Legislative Update

It’s been a busy week.  First, Ways & Means Chair Paul Ryan yielded to a tremendous amount of peer pressure and agreed to run for Speaker.  The Republican Conference vote to replace departing Speaker John Boehner is set for October 28th and appears to be all but decided.

And now Boehner made good on his promise to clear off a bunch of “must pass” items before he left, announcing last night a deal with the White House to 1) raise the debt limit through March of 2017, 2) increase the spending caps on defense and non-defense discretionary for 2016 and 2017, 3) enact longer term reforms to prop up the Social Security disability program and 4) much, much more.

The House will vote on the package tomorrow, where a majority of Democrats are expected to provide the votes necessary to send it to the Senate.  The Senate needs to act before the November 3rd, when we run up against the debt ceiling.

The Boehner-White House package is by no means a clean legislative sweep.  Missing are the highway reauthorization, tax extenders, and the actual spending bills that make up federal funding.  Speaker Ryan will have to deal with those items in the next two months.

The current highway authorization runs out this week, but the House is already acting to extend highway authority through November 20th.  At that point, everybody expects them to adopt a 6-year reauthorization together with at least two or three years of funding.

Meanwhile, once the spending levels are set for 2016, the challenge of adopting the actual spending bills becomes much less contentious, so the odds of a government shutdown this winter just dropped sharply.  Those bills, or giant omnibus combining them, still need to be adopted, however, prior to December 11th when current funding runs out.

Which leaves extenders.  Once again, these tax items are left behind to fend for themselves.  With Ryan leaving Ways and Means and the Committee leadership in play – Brady, Tiberi, and Nunes are all vying for the chairmanship – we would be surprised if Congress gets around to extending these tax provisions before December, making this the second year in a row that Congress has allowed 179 expensing, the shorter BIG recognition period, the R&E tax credit and all the other provisions to expire for almost an entire year!  That’s unacceptable and a good argument for making as many of these provisions permanent as possible.

 

Survey of Business Tax Professionals

Last week, we updated you on three leading small business surveys, which sampled business owners from around the country to gauge the national mood on the economy. This week’s survey is a little different; it comes from The Tax Council (TTY) and Ernst & Young and focuses on business tax professionals looking at the tax policy environment. The sample includes 97 tax professionals, assessing their views on a variety of legislative issues. Here’s a snapshot of what they found:

  • 63 percent of respondents said that they think tax reform will happen in 2018 or earlier, with a plurality (28 percent) saying 2017 is most likely.
  • A plurality (45 percent) think that when reform occurs, it will be comprehensive, and another 21 percent think that it will include all businesses.
  • A majority of 54.7 percent believe that reform will be revenue-neutral, while around one-third believe it will raise revenue.
  • 91 percent of respondents think that extenders will pass this year, and two-thirds think the package will cover 2015 and 2016.
  • Since the survey was taken in early September, it also has an interesting perspective on international reform—65 percent of respondents thought it would hinder the possibility of passing a comprehensive package in the future.

So the EY survey suggests the broad outlook for tax policy is similar to the S-Corp view – expect a two-year extender package adopted this fall together with a window of opportunity for tax reform after the election. There’s also a telling consensus among professionals about what would constitute good tax policy—a comprehensive package that addresses both individuals and businesses, not just the largest corporations or those doing business overseas.  That’s good for tax policy and good for Main Street businesses.

Senate Finance Working Groups Release Reports

The Senate Finance Working Groups reports are done and publicly available!  Many congrats to the Committee members and their staff for continuing the progress on tax reform.  You can check out the reports here.  The Business Income Tax report drafted by Sens. John Thune (R-SD) and Ben Cardin (D-MD) is the one of most interest to us.  We have to admit, the first few pages were bit a disappointing, as the introduction could lend the impression that pass through taxation (multiple business entities) is somehow a bad thing.

Our tax system also promotes inefficiency by incentivizing businesses to make decisions based on tax considerations, rather than for business reasons. This has manifested itself in the area of business entity choice. Consider that over the past few decades, since enactment of the Tax Reform Act of 1986, there has been movement en masse away from C-corporation status to status as an LLC, S corporation, partnership, or other pass-through business.

With the experience of our members behind us, we actually see that businesses don’t change their behavior to choose an entity type; they choose an entity type so they don’t have to change their behavior.  S corporations would stop paying dividends if they were forced into the double corporate tax.  C corporations would scramble for funding if they lost the ability to access public markets.  Partnerships would rewrite their ownership agreements if they lost the ability to formalize complex ownership relationships.  Having multiple structures in which to organize your business is a positive aspect of the tax code.

