S-CORP Testifies at IRS

Last month’s elections so dramatically changed the outlook for tax policy in 2017 that we’re still trying to catch up.  The outlook for the proposed 2704 regulations in particular has done an about-face, going from appearing almost inevitable to having the Chairman of the Ways and Means Committee, along with others, targeting them for elimination quickly next year.

But they are not dead yet, and the regulatory process moves on.  Today, the IRS hosted its public hearing on the proposed rules, and the family business community arrived in force—S-CORP in particular. We submitted our formal comments back on October 17th, which you can read here, while today we had four witnesses address the panel – S-Corp President Brian Reardon, Board Member Clarene Law, and Board Advisors Chris Treharne and John Porter.

Nearly 40 tax attorneys, CPAs, and other tax experts weighed in on the rules, but the real star was Clarene Law.  She was one of the few business owners to make the trip to DC to testify, and her story of building a successful hotel business in Jackson, Wyoming over the past half century got directly to the challenge these rules pose to real business owners.  As she told the panel:

 

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I started Elk Country Motels as a 28-year old back in 1962.   My funding came from my mother and father — a housewife and blue collar road construction worker – who had little money but lots of pride.  They trusted me with their life savings of $10,000 and enabled me to purchase a small, 17-room motel- 12 cabins and rooms above the office…,

Over 50 years later, our small business has grown and provided my extended family and employees with a stable living.  Today we manage 450 rooms, all in Jackson and employ over 100 people.

Continuing this family business is of the utmost importance to me. I have high hopes of passing it onto my children and grandchildren.  I feel we can only accomplish my wish for succession with favorable tax consideration which acknowledges legacy businesses such as ours…. 

The proposed regulations under Section 2704 have the potential to severely disrupt these plans. Ownership of Elk Country Motels and our other limited liability companies is divided between my 3 children, myself, my husband and our trusts—all minority interests.

The IRS’ application of family attribution could result in all these interests being valued as if they were controlling, preventing the use of legitimate valuation discounts and leading to estate tax increases that the next generation would have to bear.

This could force my descendants to sell the business in order to pay the taxes. After 55 years of operation, this family would like to stay in business and not just sell out to corporate America.

Longtime S-Corp advisor Chris Treharne of Gibraltar Business Valuations focused his remarks on the technical challenges the rules would pose to appraisers:

“While I understand Treasury’s perception of abuses associated with third-party owners inasmuch they may affect the inability to liquidate an ownership interest or the entity, I am again concerned that inflexible, “bright-line” rules may be potentially abusive, too… I encourage Treasury to identify and adopt alternate, more flexible language that accomplishes its goals of preventing taxpayer abuse without imparting inflexible constraints on legitimate ownership structures and strategies.”

The remainder of comments were almost universally opposed, with a number of speakers recommending that Treasury radically revise and then reissue the proposed rules in order to give stakeholders another opportunity to weigh in with comments.

 

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For his part, S-Corp President Brian Reardon focused his comments on what happens next year:

“Looking forward, it is clear these rules need to be withdrawn.  Over 28,000 comments have been received by Treasury during the comment period, and with few exceptions, they all were opposed.  That is an extraordinary outpouring of opposition by the business community and Treasury needs to be responsive. 

It is also clear that Congress needs to rewrite section 2704.  Family attribution is a fatally flawed concept, whether it’s applied broadly, per our reading of these rules, or narrowly, as written into the underlying 2704 statute. 

The S Corporation Association intends to continue to work with stakeholders and tax writers to achieve both of these goals, and we appreciate the willingness of both Treasury and the Congressional tax writers to listen to our concerns.”

With the comment period officially over, Treasury is now tasked with wading through the 28,000 comments and either adjusting the rules to reflect the concerns raised, or explain in detail why they went in a different direction.  It’s a laborious process that could literally take years, which is a frightening notion.  Meanwhile, the new Administration is expected to kill these rules quickly upon taking office.  We hope so.  Innumerable hours and dollars already have been wasted trying to protect family businesses from an unwarranted change in how they are valued.  It’s time for closure and moving on.

2704 Comment Period Closes Big

The official comment period on the proposed Section 2704 regulations closed yesterday, with nearly 10,000 comments filed!  You can review those comments here, but a cursory review this morning made clear they were nearly unanimous in their opposition to the Treasury action.

Eventually, all the comments submitted will be accessible at the regulations.gov website, but until then, here are some of the more significant comment letters we’ve seen.  Definitely worth a read if you have clients or businesses affected by the proposed rule:

The Small Business Administration’s Office of Advocacy also weighed in on the regulations. The Advocate is an independent office charged with representing the small business community before Congress and the federal government, particularly through the application of the Regulatory Flexibility Act (RFA).  According to the Advocate:

The Regulatory Flexibility Act (RFA)… gives small entities a voice in the rulemaking process.  For all rules that are expected to have a significant economic impact on a substantial number of small entities, federal agencies are required by the RFA to assess the impact of the proposed rule on small entities and to consider less burdensome alternatives.

