these fiscal hurdles without dragging tax policy into the discussion? Add in the fact that both the Ways and Means and Finance committees have made clear that reforming the tax code is a priority for 2013, and we’re confident that tax policy will be part of the mix one way or another this year.

What does that mean for S corporations? We see two distinct challenges moving forward.

The first challenge is to ensure that any broad-based changes to the tax code are a net positive for S corporations and other Main Street businesses. As our coalition letter from last year made clear, tax reform needs to be comprehensive, it needs to keep rates on corporate, individual, and pass-through income uniform and low, and it needs to continue to reduce the double tax on corporate income.

Any tax reform that claims to make American businesses more competitive will need to embrace those three goals.

Second, we need to continue to fight ad hoc efforts to raise taxes outside of tax reform. Congress is always hungry for revenues, and in recent weeks policymakers and left-leaning groups have released long lists of “revenue raisers” that include numerous threats to Main Street businesses, including:

  • Increasing payroll taxes on S corporation income;
  • Increasing the effective tax on inventories; and
  • Hiking the estate tax by increasing valuations of family-owned businesses.

As long as federal spending is out of control, this thirst for new revenues will continue and will follow the predictable path from press conference to signing ceremony — target a group of taxpayers, marginalize their legitimacy, and then push to raise their taxes.

Which means the response to challenges 1 and 2 is the same — we need to educate policymakers and the tax press on the economic and social value of S corporations. From our past studies, we know that one out of four workers wakes up every morning and goes to work at an S corporation. We also know that S corporations are in every state, every district, and every industry. Meanwhile, other studies show that S corporations already pay a very high effective tax.

Add it all up, and S corporations are a key and vital part of the local employment base in just about every community in America. Far from being marginal actors in the economy, they are one of its cornerstones.

S-Corp Payroll Tax 

Speaking of ad hoc efforts to raise taxes, the S corporation payroll tax hike is raising its head again.

In the past couple weeks, several left-leaning groups and policymakers have put forward wish lists of whose taxes to hike and by how much. Reports from the Senate Budget Committee Democrats, Citizens for Tax Justice (last year), and the Center for American Progress all encourage Congress to raise taxes on S corporations by making more of their income subject to payroll taxes.

Here’s the write-up from the Center for American Progress report:

Certain highly paid professionals sometimes take advantage of a tax loophole made infamous by former Speaker of the House Newt Gingrich (R-GA) and former Sen. John Edwards (D-NC). These professionals – lawyers, accountants, doctors, consultants, and entertainment professionals -form “S corporations,” whose profits are not subject to Medicare taxes and who characterize much of their income as profits of the business instead of salaries. Regular wage-earners can’t do this, and neither can the owners of other kinds of small businesses. Government watchdogs have flagged the S corporation loophole as an area of rampant abuse. Legislation introduced in the House and Senate in recent years would shut down this loophole, requiring these well-heeled professionals to pay their fair share into Medicare, which would raise $11 billion over 10 years.

Those who follow our efforts will understand that the issue before Congress is not one of loopholes but rather avoidance where the IRS has existing tools to fight it. The IRS already requires the owner/operators of S corporations to pay themselves reasonable compensation for their work at the business. Shareholders who underpay themselves in salary in order to avoid Medicare taxes can be and are successfully challenged.

For example, just last year the Eighth Circuit Court of Appeals ruled in favor of the IRS and against an Iowa CPA who was paying himself a minimal salary compared to his experience and efforts. According to the Court:

Here, the district court found that DEWPC understated wage payments to Watson by $67,044 based on the following evidence:(1) Watson was an exceedingly qualified accountant with an advanced degree and nearly 20 years experience in accounting and taxation; (2) he worked 35-45 hours per week as one of the primary earners in a reputable firm, which had earnings much greater than comparable firms; (3) LWJ had gross earnings over $2 million in 2002 and nearly $3 million in 2003; (4) $24,000 is unreasonably low compared to other similarly situated accountants; (5) given the financial position of LWJ, Watson’s experience, and his contributions to LWJ, a $24,000 salary was exceedingly low when compared to the roughly $200,000 LWJ distributed to DEWPC in 2002 and 2003; and (6) the fair market value of Watson’s services was $91,044. Based on the record, the district court did not clearly err.