The report then embraces number of principles for tax reform.  We were disappointed to see that the number one principle wasn’t lower tax rates for all employers, but focused specifically on lowering the corporate tax rate.

Simply put, the U.S. corporate tax rate needs to be competitive with the nations with whom we compete in the global economy. The OECD median statutory corporate tax rate is 25 percent, a reduction of 5 percentage points since 2004.

The term “corporate tax rate” is mentioned more than a dozen times in the principles.  The higher tax rates many pass through business pay are not mentioned at all.  There is one reference to pass through businesses in the principles section – highlighted as a ‘distortion’, but only to suggest “that pass-through businesses are not harmed by efforts to lower the corporate tax rate.” That’s a pretty low bar. Simply not harming pass-through businesses should not be confused with actually improving the tax code to make those businesses more competitive.

Other parts of the report reference the need for pass through businesses to “benefit” from tax reform, which is clearly helpful, as is the accurate reflection of our basic challenge:

To summarize, pass-through businesses fear that they could find themselves with the worst of both worlds: no rate reduction combined with higher effective tax rates from base-broadening efforts. This is a valid concern and one that any business tax reform effort needs to consider with the utmost seriousness.

The Working Group summed up their debate over pass-through businesses in this way:

“Members of the Business Income Tax Working Group were not able to resolve the treatment of pass-through businesses in business tax reform, one of the most vexing challenges in business tax reform, given the constraints the group faced. However, members of the group believe that any tax reform effort must fully take into account the concerns and opinions of America’s pass-through businesses. Business Income Tax Working Group members strongly urge the chairman and ranking member to examine the options above, in addition to any other approaches the committee may consider, to ensure that pass-through businesses are treated equitably, should the Finance Committee decide to move forward on business tax reform.”

The “constraint” faced by the working group is the Obama Administration’s total opposition to reducing tax rates for individuals.  The “options above” referred to the list of alternatives considered by the working group in lieu of individual rate cuts, including the Grant-Thornton business equivalency rate idea. We examined this proposal at length previously and, of all the alternatives to individual rate cuts, to us it appears the closest to embracing the pass through principles endorsed by more than 100 trade groups earlier this year.

So, all in all, a mixed bag.  The working group makes clear the challenge pass through taxation poses to the goal of overall tax reform, but they failed to recognize that pass through taxation is also the key to the solution.  Taxing business income once, when it is earned, and at a reasonable rate is the way we should tax all business income.  The sooner we embrace that model, the sooner we can achieve the more competitive business tax structure policymakers are seeking.

Highway Funding & International Tax Reform

The outlook for highways and international tax reform is coming into focus.  Senate Majority Leader Mitch McConnell announced that the Senate will take up a short-term highway bill as soon as next week, but downplayed pairing the extension with more aggressive international tax reforms and completely ruled out raising gas taxes.

Let me just say we’re not going to raise the gas tax. We’re not going to raise the gas tax,” McConnell said. “The environment committee has come out with a six-year bill … but there is considerable skepticism that you could pay for a bill of a six-year duration.

McConnell (R-Ky.) also said he was “skeptical” about the prospect of using a bipartisan plan from Sens. Chuck Schumer (D-N.Y.) and Rob Portman (R-Ohio) to overhaul some corporate taxes as a way to pay for crumbling highways, bridges and public transportation and said it would be too difficult to take on something so ambitious with just three weeks before the deadline.

So short term highway extension this month, but no international reforms.  What about the longer term outlook?

On that front, there is a concerted effort to pair highways and international reforms, and that the new international report from Senators Portman (R-OH) and Schumer (D-NY) clearly outlines what they have in mind.  As the Examiner reported this week:

Ryan, the chairman of the powerful tax-writing House Ways and Means Committee, said at a breakfast event hosted by Politico in Washington that he was optimistic about a deal to reform international taxation that would include a one-time surge of revenues from deferred taxes of multinationals’ earnings.

Such a deal isn’t possible in the next two weeks before the highway trust fund is expected to be exhausted, the Wisconsin Republican said, and Congress will have to pass a short-term funding patch through the end of the year.

But the agreement on taxing overseas earnings announced Wednesday by Sens. Rob Portman, R-Ohio, and Chuck Schumer, D-N.Y., “gives me a bit of hope” that a six-year infrastructure funding deal can be reached, he explained.