In certifying that the 2704 rules would not impact small businesses, Treasury argued that “any economic impact on entities affected by section 2704, large or small, is derived from the operation of the statute, or its intended application, and not from the proposed regulations in this notice of proposed rulemaking.”  It also argued that the rules would “affect the transfer tax liability of individuals who transfer an interest in certain closely held entities and not the entities themselves.”

The former argument represents a novel legal approach that would effectively gut the RFA by exempting all regulatory implementations of statutes, while the latter argument is simply a hoot—we’re just taxing the owners of small businesses here, not the businesses themselves.  We don’t buy it, and neither does the Office of the Advocate.  They recommend Treasury go back and conduct a proper economic assessment like they were supposed to.

Meanwhile, the Ways and Means Republicans released a letter today expressing their strong opposition to the rules.  24 committee members signed the letter, which states:

These proposed regulations as drafted represent a dramatic change from past practice and history and are not consistent with congressional intent. In order to avoid immediate and substantial economic harm to family-owned businesses and the jobs they create, these regulations should be withdrawn. Any new proposal in this area should be clearly defined and narrowly targeted within the reach of the applicable statutory rules.

With Congress returning for a Lame Duck session in two weeks, the Ways and Means letter will help us rally House members in opposition to the rule.

Looking forward, the IRS is hosting a public hearing on December 1st where we expect dozens of business representatives to come speak out against the rule.  S-Corp will be there, together with many of our allies.  Following that, the official comment period is over and Treasury will need to wade through all of the comments and address them fully, either by stating clearly why they disagree or by redrafting the rules to address the suggested changes.

Can this all be accomplished prior to the end of the Obama Administration?  Treasury officials argue no, while the political people at Treasury and the White House are less reassuring.  The White House has embraced a policy of getting as many rules out the door as possible, so we continue to operate with the possibility that these 2704 rules are part of the last-minute rush.  We hope that’s not the case, but it’s just too important to take chances.

Business Community Rallies

Thousands of family businesses signed a letter this week calling on the Department of the Treasury to withdraw proposed regulations that target family businesses for sharply higher gift and estate taxes.

Getting that many private companies to weigh in on a public issue like this one is simply astounding, and should serve as an indication of just how threatening these regulations are to the ability of family businesses to survive from one generation to the next. As Law360 reported on the letter:

NAM released a letter with more than 50 pages of signatures urging Lew to pull the proposed regulations, which tax practitioners and estate planners have been quick to reprove for purportedly ignoring the economic realities of transferred interests in closely held businesses.

The regulations, which were announced in early August, will have a detrimental effect on family-owned businesses because they could increase estate and gift taxes by 30 percent or more, divert capital from business investment, threaten jobs, and force families to sell their businesses to outsiders, Wednesday’s letter said.

“These proposed regulations would throw the succession and estate planning of thousands of family-owned manufacturers into disarray, increase tax bills and impose additional planning and legal costs on these businesses, drawing valuable resources away from the ability of family businesses to grow, invest and create jobs,” NAM said. “It is critically important that Treasury withdraw these ill-conceived regulations as soon as possible.”

The letter was released during a week full of activity on the valuation issue. Senator John Thune (R-SD) also released a letter calling on Treasury to pull back the proposed rules. Signed by 41 Senators, including numerous members of the Finance Committee, the letter follows a similar communication authored by Thune last year and makes clear the policy challenge posed by the draft rules:

Treasury should pursue policies that encourage the creation and growth of family businesses and not propose regulatory changes that make it more difficult and costly for families to transfer ownership to future generations. We thus request that Treasury withdraw the proposed regulations and ask that any regulations that Treasury may issue in the future more directly target perceived abuses in the valuation of transferred interests in family businesses.

Meanwhile, legislation has been introduced in both the House and the Senate to block Treasury from finalizing the proposed rules. Sponsored by Congressman Warren Davidson (R-OH) in the House and Senator Marco Rubio (R-FL) in the Senate, this legislation objects to the underlying premise of the proposed rules and prohibits Treasury from taking action to make them final. The House bill was introduced just last week, but already has more than 60 cosponsors.

S-Corp plans to spend October meeting with Hill offices and building support for the two bills. With Congress coming back in mid-November, the challenge will be to build sufficient support on this issue to compel the House and Senate to take action before the end of the year.

You can help. The NAM letter has already been sent, but the official comment period is open until November 2nd, so trade groups and family businesses still have the ability to weigh in on this issue. If you would like to comment, click here and file your comments! The more Treasury hears from the business community on this issue, the less likely they will be able to finalize the harmful rules as drafted. It’s that simple.

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