S-CORP News Clips

Small Business Confidence Survey

You’ll remember back in June we profiled three small business surveys from NFIB, Wells Fargo/Gallup, and Thumbtack. Together, these surveys, with different sample populations and varying methods, provide the most complete picture of the small business landscape today. When we examined their findings during the summer, we saw words like “lukewarm”, “uninspiring”, and “more of the same” to describe the private business environment.

For the third quarter of 2015, it’s “more of the same” again.  With minor variations, all three surveys show that business owners are no more confident today than they were during the summer. In particular, economic uncertainty is cited as a top concern:

  • NFIB notes that over 20% of businesses that think it is a poor time to expand cite political uncertainty;
  • 20% of Wells Fargo/Gallup respondents cite the economy or government as their top concern; and
  • Economic conditions had the most business owners worried in Thumbtack’s survey, which had over 6,000 respondents.

So government action, and inaction in some cases, is hurting the small business sector and retarding investment and job creation.  Maybe policymakers on the Hill and in the agencies should take note.

 

Where are the Democratic Tax Plans?

Most Republican presidential candidates have released a tax plan in one form or another to date. They range from Sen. Rubio’s detailed legislative proposal that he co-wrote with Sen. Lee (R-UT) to op-eds in the Wall Street Journal and elsewhere from candidates Chris Christy, Jeb Bush, Donald Trump, and others.  The details vary, but a common theme in all the plans is the need to use the tax code to stimulate investment and job creation.

On the other hand, no candidate on the Democratic side has released a comprehensive plan. Secretary Clinton and Senator Sanders (D-VT) have released targeted proposals calling for profit sharing, as well as higher taxes on financial transactions and capital gains, but not only are these not comprehensive reforms, they would also, as Peter J. Reilly at Forbes writes, only serve to make the tax code more complicated.  Tax policy was largely missing from the recent debate, too.  Other than some vague references to higher taxes for the wealthy—particularly from Sanders — tax policy was a no-show.

Our friends at the Tax Foundation have been scoring and writing on all the Presidential plans.  You can access their chart here.  We expect that as the campaign matures, we’ll see more robust proposals from the Clinton campaign and others in the Democratic field.  Tax policy is always a key part of any presidential run, and we expect 2016 to be no different.

 

Et Tu, CRS? 

Last month, Treasury (or at least the bulk of their tax economist team), released a study on pass through businesses and the taxes they pay.  We raised concerns with the Treasury approach here and here.

Now CRS also has a paper focused on pass through businesses and the challenge they present to reforming the corporate tax code.  As BNA summarized, the basic message of the paper is this:

The 35 percent statutory corporate tax rate tends to be higher than the average marginal statutory rate for noncorporate business, estimated to average about 27 percent, according to data from the Internal Revenue Service. In addition, effective corporate tax rates are higher in most cases and for most assets than effective rates for passthroughs, and administrative and compliance costs would be lower if tax provisions such as depreciation and inventory accounts were harmonized across organizational forms.

As with the Treasury paper that preceded it, however, the lower effective (or average) rate for pass through businesses in the CRS paper is almost entirely due to the inclusion of lower-income sole props and other pass through businesses in their calculation.  In other words, they’ve compared the effective tax rate of Wal-Mart to the handy man down the street and found, not surprisingly, that Wal-Mart pays a higher rate.

One interesting aside is the CRS estimate for shareholder level taxes.  You’ll recall that Treasury estimated dividend and capital gains taxes on C corporation shareholders adds about 9 percentage points to the corporate effective rate.  As we pointed out, Treasury made some very interesting assumptions to get there.

CRS appears to agree with us on that matter.  Their estimate for shareholder level taxes is about one-fourth of Treasury’s, or just 2.3 percentage points.  CRS lists the lower rates on capital gains and dividends, tax exempt shareholders, and capital gains that are passed on as part of an estate as the primary reasons for the lower estimate.

