Business Community Comes Out in Support of S Corp Reforms…

A broad coalition of business groups came out in support of S corporation reforms today, writing to House of Representatives in support of HR 4453, the S Corporation Permanent Relief Act of 2014.  The House is expected to vote on this measure tomorrow.

As Wire readers know, making permanent the five year recognition period for built-in gains has been a priority of the S Corporation Association for years, and while we’ve been successful in reducing the recognition period on a temporary basis, this is the first time either the House or the Senate has considered a permanent fix.  Given the current softness of the economy, particularly when it comes to business investment levels, acting now makes perfect sense.

Unlike public corporations, these closely-held businesses have little or no access to the capital markets. Instead they rely on banks, relatives, and their own savings to fill their investment and working capital needs. An overly long built-in gains recognition period makes this disadvantage worse by preventing converted S corporations from accessing their own capital and putting it to better use.

Locking up a company’s capital for an entire decade is simply unreasonable.  Past Congresses have recognized that a decade is too long and voted to reduce the recognition period on three separate occasions, but those temporary measures have expired and the 10-year rule is back in effect. 

You can read the entire letter here.


…And Against Buffett Tax

In another trade group letter, more than thirty business groups, including the US Chamber of Commerce, the National Association of Manufacturers, the Restaurant Association, and the S Corporation Association, wrote to Senate leaders expressing their strong opposition to the Buffett tax provision included in the student loan bill (S.2432) pending before the Senate.  As the letter states:

Included in S. 2432, the Bank on Students Emergency Loan Refinancing Act, the Buffett tax is a permanent $73 billion tax increase on taxpayers and business owners to pay for new federal spending.  This new tax would be imposed on top of the other taxes business owners must currently pay, resulting in an increase in both the amount they pay and the complexity involved in calculating how much they owe.

As outlined in the bill, the Buffett tax requires those making over $2 million per year to pay a minimum 30 percent effective tax rate on all adjusted gross income.  For taxpayers making between $1 million and $2 million, the bill includes a phase-in period that results in marginal tax rates well in excess of existing tax rates.  While the Buffett tax does make some allowance for charitable contributions, the value of all other deductions and credits, including Section 179 small business expensing and other business deductions, would be reduced or eliminated under this tax. 

The business community’s opposition helped to defeat the legislation, which lost on a procedural vote 56-38 (60 votes were necessary for the legislation to move forward).

So the Buffett tax has stalled for the moment, but the effort to raise tax rates on Main Street businesses will continue.  The Senate has repeatedly attempted to pay for new spending in the past couple years by raising tax rates on individuals and pass-through businesses.  The current Senate leadership supports significantly higher tax rates and that support has already resulted in the tax hike on S corporations following the fiscal cliff negotiations, as well as the new 3.8 percent investment tax used to help pay for health care reform. Both of these tax increases took effect at the beginning of 2013 and resulted in top rates for Main Street businesses rising from 35 percent to nearly 45 percent.

Now they want more, and they will continue to press for more, until the business community steps up and says “enough.”  If it makes sense to reduce tax rates on corporations to “make American businesses more competitive” why doesn’t that same argument apply to pass-through businesses employing the majority of private sector workers?  As we have made abundantly clear, pass-through businesses pay more in taxes, they employ more people, and they are the heart and soul of nearly every community in America.  The S corporation community is 4.6 million strong.  It’s time the Senate started to appreciate that.

Thune Files S-CORP Amendment

More good news on the tax front.  Senator John Thune (R-SD) has filed an amendment making permanent two key S corporation reforms.  Joined by Senators Ben Cardin (D-MD) and Pat Roberts (R-KS), the Thune amendment would make permanent the shorter, five-year recognition period for built-in gains as well as an improved basis adjustment for charitable contributions by S corporations.

The text of the amendment is identical to the text of H.R. 4453 and H.R. 4454, legislation sponsored by Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) that passed the Ways & Means Committee earlier this month and are due to be considered by the House of Representatives in coming weeks.

As with the Reichert/Kinds bills, a large coalition of business organizations wrote in support of the Thune amendment.  The letter, signed by the American Trucking Association, the Associated Builders and Contractors, the S Corporation Associations, and twenty-one other organizations, closes, “On behalf of America’s Main Street business community, we respectfully ask that you support the Thune amendment and permanently extend the 5-year recognition period for built-in gains.”

The Thune/Cardin amendment would makes changes to the tax extenders package currently being considered by the Senate, That package already includes two-year extensions of the BIG and charitable provisions, but it faces an uncertain future.  Earlier reports suggested Republicans would vote en bloc against closing out debate to protest their on-going inability to offer amendments on the Senate floor.

The latest news, however, suggests that Republicans may support closing debate in order to ensure that the extender package keeps moving through the legislative process.  As National Journal reported earlier today:

Usually when Majority Leader Harry Reid prevents Republicans from offering amendments, GOP senators block the underlying bill. At least, that was how Republicans handled the recently dispatched energy-efficiency bill, which went down earlier this week.

“There’s probably a lot more support among Republicans for tax extenders than there perhaps was for energy efficiency,” said Sen. John Thune of South Dakota, the chamber’s No. 3 Republican.

The difference, according to lawmakers, is that some of the roughly 60 provisions in the tax-extenders package benefit constituents in some way. Thune also said that members view extending current tax policy differently than they do enacting new energy legislation.

“I just think you’re talking about tax policy,” Thune said. “You’re talking about extending tax policy. And many of them are things that our members are supportive of.”

The tax provisions that expired at the end of 2013 are extremely popular with the business community and, now that tax reform has been set aside, the only real opportunity to see them extended would be for the House and the Senate to come together on a package and send it to the President.  With strong leadership in both the House and the Senate, these two S corporation provisions are well positioned to be part of that package.

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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