The report itself calls for moving to a territorial tax system, creating a patent or innovation box to incent the development and retention of domestic intellectual property, and taxing existing balances of overseas corporate income to pay for both the international reforms and offset the cost of highway funding.  That latter bit has been endorsed by a number of Democrats and Republicans, including Portman and Ryan, while others have expressed strong opposition to using “deemed” repatriation for anything other than tax reform.

The key remaining question is how long the extension considered this month will be – just through the end of the year or through the 2016 elections?  Late today, reports surfaced that Rep. Ryan was working on an $8 billion extension that would last through the end of the year.  This runs counter to what Senate leaders have supported—an 18-month extension that would push international tax reform into 2017. When discussing the extension in The Hill, Ryan responded to that difference:

“Mitch and I have the same long term goals, we want comprehensive tax reform and we want a long term highway bill,” he said. “They have their body to deal with, we have ours to deal with. We…think we should do a long term highway bill and we think tax reform is the best way.”

Ryan did specify how he plans to pay for his proposed temporary highway funding extension, saying only “I think we’ll be able to put together a package that kind of innocuous, boring stuff that shouldn’t be a surprise to people.

“We’ll post it when we have it ready,” he said.

If this passes, that would mean fewer revenue offsets this month, with an enhanced possibility for the prospect of international tax reforms to gain traction before December. Of course, we’ll be watching the short-term patch closely, particularly to see what Rep. Ryan comes up with to find the needed $8 billion.

Extenders

Extenders are back under discussion, thankfully.  Rumor is that the Senate Finance Committee will take up a 2-year extender package in the next couple weeks, while Chairman Ryan said Thursday that he’s looking for Ways & Means to move extenders in September.

This accelerated time table is good news—at least when compared to last year’s delay in an agreement until the very end of December. Another positive is the emphasis on making at least some of these provisions permanent.  There is no reason the R&E tax credit, higher 179 expensing limits, and shorter built-in gains recognition period expire every few months.  That said, there is opposition to the House has made to enact these very extensions permanently.  According to Politico:

Democrats are opposed to efforts to make extenders permanent, arguing that the revenue losses must be offset. Republicans are quick to note that quirks of legislative scoring allow the cuts to be temporarily renewed — often cumulatively surpassing the 10-year “permanent” scoring window — without counting as a revenue loss.

Bottom line is that we expect to see action on extenders, at least at the committee level, soon.  Our hope is that this new activity results in a package adopted by Congress well before the end of the year.  Fingers crossed.

 

 

S Corp News Clips

More on Tax Reform

We’ve previously commented on Chairman Paul Ryan’s desire to do as much as he can this Congress to lay the groundwork for comprehensive tax reform in 2017. Now, in the Wall Street Journal, he gives us a better sense of what that groundwork looks like.

“There’s a big difference between our view and the president’s view. He believes we should have higher tax rates on individuals. We think they should be lower. And when eight out of 10 businesses in America are what we call pass-throughs, LLCs, sole proprietors, sub S corporations, their top effective tax right now because of this president is 44.6%.

The international average tax rate on businesses is 25%. So we have to get these rates down across the board. That is something that the administration doesn’t share with us. So there’s an impasse.

The question is what can we do in the meantime that gets us a step in the right direction.

And as we’re looking at that, we’re looking at the international system. We want to move to an exemption system [where companies can repatriate foreign earnings without paying U.S. taxes on them]. We want to make every day a repatriation day for firms.”

Rep. Ryan’s remarks included his refusal to enact business tax reform without lowering the rates for pass-throughs, saying that corporate-only reform would “exacerbate the disparity” in rates between C corporations and pass-throughs.  Amen to that!

On extenders:

Ryan told the Journal audience that the Ways and Means Committee intends to address expired tax deductions, credits, and incentives “as early as possible in the fall” to avoid a repeat of last year’s legislative process in which “taxpayers had to wait until December 11 to find out if these provisions were being extended.” He also emphasized that some temporary tax provisions, such as the research and experimentation credit and enhanced section 179 expensing, should be extended permanently.

With comprehensive reform unlikely until 2017, extenders and international reform appear to be the next-best options for action this year.  S-Corp has commented extensively on the unique place S corporations with foreign operations have in the Tax Code (herehere, and here) and we’ll be spending the next several weeks highlighting those comments with the Ways and Means Committee and other tax writers.

 

Highway Trust Fund Funding

For months now, we’ve been hearing of an idea to use deemed (read “forced”) repatriation of overseas corporate earnings to help pay for a multi-year extension of the highway funding.  To give readers an idea of the challenge, policymakers would need to raise $92 billion in new revenues to keep highway funding level for six years.  According to the JCT, a properly structured repatriation could raise twice that amount.

