S-CORP Clips | Week of December 12

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

Hatch Tax Reform Report

For weeks, there had been K Street rumors of a “secret” tax reform plan being put together by in-coming Finance Committee Chairman Orrin Hatch (R-UT).  Apparently, the “Comprehensive Tax Reform for 2015 and Beyond” report released yesterday is it, although it’s not so much a plan as an analysis of the current code and the challenges policymakers will face in reforming it.  After a quick review, it’s obvious the Finance Republican staff spent an enormous amount of time and effort putting this together and it shows.  As our friends at Politico summarized:

Before lawmakers can reform the tax code, they need to understand it.

Towards that end, incoming Senate Finance Committee Chairman Orrin Hatch released a nearly 350-page report today on all-things tax reform.

It traces the history of the tax code, and efforts to reform it, as well as issues ranging from patent boxes to refundable credits to the case for moving to a territorial system, along with what, exactly, is a territorial system.

From the pass-through business community’s perspective, there’s lots to like here, particularly the report’s emphasis on integrating the corporate code with the individual code to eliminate the double tax on corporate income.  We’ve been advocating for corporate integration for years.

The report also advocates for comprehensive reform, another priority of the Main Street business community.  Here’s what it says:

Tax reform also needs to address the more than 90 percent of U.S. businesses organized as pass-through entities, such as partnerships, S corporations, limited liability companies and sole proprietorships. According to recent data, approximately 58 percent of all net business income in the United States is earned by pass-through entities.22 If real estate investment trusts and mutual funds are included as pass-through entities, then the percentage rises to 78 percent.23 Because of these numbers, it is important that we approach tax reform in a comprehensive manner, addressing both the individual and corporate tax systems. As the data show, both systems are intertwined and must be looked at in the whole.

On the other hand, the report does signal just how much work the pass through community has in educating policy makers on the importance of pass through businesses to jobs and investment.  The chapter on business tax issues is wholly dominated by corporate concerns, while the subchapter on pass through tax issues is only three pages long.  More on this to come. 

Inversions

Ryan Ellis of Americans for Tax Reform reminds us in his recent Forbes article that corporate inversions are driven by bad tax policy, not bad corporations.  He writes:

To say the least, the United States has not created a friendly tax environment for our largest employers.  They face the highest marginal income tax rate in the developed world (whether they are corporations with a 40 percent rate or flow-through firms with a nearly 50 percent rate).

…There should be a giant notice at the top of every business tax form released by the IRS which says, “Get out of our country, and take your jobs and capital with you.” Corporate inversions are a natural and a regrettable side effect of this treatment.”

Extender Recap

Last month, your S-Corp team was popping champagne corks when we learned that congressional leaders had reached an agreement to make permanent several of our priorities – including the five-year built-in gains holding period – as part of a broader extenders package.  We then had to put the corks back in the bottles (not easy) when a preemptive veto threat from the White House dismantled the deal.

We are now left with Plan B – an extension of expired provisions for tax year 2014 only.  The legislation, which was passed last week by the House, retroactively renews the provisions going back to the start of 2014 and would therefore expire just a few weeks after passage.  So starting January 1, we’ll be right back at it.

Charitable

This week the White House further demonstrated its aversion to permanent tax provisions when it issued a veto threat against legislation that would lock in three charitable provisions.  According to the Hill, the bill would “…permanently extend preferences for donations of excess food inventory; waive some limitations for donations of land to conservation easements; and make permanent a provision allowing tax-free donations from Individual Retirement Account funds.”  That package is now dead too.

 

Highway Bill, Extenders, and the Tax Outlook for the Rest of the Year

The pending debate over highway spending has tax implications and the pass-through business community should pay attention.

The Highway Trust Fund will run out of money in the next couple weeks and both the Senate and the House are planning a two-step response — a short-term patch that will keep highway projects funded into next year and then longer bills that would establish highway policy for the next couple years.

How to allocate all those dollars for roads and bridges is always a complicated and politically charged affair.  So is how to pay for it.  Finance and Ways and Means both are expected to hold markups tomorrow on their respective plans.  Here are the offsets for each:

  • Ways and Means:  $11 billion in offsets from pension smoothing ($6.4 billion), customs user fees ($3.5 billion), and transferring funds from the Leaking Underground Storage Tank fund ($1 billion)
  • Finance:  No final deal yet, but it looks like they are shooting for $10 billion in offsets including mortgage reporting ($2.2 billion), extending the statute of limitations on overstatement of basis ($1.3 billion), and a host of other items.

Considering the alternatives — gas tax hike, tolls on interstate highways — this set seems pretty tame.  That said, the debate over the highway bill should serve notice to the business community that while tax reform may be on hold, Congress will continue to look to tax policy to offset some of its other priorities, so we need to be vigilant.

