S-CORP Clips | October 1-10

A compilation of the business tax related stories that caught our eye

 

Administration on Tax Reform

The President’s economic advisors have been unusually busy in recent weeks.  National Economic Council Director Jeffrey Zients was firm in his conviction that tax reform could get done in the new Congress, citing the “remarkably overlapping” approaches of Obama’s plan and the Camp draft.

It is true there are some common themes in the Camp and Administration proposals, but also there are major – and fatal – differences as well, including:

  • The Camp Draft is budget neutral while the Administration’s plan would raise revenue;
  • The Camp Draft adopts a territorial tax system while the Administration appears to strengthen our world-wide system; and
  • The Camp Draft is comprehensive while the Administration plan would reduce rates on corporations only – an approach rejected by Democrats and Republicans alike.

Add to those differences the fact that the Administration’s draft landed with a thud when it was released back in 2012 and has barely been discussed since, and the idea of House Republicans and the Obama Administration coming together on tax reform in the next Congress seems laughably remote.

Meanwhile, Council of Economic Advisers Chair Jason Furman spoke in New York the other week on tax reform, offering additional context to the Administration’s tax reform proposal and addressing some of the concerns that have been raised.  We’ll have more to say about this later, but this paragraph caught our eye:

On the economic merits, it is important to remember that C corporation income is partially taxed at two levels while pass-through income is only taxed at one level. As a result, today C corporations face an effective marginal rate that is 6 percentage points higher than that on pass-through businesses. Although the President’s Framework would cut and simplify taxes for small business, including small pass-through entities, for larger businesses we should be moving towards greater parity—with the goal of equal effective rates on an integrated basis, a goal that would not be served by parallel reductions in individual and corporate tax rates.(Emphasis added)

That’s not exactly true.  Recall that our study on effective tax rates released last year found that S corporations face the highest effective tax rate of any business type.  Those estimates were based on real businesses and actual tax returns.

The numbers Jason is referring to are based on hypothetical future investments.  They can be found in a three-year-old Treasury analysis under the heading of “Effective Marginal Tax Rates on New Investment.”  Jack Mintz authored a comprehensive critique of these estimates for the Tax Foundation last February, some of it pretty damning.

For our purposes, we will just point out that Treasury’s analysis, correctly done, would be appropriate if you wanted to measure the tax burden on marginal investment decisions – should we build that new facility, should we buy that piece of equipment, should we use debt or equity? – but it doesn’t support the notion that C corporations today pay a higher effective rate than pass-through businesses.  You need to estimate average effective tax rate to make that claim, which is what our study does.

Jason is right to point out that the double tax on corporations hurts US competitiveness.  That’s the reason the pass-through business community advocates for its reduction as an essential goal of tax reform.  There’s little point in reforming the tax code if the result doesn’t reduce the tax on investing in the United States, and the best path to achieving that is to tax business income once at reasonable rates and then leave it alone.  That’s how S corporations are taxed today, and real reform would move C corporations in that direction.

 

Ryan on S Corporations

Contrast the Administration’s approach with that of Representative Paul Ryan (R-WI), a leading contender to take the gavel as the next Chairman of the Ways and Means Committee.  He recently gave a speech at an event hosted by the Financial Services Roundtable in which he made clear the importance of improving the tax code for all businesses, including S corporations and other pass-through businesses. Here’s what he had to say:

“Tax reform is one of those things that we don’t know if we’re going to be there at the end of the day, because we want to make sure that, as we lower tax rates for corporations, we do the same for pass throughs.

You know, a lot of people in the financial services industry – banks – are subchapter S corporations.

Where Tim [Pawlenty] and I come from, “overseas” is Lake Superior, and Canadians are taxing all of their businesses at 15 percent. And our subchapter S corporations, which are 90 percent of Minnesota and Wisconsin businesses, are taxed at as high as a 44.6 percent effective rate.

So we have to bring all these tax rates down, but we have a problem with the Administration being willing to do that on the individual side of the tax code.”

We’ve been beating the “comprehensive tax reform” drum for three years now and it’s nice to see key policymakers embrace the message.

 

American Progress on S Corp Payroll Taxes

Meanwhile, Harry Stein of the Center for American Progress is out published a report with broad recommendations on how to best reform the tax code. Among its suggestions is one to close the “Edwards-Gingrich loophole,” an issue we’ve covered extensively in the past. On that subject, the S Corporation Association has developed the following position:

  1. We don’t support using the S corporation structure to avoid payroll taxes.  We represent businesses that comply with the law, not sneak around it.
  2. It’s not a loophole, its cheating.  This issue is often described as a loophole, but that’s not accurate.  Underpaying yourself in order to avoid payroll taxes is already against the rules.
  3. The IRS has a long history of successfully going after taxpayers who abuse the S corporation structure.  The current S corporation rules on this have been in place since 1958.
  4. Any “fix” needs to improve on the current rules.  That means they need to be easier to enforce and they need to target wage and salary income only.  Employment taxes should apply to wages only, not investment (including business) income.