At a June 24th hearing, the Ways and Means Subcommittee on Select Revenue Measures more closely analyzed the use of repatriation for highways and the net result was to leave attendees even more in doubt that this was the best source of the funding.

Chairman Reichert cautioned against standalone repatriation in his opening statement:

“However, as you will hear today, current repatriation proposals are not that simple nor are they without serious policy implications. That is why we are having this hearing-to drill down on what people mean when they say repatriation and how the different forms of repatriation work. A key, but often overlooked, part of this is that repatriation includes taxing earnings that have been reinvested abroad.

“What we know to be true is that repatriation cannot be done as a standalone; it must be part of a transition to a more competitive system. I expect to hear today that, taken outside of the context of a transition, mandatory repatriation would be a tax increase. A tax increase that American companies would be forced to pay unlike their foreign competitors.”

In his testimony, Curtis S. Dubay, Research Fellow in Tax and Economic Policy at The Heritage Foundation, echoed Rep. Reichert:

“If Congress changed repatriation policy as a stand-alone measure to cover a hole in the HTF, it would create less incentive to change the tax policy from a worldwide system to a territorial system. Instead, Congress should focus on establishing a territorial system and reserve changes to repatriation policy for aiding that sizable improvement to the tax code.”

Meanwhile, several large trade groups, including the National Association of Manufacturers and the National Retail Association, submitted strong statements against using repatriation for highways, leading Republican Tom Reed to observe that “If the stakeholders are going to be adamantly against [repatriation], it’s going to be difficult.”

So, if repatriation will not be used for funding the HTF, what will? And would any of these measures affect businesses? Deloitte’s summary of hearings from the previous week touch on a wide variety of potential funding sources:

Witnesses at the hearings – who, in addition to former Transportation Secretary LaHood, included president of the American Trucking Association and former Kansas Gov. Bill Graves, CBO officials, and think tank policy analysts – discussed a variety of other options for long-term funding, including mileage-based user fees, financing mechanisms such as Build America bonds and municipal bonds, devolving infrastructure responsibility to the states, public-private partnerships, and raising money from oil drilling rights on some federal lands. However, they noted that these methods would generally take time to implement and/or scale up and so were not immediate solutions.

Without a consensus, another short-term extension seems likely-the signal from Rep. Ryan is that it’s “unavoidable.”

 

Where the top 2016 Candidates Stand on Taxes-So Far

Wondering what the presidential candidates are doing on the tax front.  With official announcements from Hillary Clinton and Jeb Bush in the past week, we thought it would be a good time to review where the major candidates stand:

  •          Rubio’s plan, which we analyzed in an earlierWashington Wire, is the most in-depth. Check out thescoring from our friends at the Tax Foundation for a refresher-in short, it’s one of the most pro-growth, pass-through friendly plans we have seen in a while.
  •          The Tax Foundation also looked at Rand Paul’s plan, which would be a complete overhaul of the current code in favor of a flat tax on individuals and a type of VAT on corporations. While the Tax Foundation determined Paul’s plan would bring over 9% of additional growth in the economy over 10 years, the revenue loss, even using dynamic analysis, is over $1 trillion!
  •          Rand Paul is not the only candidate with a flat tax proposal-Ben Carson has one, as does Sen. Ted Cruz.
  •          Christie’s plan came in the form of a Wall Street Journal Op-Ed. It appears to be a close cousin to Rubio-Lee, and would reduce the marginal individual rate to 28%.
  •          Mike Huckabee would scrap the income tax altogether in favor of the “FairTax,” a national sales-tax. He ran on this platform in 2008, when he generated some early momentum against Sen. John McCain.
  •          Republican contenders Jeb Bush and Scott Walker have yet to release their own tax plans. It’s still early, so we’ll be sure to provide analyses as these campaigns heat up.
  •          On the Democratic side, neither Hillary Clinton nor Sen. Bernie Sanders have released full plans. During her campaign announcement last week in New York, Clinton promised to rewrite the tax code so that it “rewards hard work, and not quick equities trades or money stashed away overseas.” The only specific so far is a $1,500 tax credit for each apprentice that a business hires-a measure similar to bills introduced by Sens. Tim Scott and Cory Booker as well as Sens. Maria Cantwell and Susan Collins.
  •          As for Sanders, all indications from his interviews and record in the Senate point to increasing revenue for the government. During an interview on Charlie Rose, Sanders said that he would raise the marginal tax rate for individuals “above 50%.”  Ouch.
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