Meanwhile, action on extenders and related items continues at a low level.  This week, the House will take up a permanent 50 percent bonus depreciation bill.  While bonus depreciation is not really an “extender,” it does keep the focus on all those expired provisions, and it’s not bad policy either.  Coupled with the higher Section 179 limits, the bill goes a long way towards moving the tax treatment of business investment towards general expensing, something many economists have argued is good for the economy.  As the Tax Foundation noted:

We find that permanently extending this provision would boost GDP by over 1 percent, wages be 1 percent, and create 212,000 new jobs due to its effects on the cost of capital. It would also increase federal tax revenues by $23 billion after taking into account the increases wages and incomes caused by making bonus expensing permanent.

Extending R&E, Section 179, and built-in gains — either permanently or for several years — would be good for the economy too.  These provisions already expired at the end of last year (2013), so every day Congress waits is a day of benefit lost.  When Congress does act, it will make the extension effective back to January 1st, but it will be hard to argue that business investment increased in 2014 because of higher Section 179 limits that weren’t retroactively extended until this December, won’t it?  The behavioral effect will be lost.

Moreover, any extension that is less than two years (2014 and 2015) would require Congress to come back next year and perform the exercise all over again.  How Congress expects businesses to use these provisions to their advantage when they keep expiring is beyond our ability to explain, and one of the best arguments behind Chairman Camp’s push to make them permanent.

Despite the strong case for action now, any meaningful movement prior to the elections would be shocking.  There’s only seven or eight weeks of session left before Congress recesses for the elections, and with the extenders already expired, we can’t see a real catalyst out there that would compel the House and Senate to come together on a package.

That’s too bad, and is just one more reason why both the tax code and the policy making process that creates it appear wholly dysfunctional.

BIG Tax Relief on House Floor

It’s a big week for S corporations!  The House is scheduled to vote on several small business tax items, including permanently higher section 179 expensing limits and S corporation modernization legislation too!

The S corporation bill, newly-named the S Corporation Permanent Tax Relief Act of 2014, will bundle together HR 4453 (permanent 5-year BIG period) and HR 4454 (basis adjustment for charitable contributions). We expect the bill to be considered by the Rules Committee later today with debate and a vote on the bill to take place Thursday.

Making the five-year recognition period for built in gains permanent has been an S-CORP priority for years, and while we have been successful at enacting temporary reductions in the past, this week’s action marks the first time either the House or the Senate has considered a permanent fix.

By way of background, here are some of the documents we have developed over the years to support the shorter holding period as well as the charitable donation provision:

The case for the shorter five-year recognition period is strong and is certain to help encourage business investment.  As Jim Redpath testified early this year:

I find the BIG tax provision causes many S corporations to hold onto unproductive or old assets that should be replaced. Ten years is a long time and certainly not cognizant of current business-planning cycles. Many times I have experienced changes in the business environment or the economy which prompted S corporations to need access to their own capital, that if taken would trigger this prohibitive tax. This results in business owners not making the appropriate decision for the business and its stakeholders, simply because of the BIG tax.

We are recirculating the business community letter to allow additional groups to sign on is support of BIG tax relief.  We’ll post the letter tomorrow and we will be working with our House allies to ensure the vote on Thursday is as broad as possible.

Senate to Vote on Buffett Tax

While the House is working to reduce the tax burden for S corporations, the Senate is seeking to raise them.  This week, the Senate will consider legislation to provide student loan relief paid for with our old friend, the so-called “Buffett Tax”.

We’ve criticized both the theory and execution of the Buffett tax in the past (here, here and here), and all those arguments still apply:

  • The federal tax code is already steeply progressive;
  • The tax code already has three distinct income taxes – the regular income tax, the Alternative Minimum Tax, and the Affordable Care Act investment tax.  The Buffett Tax would be a fourth!
  • Much of the Buffett tax will fall on the owners of pass-through businesses; and
  • For sales of S corporations, the Buffett tax would eliminate the benefit of the lower tax on capital gains.

The Tax Foundation agrees with our concerns, and posted a nice analysis of the provision when it was introduced last month.   Here’s what they had to say about the structure of the tax:

Besides the 30 percent effective tax rate in the Buffett rule, there is a phase-in of the tax over $1,000,000 of AGI. This phase-in creates a spike in taxpayer’s marginal tax rate of over 50 percent. Our current tax code is no stranger to hidden marginal tax rates caused by phase-ins and phase-outs. However, these are not positive aspects of the code. They obscure peoples’ true tax burden, add unnecessary complexity, and create marginal tax rate cliffs that incentivize people to change behavior to avoid them.

The Buffett Tax vote is tomorrow.  We doubt it will receive the 60 votes necessary for this poorly thought out policy to move forward, but it will be interesting to see who votes to raise taxes on Main Street businesses in order to increase federal spending.

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