 

Year-End Wrap Up

Two headlines in Politico this morning tell the story on tax policy for the remainder of the year: “Tax Cut Boils Down to Who Pays” and “K Street Mounts Last-Ditch Blitz for Tax Breaks.”

The first headline refers to the pending expiration of the payroll tax holiday. The Administration, Congressional Democrats, and some portion of the Republican conference support extending the payroll deduction through the upcoming year. As Politico reports:

It’s all but a foregone conclusion that President Barack Obama will win on the payroll tax-cut extension - on politics, policy or both - but Congress still has two weeks to fight over the particulars of who foots the bill or who takes the blame.

We’re not sure how “forgone” extending the payroll tax holiday is. The challenge for the payroll tax extension goes beyond finding an offset that a majority of members in the House and the Senate can live with. It also means overcoming opposition among conservatives, primarily in the House, to any temporary “stimulus” measure that either increases the deficit or uses up spending and revenue measures that could be otherwise used for deficit reduction.

The latter challenge was made clear last week when a majority of Republican Senators opposed a McConnell-led effort to offset the payroll tax extension with cuts to federal employee benefits and jobs. Nonetheless, House Speaker John Boehner intends to bring up an extension, perhaps as early as this week.

Meanwhile, Senate Democrats will reveal a new payroll tax proposal as early as today. According to the National Journal:

Senate Majority Leader Harry Reid, D-Nev., on Monday will offer a new Democratic proposal to expand a payroll tax for employees while tweaking how the bill is paid for in a nod to Republican concerns.

Democrats will scale back a bill rejected in a Senate vote last week by eliminating proposed payroll tax benefits for employers. The new bill will leave in place a proposal to cut the payroll tax for employees from 4.2 to 3.1 percent, a senior Democratic aide said. That will cut the cost of the plan from $265 billion to $180 billion, in an attempt to address GOP concerns about the overall cost of the measure, said the aide.

What’s left unclear is how the lower price tag will be covered. The last Democrat offering was offset by a 3.25 percent surtax on incomes exceeding $1 million. As a prior Washington Wire pointed out, four out of five of those taxpayers impacted are business owners. More recent talk is that the new offset might be savings from drawing down forces in the Middle East.

Meanwhile, Congress continues to work on other “to-do” items for the remainder of December, including federal government funding plus a possible UI extension, the so-called Doc Fix, an extension of expiring tax provisions, and protecting middle-class taxpayers from the Alternative Minimum Tax.

The second Politico headline makes clear just how difficult this “to-do” list is. The story focuses on all the tax provisions that will expire at the end of the year and is pointed at K Street, but each of those provisions has a Main Street constituency and collectively could affect the economy as much, if not more, than the expiration of the payroll tax holiday. As Politico notes:

Industries as diverse as real estate, housing, education, energy and automobiles are making the case to lawmakers that passing an extenders package is just as important to the economy as measures that appear more likely to pass, such as unemployment insurance, the doc fix and the payroll tax holiday.

The largest are the R&E tax credit relied upon by manufacturing and high-tech firms, as well as the state sales tax deduction used by taxpayers in states without an income tax. For S corporations, the current 5-year holding period for built-in gains assets would return to an unreasonable 10 years, while the more friendly treatment of charitable donations would expire.

Politico says the payroll tax fight comes down to “who pays,” but that really applies to all the remaining items. Coming up with $200-250 billion in permanent offsets to extend existing policies for a year is a serious hill to climb, and there’s only two weeks to figure it out. As with the Super Committee, we’re skeptical Congress can figure it out in time. Some of these items may pass, but it’s unlikely all of them will.

New Year – New Challenges

Happy New Year! As we’re preparing for the new Congress and the new challenges it brings, we would like to once again thank you for your continued support of the S Corporation Association and to emphasize the important work we do in defense of the S-Corp community.

Perhaps the best that can be said about 2010 is that it showed consistent improvement. The year started with a horrible economy and policy clouds on the horizon. And though some of those policies were enacted – the new 3.8 percent tax on S corporation income, for example – many were defeated and the year ended in a much better place than it began.

Tax hikes were avoided, the rules governing S corporations were improved, and policymakers are better educated about the critical role that flow-through businesses play in creating jobs and economic growth. And through it all, the S Corporation Association was right in the middle, representing our members and protecting the community from policies that would harm our ability to invest and grow.

