S-CORP Testifies

S corporation tax policy took center stage on the Hill earlier this month.

Carrying the S-CORP flag before the House Ways and Means Select Revenue Subcommittee was Tom Nichols, the Chairman of S-CORP’s Board of Advisors. The hearing focused on pass through business taxation issues and, in particular, the merits and shortcomings of the “Pass Through Draft” that Chairman Camp released earlier this year.

From the beginning, Tom’s testimony hit the high notes of the advocacy we’ve been conducting for the past two years:

“Tax Reform needs to be comprehensive and address the individual, pass through, and corporate tax codes at the same time. Congress should continue to foster progress toward a single level tax system for all businesses, and continue to strive to keep the tax rates paid by businesses and individuals as low as possible.

In this regard, the bipartisan Tax Reform Act of 1986 stands out as an excellent template for Tax Reform. It expanded the tax base by eliminating numerous preferences and privileges for specific taxpayer groups, thereby creating room to dramatically decrease the tax rates for C corporations, pass through businesses and individuals alike.

This approach allowed many, if not most, owners and managers to get out of the tax planning business and immerse themselves in the operations of their real businesses instead. It is my hope that the current Tax Reform effort will build on the policies and lessons learned in 1986.”

Tom went on to highlight provisions in the discussion draft that would help S corporations, including those provisions taken from H.R. 892, the S Corp Modernization Act of 2013. This legislation has been an S-CORP priority for years and forms the core of “Option 1″ in the draft.

While the panel expressed some reservations regarding the more aggressive “Option 2,” Tom did highlight several positive ideas incorporated in the reform, including making public-private ownership the new, improved line of demarcation between pass-through and C corporation tax treatment. That’s a reform that can and should be included in any tax reform package.

This hearing is one of several we expect over the course of the summer, all leading up to the possible House consideration of tax reform sometime this fall. As we’ve observed previously, others have argued that enacting tax reform is just too big a lift this year, and that little will happen. We’re not so sure about that. Congress needs to raise the debt limit, and it needs to address the long-term deficit picture. How that happens is anyone’s guess, but there’s a confluence of fiscal policies all coming to a head this fall together with two very determined chairs of the tax-writing committees which suggests consideration of a big package that includes tax reform should not be discounted. We’re certainly not.

New York Times on Tax Reform

The New York Times has weighed in with a couple of tax reform stories in recent days.

The first, entitled “In Tax Overhaul Debate, Large vs. Small Companies,” focuses on the possible rift between US-based multinational corporations and privately-held businesses over the goals of tax reform.

As we have noted before, we believe this rift is overstated. Yes, there are a couple large corporations that argue Congress should cut their taxes while making private companies pay more, but these businesses are a distinct minority and their voice is falling on deaf ears among tax-writers. The vast majority of the business community is united behind a tax reform effort that would lower rates on all forms of business while broadening the tax base.

The NY Times piece featured a couple of S-CORP Board members making this case, as well as the need to reduce high effective tax rates as the best means of encouraging increased investment and job growth. As the story notes:

Companies that switched said the simpler, generally lower single-tax rules gave them a leg up and helped them grow.

McGregor Metalworking Companies, a family-owned business in Ohio and South Carolina, had 80 employees when it converted in 1986 and now has a work force of 370.

“It has been a real force for reinvestment,” said Dan McGregor, 69, chairman of the company, which has seven shareholders.

This impact is not for metalworking companies alone. As our first Ernst & Young study made clear, the existence of pass-through businesses in the US means more investment, higher wages, and more jobs than if every business was subject to the double tax. That’s the reason why Principle Three in the Main Street Coalition’s Principles for tax reform calls for tax reform to reduce the existing double tax.

The second story appeared over the weekend and gets right to the heart of the challenge over tax reform,  i.e. the looming battle between those firms and industries that pay a high effective tax and those that do not:

Corporate taxes burst into the spotlight last week, with the release of a Senate committee report on Apple’s tactics to reduce its tax payments. More quietly, but perhaps more significantly, the House Ways and Means Committee has begun work on a potential overhaul of the tax code. Edward D. Kleinbard, a tax expert and former Democratic Congressional aide, said he had been impressed so far by the seriousness of the committee’s work.

The effort has a long way to go, but if it succeeds, both liberal and conservative tax experts hope it will reduce the statutory rate while also eliminating tax breaks. The net effect could be to close the gap between companies that pay relatively little in taxes and those that pay much more. The market, rather than the tax code, would then play a bigger role in determining companies’ success and failure.

As the Times notes, done correctly, tax reform will help level the playing field between those companies and industries currently paying little or no tax, and those that are currently shouldering a much higher tax burden.

Lastly, we should point out that a reader of these Times articles might come away thinking that pass-through businesses, including S corporations, pay a lower effective tax rate than their larger competitors. We’re confident that’s not the case. Previous work has shown that S corporations pay the highest effective tax of any business structure, and their marginal tax rates just went up, not down. Meanwhile, as the second Times story made clear, the news is full of stories about how our largest corporations pay little or no tax.

More on this to come.

More Support for S Corp Modernization!

More groups are coming out in support for the provisions contained in H.R. 892, the S Corporation Modernization Act of 2013, sponsored by S-Corp champions Representatives Reichert (R-WA) and Kind (D-WI).