So the IRS already has the authority and the tools to go after Gingrich and Edwards if they choose. Admittedly, these tools are “facts and circumstances based,” but so are the fixes proposed in Congress. The version that failed to pass the Senate last year is illustrative of the problem. For example, the proposal applies to:

Any other S corporation which is engaged in a professional service business if 75 percent or more of the gross income of such business is attributable to service of 3 or fewer shareholders of such corporation.

Exactly how is the IRS supposed to determine if 75 percent or more of the gross income is “attributable” to the “service” of three or fewer shareholders? Even if the test were made clearer, this standard might not bring in the revenue its authors claim. In the court decision referenced above, it’s doubtful the CPA would have tripped this test — according to the court record, he came nowhere near generating 75 percent of his firm’s gross revenues.

So the Senate was attempting to fix a problem by giving the IRS less effective tools than it already has, and this was going to raise $11 billion. Sure.

Which brings us back to the M.O. of tax-raisers listed in the first entry — identify a group of taxpayers, challenge their legitimacy, and then raise their taxes. They’ve spent the last decade trying to apply payroll taxes to more S corporation income. Too bad they didn’t spend more time getting the policy right.

President’s Budget Proposal Released Today

We don’t usually involve ourselves in spending debates but the President’s budget proposal came out this morning and, given the sea of red ink ahead, we thought a quick overview of the budget process and challenges ahead might be in order.

The President’s budget would reduce the deficit by $1.1 trillion over the next decade b- two-thirds from spending cuts and one-third from tax increases. The proposed budget would trim or terminate 200 federal programs within the next year, reduce Pentagon spending by $78 billion, freeze non-security discretionary spending for 5 years, and increase spending in education, transportation and energy and medical research.

The budget also offers a 3-year paid-for patch for the Alternative Minimum Tax and calls on Congress to work with the Administration on budget-neutral corporate tax reform. Tax increases include allowing the 2001 and 2003 tax cuts for high-income earners to expire beyond 2012 and limiting the value of the itemized deduction for those same earners. Importantly, the budget does not include specifics on the President’s corporate tax reform proposal or any entitlement spending reforms. You can view the entire budget here.

The budget comes during a week when House Republicans are preparing to debate spending cuts included in the Continuing Resolution (CR) to cover government funding for the rest of the current fiscal year. These cuts are far below what was projected in the past - $100 billion below the President’s FY2011 request and $61 billion below FY2010 spending levels - and their success or failure will strongly signal how much deficit reduction is possible this year.

The debate itself should be lively as they will consider the CR in an “open rule” process where members will be able to introduce amendments on the House floor without getting them pre-approved. Considering the high level of interest from the freshman class and other conservative Republicans on this issue, we expect even more spending cuts proposed on the House floor through the amendment process.

Next up on the budget, House Budget Chairman Paul Ryan is expected to begin working on his budget resolution due in April. The rolling-out of the budget should overlap with the CR debate, as Senate Democrats have vowed to block the controversial cuts included in the House Republicans’ CR  placing at risk a potential government shutdown if a deal isn’t struck by March 4th when the current-law CR expires.

Most likely, short-term CR extensions will continue to pass until negotiators strike a deal. Further complicating the FY2012 budget process is the fact that we’re running up against the debt ceiling. Conservative Republicans are insisting on structural budget reforms, and potentially additional spending cuts as their price for support raising the ceiling, if they support it at all.

That debate is scheduled to take place in the April/May time frame, and while there’s a lot of random speculation about possible government shutdowns and defaulting on the debt, the simple fact is that Treasury has numerous tools at its disposal to keep things running until the Congress takes action, so we expect a negotiated compromise coming out of this process, not a budget crisis.