Key among these victories was the defeat of the $11 billion payroll tax hike on the incomes of certain S corporation shareholders. This policy passed the House earlier in the year and came within one vote of passing the Senate, too. Check out past Washington Wires for the full story, but the short version is the S Corporation Association rallied the business community and our friends and allies in the Senate and, led by Senators Olympia Snowe of Maine and Mike Enzi of Wyoming, was able to ensure that the provision was not included in the final bill. In the process, we helped save S corporation shareholders from higher taxes and higher compliance costs, and ultimately sent a message to the Hill that S corporations, as one of our members eloquently put it, were not to be treated like the government’s private ATM machine.

In addition, the Association successfully championed legislation temporarily reducing the built-in gains holding period from ten years down to five years. This provision has been a multi-year undertaking for us and it builds upon our previous success in lowering the holding period down to seven years in 2010. As a result, thousands of S corporations are free to sell underutilized assets in 2011 and put that money back to work. In an economy starved for capital, what makes better sense than allowing firms to access their own capital?

And finally, S corporations and all flow-through businesses got an early Christmas present when Congress passed a two-year extension of the lower tax rates, including the top marginal tax rates and the 15 percent rate on capital gains, this December. While we advocated for a permanent extension, two years is still one year longer than we hoped for, and it sets the stage for some serious tax policy work between now and the Federal elections in 2012.

Looking forward, our plate is full: extending the five-year built-in gains holding period into 2012 and beyond, fighting efforts to increase S corporation payroll taxes, advocating the repeal of the new 3.8 percent tax, and educating policymakers on the role of Main Street businesses in job creation will be no small task, but not one we’re about to shy away from.

One new issue emerging from the headlines is the push for corporate tax reform this year (see below). We are all in favor of improving the tax code for corporations– as long as it doesn’t hurt the five million or so employers who are not structured as C corporations. That, of course, is the challenge.

Another goal for this year is to pass the full array of reforms included in our S Corporation Modernization Act. This legislation includes several priority items, including allowing S corporations access foreign capital and expanded benefits for S corps that engage in charitable activities.

To champion this bill and our other priorities, we are fortunate that our House team remains intact, with Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) ready to reintroduce our modernization bill early in the 112th. Meanwhile, in the Senate, we are thrilled that our long-time S corporation supporter Orrin Hatch (R-UT) has taken over as Ranking Member on the Senate Finance Committee, and together with Senator Snowe, we are thankful that they will continue to champion our efforts.

Another S-CORP priority this coming year will be to preserve the IC-DISC and its benefits to small and closely-held exporters. Many of you have not heard of the IC-DISC, but if you export, then you know how critical the DISC is to ensuring competitiveness in those foreign markets. Despite being in law since 1984, the DISC has its critics and detractors, but nevertheless, the S Corporation Association will lead an inspired defense in 2011.

Those are the S Corporation Association goals for the 112th Congress. As always, we look forward to working with you in 2011 to defend the greatest vehicle for private enterprise ever invented — the S corporation.

Corporate Tax Reform Front and Center

We are hearing increasing noise that corporate tax reform may see an early push here in the 112th Congress:

  • Treasury Secretary Tim Geithner met with the CFOs of 20 major U.S. companies on Friday, discussing rates and the possibility of reform;
  • The House Ways and Means Committee will hold its first hearing of the year on tax reform and tax complexity on Thursday, January 20th; and
  • President Obama is being encouraged to highlight tax reform in his January 25th State of the Union Address.

For S Corporations, partnerships, and sole proprietorships, the challenges of tax reform were best highlighted by the 2007 bill H.R. 3970 — termed the “Mother of all Tax Bills” by its sponsor Representative Charlie Rangel (D-NY). That legislation would have broadened the tax base for corporations while reducing the top tax rate they pay from 35 to 30.5 percent.

What many did not realize is that the base broadening would have also affected partnerships and S corporations while their rates were scheduled to go up as well! As a result, the Rangel “Mother” bill would have resulted in a dramatic tax burden increase on smaller, privately-held businesses.

The effects of the recent report from the President’s National Commission on Fiscal Responsibility are less clear. Although the Commission called for cutting both corporate and individual rates – a welcomed proposal - it appears that, overall, the report also proposes to shift the tax burden from public companies to individuals and smaller businesses.

As you can imagine, this negative outcome for S corporations has caught our attention, and we are working with other business groups around town to make certain policymakers understand the implications of any reform proposals out there.

Tax reform is great in theory, but if it is used as a cover to raising the overall tax burden, or to shift the tax burden from one sector to another, then policymakers need to be made aware.

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