As you recall, S Corporation Modernization made up a significant part of Option One of the Ways & Means Pass-Through Discussion Draft. Now, a group of 19 business groups, including the National Federation of Independent Business, the National Restaurant Association, the National Roofing Contractors, the Printing Industries of America, and the S Corporation Association sent a letter to Congress expressing their strong support for the modernization of outdated S corporation rules. As the letter states:

Main Street businesses are the growth engine of America’s economy and S corporations are the cornerstone of the business community. There are more than 4.5 million S corporations nationwide. They are in every community and every industry and they employ one out of every four private sector workers.

Yet many of the rules that govern the day-to-day management of S corporations date back more than half a century. These outdated rules hurt the ability of S corporations to grow and create jobs. Many family-owned businesses would like to become S corporations, but the rules prevent them from doing so. Other S corporations are starved for capital, but find the rules limit their ability to attract investors or even utilize the value of their own appreciated property.

Next, the American Bar Association Section on Taxation also submitted comments supporting reform to the S corporation rules. Under the heading of “Options for Tax Reform in Subchapter S” the authors list out a number of reforms to the rules governing S corporations that are consistent with many of the provisions included in H.R. 892, including Sting Tax Relief. According to the authors:

Without a clear rationale for continuing the tax on excess net passive income, we believe that its repeal simplifies Subchapter S, eliminates traps for the unwary, reduces the administrative and recordkeeping requirements for S corporations, and promotes use of Subchapter S and the economic growth of small business corporations, without an appreciable loss of revenue.

Finally, an independent group of former and present chairs of the S Corporation Committee of the American Bar Association Tax Section submitted independent comments to the Pass-Through Working Group in support of reforming the rules governing S corporations. As their letter states:

“We support permanently reducing to five years (from ten years) the built-in gains recognition period – the period following a C corporation’s conversion to S corporation status during which it must pay a corporate-level tax on certain net realized built-in gains. The impact of the built-in gains tax may be quite significant when coupled with the individual-level tax imposed on the built-in gain passed through to the shareholders. As a consequence, S corporations may avoid or delay restructurings or dispositions of assets no longer required or needed in the operation of the business, which can have an adverse effect on the business, and, in turn, can adversely affect the economy at large. We believe that, once a reasonable period has passed to accomplish the purposes behind the built-in gains tax, the tax laws should no longer discourage sales of assets that no longer serve a productive purpose in the operation of a closely held business. We further believe that a five-year period is sufficient to accomplish the purposes of the built-in gains tax, and that a longer period might well be counterproductive.

Regarding other provisions included in the S Corp Modernization Act (as well as Option One of the Pass-Through Discussion Draft), the S corporation experts support many of those as well:

We also support the proposals with respect to charitable contributions, specifically modifying the shareholder basis adjustment rules for S corporations making charitable contributions and allowing a U.S. electing small business trust (an “EST”) to deduct charitable contributions made by the S corporation subject to the contribution limits and carryover rules applicable to individual donors. We also support the proposal permitting non-resident aliens to be S corporation shareholders through an EST. Because an EST is separately taxed on income earned from the S corporation, non-resident aliens will be subject to U.S. tax on their interests in S corporation income.

The S Corporation Association, with the help of its allies on and off the Hill, has been successful in its work to enact several of the S Corporation Modernization provisions over the years. With strong support like that expressed above, we are hopeful we can repeat that success in the future.

S Corporation Modernization Bill Reintroduced in House

Good news! Last week, S-Corp champions and Ways & Means Committee members Dave Reichert (R-WA) and Ron Kind (D-WI) introduced the latest version of the S Corporation Modernization Act of 2013. Designated H.R. 892, the bill seeks to improve the rules governing S corporations by making permanent the five years BIG holding period, allowing non-resident aliens to invest in S corporations through an EST, and reducing the sting of the “sting tax”, among other provisions.

Specifically, H.R.B 892 would make needed changes to keep S corporations competitive and ensuring continued success of America’s predominant private business model by:

  • Increasing the ability of S corporations to access much-needed capital;
  • Modernizing the rules that apply to firms that have selected S corporation status; and
  • Easing and expanding S corporations’ ability to make charitable donations.

Said Congressman Reichert of the bill in a press release,which also cites our 2011 Ernst & Young study, issued on Thursday:

This tax relief proposal that would make it easier for S corporations to access capital, compete, and hire new workers by modernizing outdated rules that currently stifle their growth. A 2011 independent study revealed tax law dealing with S corporations affects 31 million Americans as S corporations employ one out of four workers in the U.S. private sector.

“S corporations and similar businesses are responsible for more than half of the jobs in Washington State and across America,” Rep. Reichert said. “As our economy continues to struggle to regain sound footing, I’m proud to introduce bipartisan legislation to help these proven job creators access the capital needed to grow, compete, and get Americans back to work. Working with the Ways and Means Committee toward comprehensive tax reform, I am committed to supporting these small businesses by advocating for pro-growth tax policies.”

The Reichert-Kind legislation presents a realistic set of reforms that would improve the ability of 4.5 million S corporations to access much-needed capital and increase their hiring capabilities. These reforms would improve the ability of S corporations to respond to the current business environment and remove impediments that prevent them from competing on a level playing field at home in the United States.

The bill is consistent with legislation introduced in the past, and we’re confident several of these provisions will be seriously considered this Congress. Thank you Mr. Reichert and Mr. Kind!

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