Back to the President’s budget, several folks have observed that the Administration chose not to follow the recommendations made by his Deficit Commission late last year, but that doesn’t mean the policies put forward by that group are dead. Senators Mark Warner (D-VA) and Saxby Chambliss (R-GA) are working diligently to advance the Commission’s blueprint. They are working with a broad group of 31 senators (including those who served on the Commission) Durbin (D-IL), Crapo (R-ID), Coburn (R-OK), and Conrad (D-ND). The group is shooting to put together legislation along the lines of the Commission report and have it ready by the debt-ceiling debate.

So we have lots of movement on spending and deficits, and we have three significant budget events overlapping in the next couple months –  the CR funding the government for the remainder of this year, the budget resolution setting the spending and tax outline for next year and beyond, and the debt ceiling increase.

All of which suggests that by the time June rolls around, we’re going to have a really good idea whether Congress and the President are going to take real action and make progress to address the record deficits and fiscal crisis we face, or if, instead, gridlock will prevail and these issues will be pushed off until the 2012 elections. We’re voting for progress, but we’ll see.

Taxes in Budget and Rate Debate Ahead

We will spend the next year debating the details of the President’s tax policies included in the budget today, but here are some of the highlights that jumped out at us today:

  • The budget calls for revenues over the 2012-21 time frame to total $38.7 trillion, or about $1.3 trillion less than the CBO baseline. The difference is just about the same as the cost for extending the middle-class tax relief from the Bush tax cuts beyond 2012. Which means all the other tax cuts in the budget (the AMT patch, for example) are offset by revenues increases someplace else (curbing deferral for US multinationals, etc.)
  • The President is sticking with past positions and arguing for higher tax rates on upper income taxpayers, beginning 2013, where the top rate on those families and businesses will rise from 35 percent to 43.4 percent. (Remember, that’s the year the health reform bill’s 3.8 percent investment tax and .9 percent Medicare tax take effect.) All of which suggests we’re going to relive the rate debate of last fall in less than two years.
  • The President continues to press for taxing capital gains and dividends at 20 percent for upper income taxpayers. They are both at 15 percent for the next two years, with the dividend rate scheduled to return to 39.6 percent while the capital gains would revert to 20 percent in 2013. Again, this income would be subject to the new 3.8 percent investment tax, too, so the real rate for dividends and capital gains would be 23.8 percent.
  • On the estate tax front, the President calls for returning to the 2009 rules of a $3.5 million exemption and a 45 percent top rate rather than either the current policy ($5 million and 35 percent) or the current law in 2013 ($1 million and 55 percent.) In an ongoing oddity, the budget again assumes the 2009 rules as part of the baseline, despite the fact that those rules are neither current law nor current policy.
  • As noted above, the budget mentions corporate tax reform as something they would like to pursue, but does not include any details on how they might approach this, beyond that the reform should be budget neutral. Combined with the large increase in corporate taxes from reducing deferral and other provisions, it’s clear the President’s budget reflects a significant tax increase for both C corporations and S corporations compared to current policies.
  • LIFO accounting is one of the “loopholes” to be closed under this budget. As Washington Wire readers know, we have been LIFO advocates for years and reject the idea that LIFO is a tax expenditure or a loophole. Nonetheless, it continues to be on the short list of provisions proposed by the President to be repealed in the future, either as part of corporate reform or outside of it. LIFO companies beware.

Rate Debate Continues

Happy Thanksgiving to everyone. Here’s a quick update on the tax outlook.

Congress returned last week, but didn’t make much progress. The big news was the cancellation of the bipartisan leadership meeting at the White House on the 18th; that meeting is now scheduled for November 30th. Politico has a really good write-up on what happened, but what was the impact on the tax debate?

In our view, mostly timing. Nobody expected the get-together to result in a deal, but we did expect it to jump start discussions, with the possibility of some sort of agreement worked out by the time Congress returns. Now, that schedule has been set back two weeks making a late December adjournment a distinct possibility. It also means there’s less time for all of the parties to come together, so it also increases the chances that there’s a stalemate and nothing happens before Christmas.

As for the policy, the positions of the various sides are slowly emerging.B Majority Leader Reid wants to hold two votes after the November 30th meeting — one on his plan to extend the middle-class relief only, and one on Minority Leader McConnell’s competing plan to extend everything for two years.