What’s missing from both the CRS and Treasury analyses is a comparison of likes – a large C corporation to a large S corporation in the same industry.  That comparison would inform policymakers as to the respective tax burden of different business forms and help them make better policy decisions, but you are not going to find that sort of comparison in either the CRS or Treasury papers.   Based on our previous work, we’re confident the S corporation in that analysis would pay the higher effective rate.

S Corp Payroll Tax Hike Resurfaces

Last week, Senate Democrats released a paper highlighting a dozen tax increases they would like to use to offset spending cuts in the current budget negotiations. As Politico reported:

Tax expenditures topping the list include the deduction corporations take when they move operations overseas and the carried interest loophole, which allows private equity and some other investment advisers to pay the lower capital gains tax rate on some of their income.

Also on the list is our old nemesis, the S corporation payroll tax hike. Labeled the Edwards Loophole by Republicans and the Gingrich Loophole by Democrats, the issue is that some professionals are using the S corporation structure to avoid paying payroll taxes. According to the Democrats’ release:

Some wealthy business owners knowingly mischaracterize their income as business profits instead of salary to avoid Medicare and Social Security payroll taxes. Ending this loophole would save about $12 billion over the next ten years.

We have a number of objections to this characterization. First, using your S corporation to avoid payroll taxes is not a loophole, it’s tax avoidance. The current reasonable compensation rules are clear and the IRS has a history of going after offenders and winning.

Second, the proposals offered to date are worse than the existing rules. The JCT might score them as raising $12 billion over ten years, but it’s hard to see how the IRS would be able to come up with that level of enforcement.

For example, the provision defeated by the Senate back in 2012 would have replaced reasonable compensation with a “principle rainmaker” test where the IRS would have to determine whether 75 percent or more of the gross income of the S corporation is attributable to the service of three or fewer shareholders. Oh, that’s easy. As a letter signed by 38 business organizations observed:

This new approach, particularly the ”principal rainmaker” test, is neither clear nor more enforceable than existing rules. These rules have been in effect for over half a century, and the IRS has repeatedly and successfully used them to ensure that active S corporation shareholders pay themselves a reasonable wage, most recently in Watson v. US (2011).

The business community responded strongly in 2012 and that opposition remains today. We do not support the misuse of the S corporation structure to avoid payroll taxes, but any replacement to the current ”reasonable compensation” test must be easier for the IRS to enforce and for businesses to comply with.

For those who want more, here are links to the business community letter as well as a longer history of the issue:

SBA Weighs in on Corporate Tax Reform

A new study sponsored by the Small Business Administration adds to the case that corporate-only tax reform, as advocated for by the Obama Administration, would shift the tax burden on to smaller, private companies. As reported by Politico:

Cutting corporate tax rates by trimming costly breaks is a popular selling point for a tax code overhaul, but some small businesses could wind up unintended victims, an independent government agency on Wednesday said, lending support to Republican concerns.

New data from the Small Business Administration warn that the trade-off would be a double whammy to smaller businesses that file taxes as individuals.

These businesses get nothing from a corporate rate cut but they could still lose their tax breaks. The SBA study found that these businesses account for about $40 billion in tax benefits, or about one-third of the $161 billion spent each year on all business tax expenditures.

The top U.S. corporate rate is 35 percent, among the highest in the industrialized world. Although the code is riddled with breaks and loopholes that allow some companies to pay far less, others pay much more.

By contrast, the top rate for individuals, including these so-called pass-through entities, is more than 40 percent.

The study compared the value of tax expenditures for all businesses with those used by pass through and corporate businesses with annual receipts under $10 million. As the study notes:

Of the largest tax expenditure provisions utilized by all businesses in 2013, small businesses will utilize approximately $40 billion out of a total of $161 billion. The estimates indicate that small businesses will utilize approximately 25 percent of the largest business tax expenditure provisions in 2013.

So any effort to eliminate tax expenditures to pay for a lower corporate tax rate would also hit pass through businesses that pay at the individual rates. Not good. As our 2011 E&Y study made clear, such a policy would increase taxes on pass through businesses by $27 billion a year.

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