Both plans would need 60 votes to pass, which appears unlikely the first time out, which is one of the reasons we’re expecting a long December session. It’s possible the two sides come together, but it’s going to take time.

Meanwhile, at the White House, different spokespeople appear to be staking out competing positions. One advisor says the President is open to extending the upper-income tax rates, while another says he opposes making permanent anything but the middle-class tax relief. Keep in mind though that both of these positions are consistent with the idea floated by the White House prior to the election: “decoupling” the middle class tax relief from the upper-income tax relief. Their idea was to make the middle-class provisions permanent while extending the upper-income provisions one or two years — long enough to get us past the recession and subsequent recovery. Statement confusion aside, our take is that they are still pushing the decoupling approach.

Finally, in the House, there’s talk the Speaker will bring up a middle-class bill under the so-called “suspension of the Rules” process. Suspension bills are not open to amendment, debate on them is limited to 40 minutes, they require a two-thirds vote to pass, and are usually reserved for small, noncontroversial bills.

As we’ve observed, we believe a majority of House members would vote to extend all of the tax relief if given the chance, so the Speaker has little or no chance of seeing a middle-class-only bill adopted using the suspension process. Therefore, a suspension vote would be more about demonstrating control, not enacting legislation.

Considering all of these factors, we’re looking at a three-step legislative dance this December. Step One: White House meeting on November 30th. Step Two: Preliminary, and, ultimately, failed votes in both the House and Senate. Step Three: The real negotiations begin.

Which brings us to the bottom line: Speaker Pelosi doesn’t represent the majority of House members on the tax issue. If she brings up a middle-class bill under the regular order, Republicans will offer their “extend everything” alternative, and it’s likely they have the votes.

So, the Speaker is in a position where she could call up an issue where she knows she will lose, or refuse to bring it up and let everyone’s taxes go up in January. It’s really up to her.

The one person in the best position to influence her on this decision is President Obama. If he says he’s willing to sign a one- or two-year bill to extend everything, the Speaker would likely follow suit. If, on the other hand, he sticks to his current position, it is looking more likely that, come January 1st, taxes are going up.

Lame Duck and Tax Policies

Congress is set to return for its lame duck session the week after next. With Thanksgiving in the middle and Christmas at the end, Congress has maybe three weeks to fund the government and figure out what to do with tax policy.

Before the election, we believed two outcomes were possible on extending the tax rates: either Congress adopts a one-year extension of everything (with some middle ground for the estate tax), or Congress does nothing and the new Republican House takes the issue up first thing in January.

The President’s original preference of extending only the middle-class tax relief does not enjoy majority support in the House and is not an option. His more recent offer of extending the upper income relief for one year and making permanent all the rest — so-called decoupling — has a better chance to pass, but we think it’s simply too complicated to construct and pass quickly. So the choice is between everything and nothing.

Our metric of which option might prevail was yesterday’s results — if Republicans had a big day, then the odds of Option 1 increased and action in the lame duck would be most likely. Well, Republicans had a big day and we now expect to see Congress and the Administration come together on a one-year deal before the New Year.

Why one year? Because the Administration does not want this issue to hang over into 2012 and their reelection. How certain are we? Not very — maybe two in three that Congress passes a one-year extension. There is still a serious risk that nothing gets passed and rates go up.

S Corporation Reform

Champions of S corporation reform had a mixed day yesterday. On the positive side, S-Corp champion Representative Ron Kind (D-WI) withstood a serious challenge and won reelection in western Wisconsin. Representative Kind was the lead sponsor of our S Corporation Modernization Act (H.R. 2910) this Congress, and helped shepherd through built-in gains relief this year. His cosponsor, Dave Reichert (R-WA), also survived a tough reelect up in Washington State. With the reelection of Representatives Kind and Reichert, S-Corp’s reform team remains intact in the House.

On the other hand, Senator Blanche Lincoln (D-AR) lost her reelect bid in Arkansas. Each election cycle seems to have at least one member who, despite representing their state well, loses out to the broader wave. In 2008, it was S-Corp champion Gordon Smith (R) who lost a close election in Oregon. This time around, it was Senator Lincoln. Lincoln was our lead sponsor in the past two congresses, spearheaded our Sting Tax success in 2007, and has been a tireless advocate for private businesses. Her leadership on these issues will be missed.

Another S-Corp Champion, Senator Chuck Grassley (R-IA) easily won reelection to the Senate. Senator Grassley was instrumental in moving built-in gains relief last summer — his five-year holding period became law this fall — and he partnered with Senator Olympia Snowe (R-ME) to defeat the ill-advised payroll tax hike last summer. Senator Grassley will be stepping aside from his position as Ranking Member on the Finance Committee, though he will remain a senior member of the Committee, and his replacement will be another S-Corp champ, Senator Orrin Hatch (R-UT). Senator Hatch has sponsored our modernization bill for over a decade, and we’re looking forward to his leadership on the Committee.

Improving the rules governing how S corporations are structured and operate continues to be the central role of the S Corporation Association and, with our remaining champions, we’re eager to build on this year’s successes and get the new Congress started off on the right foot

Macro Policy Outlook

It’s never too early to look towards the next election, and this cycle in particular could play a significant role in how Congress — specifically the Senate — acts over the next two years.

Our basic view is there will be three distinct entities vying for control over the next two years: the Republican House, a largely ungovernable Senate, and the Obama Administration.

The House is designed to be the body of the majority, and with a 20-plus seat advantage, future Speaker John Boehner (R-OH) should have a relatively easy time constructing and passing Republican-oriented legislation. On most issues, we expect the House to produce clear statements of policy consistent with their majority and the underlying political landscape.

In the Senate, on the other hand, two key factors stand out. First, the Democratic majority is reduced. They went from 60 to 52 or 53 seats in less than a year. Second, of the remaining Democratic members, more than 20 are up for reelection in 2012. Having that many members up for reelection at the same time is a challenge, and the combination of a small majority and lots of nervous members means that Majority Leader Reid has his work cut out for him. Given these challenges, predicting what legislation emerges from the Senate, and what alliances form to pass it, is simply beyond our forecasting ability. The Senate is a wild card.

We are also likely to see a high level of distrust between Senate Democrats and the Obama White House. The President’s policies — particularly the health care bill and his cap-and-trade efforts — played a significant role in Democratic losses, while successful Democratic candidates largely ran away from those policies, a trend that’s been noted up on the Hill. (West Virginia’s Democratic Senator-elect Joe Manchin literally shot a bullet through the cap-and-trade bill.) So for the next two years, the Democratic caucus will be made up of a handful of Senators who ran opposing the Obama agenda and a larger group of Senators in cycle and running similar campaigns. Under such circumstances, a stable alliance between the Obama Administration and the Democratic Senate is unlikely to emerge.

All of which suggests we’re going to have a three-headed government beginning next year, and two possible macro policy trends. One possibility is the tri-headed government proves unworkable and gridlock prevails. As we observed yesterday, gridlock is not our friend. Current law includes a number of negatives — expiring tax provisions, pending tax hikes, the growth of the AMT, costly 1099 reporting requirements, pending greenhouse gas regulations, etc.

If gridlock prevails, we will see higher taxes and increased regulation, so the business community loses.

The second possibility is that the pressures of deficits, a weak economy, and expiring tax policies will force the tri-headed government to come together and address these issues. That would mean legislation on spending and deficits, permanent tax policies going forward, and clarity on how the EPA is going to move forward (or not) on greenhouse gas regulation. With a divided government, any legislation in these areas inevitably means compromise. Given the alternative, however, a little clarity packaged in a mixed bag might be better than the status quo.

The President’s press conference today signaled more gridlock. It’s possible he was just avoiding negotiating with himself on taxes and health care, but at no point in the back-and-forth with reporters did he indicate a willingness to step back from his current policies. Time will tell, but the American people elected a divided government yesterday, and division is just what they might get.

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