So what do we know about the Administration’s tax announcement scheduled for tomorrow? First, we expect the announcement will be limited to principles and a couple key proposals – not a full blown tax reform plan.
Second, the emphasis appears to be on cutting tax rates. We expect something similar to the Trump campaign’s proposal setting the top rates at 33 percent for families and 15 percent for businesses.
Finally, there is likely to be a call for territorial tax treatment coupled with some commentary on the need for leveling the international tax playing field. We could see the term “reciprocal taxes” used again but, as in the past, it’s unlikely to be fully spelled-out what that means – some sort of tariff or the border adjustment provision the House is pushing.
For S corporations and the pass through business community, the good news, as reported in the Wall Street Journal, is that S corporations should be eligible for the lower 15 percent rate:
President Donald Trump on Wednesday is planning to unveil a proposal to slash the top tax rate on so-called pass-through businesses, including many owner-operated companies, to 15% from 39.6%, said White House officials familiar with the planning.
We’ve been advocating “rate parity” for pass through businesses for seven years now, so assuming the Wall Street Journal is correct, it is gratifying to see the White House embrace our message.
Exactly how to enforce the new lower rate will be a hot topic. As the Wall Street Journal notes:
Lawmakers will struggle to fit the 15% tax rate inside budgetary and procedural constraints and it will be hard for Congress to write rules that prevent people from converting higher-taxed wages into lower-taxed business profits.
Both are good points that will have to be addressed, but for now we will focus on the positive, as it appears all three of the players in tax reform – the House, Senate and White House – support the general concept of taxing all business income at the same top rate. That’s a vast improvement compared to where we were just a couple years ago, and should be cause for optimism in the Main Street business community.
So what does it all mean for the prospects of tax reform? It should increase the likelihood that any tax plan passed this year would be more narrowly crafted and focus on cutting tax rates as opposed to a full-blown reform. It has been obvious since the election that President Trump prefers a straightforward rate cut approach over comprehensive reform, and we expect tomorrow’s announcement to reflect that preference.
And it signals that reform efforts may take longer than we thought earlier this year. The case for quick action on tax policy was predicated on the White House, the House, and the Senate coming together on the broad outlines of a plan and then working that plan through the legislative process. With the White House reverting to something resembling their campaign proposal, we are moving away from a general agreement, not towards it.
That said, both the Congress and the White House continue to work hard on tax reform, meeting on a regular basis and raising these issues consistently. President Trump has talked about taxes more in the last few months than his predecessor did in eight years, so it’s obviously a priority. With everything else going on, that may be tomorrow’s most important takeaway. Where there’s a will….
As our members know, S-Corp wears two hats when it comes to advocacy – one is defensive where we protect S corporations from bad tax policy. The other is proactive and seeks to improve the S corp rules.
Both hats were on display this week before the House Ways & Means Committee. First, Rep. Dave Reichert (R-WA) discussed his S Corporation Modernization Act which makes a number of improvements to the S corporation rules, including opening the door to foreign investment into S corporations. As Rep. Reichert told the Committee:
“I’ve heard from a seventh-generation family-owned company and the struggles it has faced based on the nationalities of the spouses of the family members, including family members who have had to sell their stock in the company because of current restrictions. With the number of burdens our business owners face, does it make sense to maintain yet another hurdle simply based on who someone decides to marry?”
Allowing S corporations to attract foreign investment has been an S-Corp priority for years. The current restrictions simply make no sense, particularly if the fix is done through an ESBT structure in which the Treasury can be certain taxes will be paid. We’ve come close to getting this policy enacted in the past, and with Rep. Reichert’s leadership, we look forward to seeing it move through Congress soon.
Second, Rep. Vern Buchanan (R-FL) was able to educate the committee on the importance of tax rate parity. For a decade – between 2003 and 2012 – all forms of business paid the same top rate. Today, as a result of the Fiscal Cliff and Obamacare, C corporations continue to pay the same 35 percent top rate, but the rate on pass throughs is nearly 45 percent!
In response, Rep. Buchanan has introduced legislation – the Main Street Fairness Act – which would restore rate parity by capping taxes on pass-through businesses at the top C corporation rate:
“Today, the average business in Florida, a pass through, [pays] 43 percent, big corporations are at 35 percent. In many places in the country, state and federal is over 50 percent. My bill simply says lower those tax rates to nothing higher than corporate rates going forward.”
What’s the prognosis for these efforts? Shortly after the hearing, Ways and Means Chairman Kevin Brady (R-TX) announced that he was committed to restoring regular order in the Committee, stating:
“Today’s hearing demonstrates that we are serious about considering tax legislation through an open and transparent process. We’re committed to introducing bills, considering them and moving them to the floor. The fact that over 30 Members are sharing their ideas today is a testament to our new process – and to our return after so many years to regular order.”
Does this mean a markup of member-driven proposals is in our future? That remains to be seen, but the fact that the Committee is giving members an opportunity to speak about their respective efforts is promising, and we will continue to work with our friends on the Committee both to protect S corps from bad policies and to fight for improved rules.
Business Community Unites Against 385 Regs
Speaking of bad policies, some of the largest business trade groups in the world have sent Treasury a letter calling on the agency to rethink the proposed section 385 regulations it released last April 4th. You can read the whole letter here, but the core of the letter’s message is contained in these two paragraphs:
Based on Treasury’s April 4 press release, the proposed 385 regulations are designed “to further reduce the benefits of and limit the number of corporate tax inversions, including by addressing earnings stripping.” Nonetheless, even a cursory review of these regulations clearly indicates that they go far beyond cross-border mergers and apply to a wide range of ordinary business transactions by global and domestic companies both in and outside the United States.
Indeed, the proposed 385 regulations affect all aspects of both a company’s capital structure and the funding of its ordinary operations and fundamentally alter the U.S. tax rules on intercompany debt by overturning the well-established facts and circumstances analysis used by the courts and the Internal Revenue Service (IRS) to determine whether an instrument is debt or equity. Whether an instrument is debt or equity has significant, collateral consequences to business operations that go well beyond the interest deduction on the instrument and include the legal classification of an entity, eligibility for withholding tax exemptions under tax treaties and the ability to file a consolidated tax return. These issues present a severe impediment to the use of intercompany financing for even normal operations and will significantly increase the cost of capital and limit the amount of capital available to invest in the United States.
We noted in a previous post that these regulations pose a particularly acute threat to S corporations. All the concerns listed above apply to S and C corporations alike, but S corporations also face the possibility that they could lose their classification and be forced back into the C corporation world.
The comment period for these proposed regulations ends on July 7th. We intend to submit extensive comments and hope that others do as well. Our message is simple – these regulations were not well thought out and need to be pulled.
For five years, the S Corporation Association and its allies have asked tax writers to pursue business tax reform that taxes all business income just once and at the same, reasonable top rates. That’s the correct way to tax business income and more than 100 trade groups, including the largest trade groups in the country representing millions of employers, have signed on to this premise.
And for five years, we’ve watched as the tax code moved in exactly the opposite direction.
Instead of preserving rate parity, the combination of the Fiscal Cliff and the implementation of the Affordable Care Act resulted in pass through businesses paying at a top rate nearly 10 percentage points higher than C corporations. Instead of reducing the double corporate tax, President Obama signed into law new polices that raised shareholder taxes dramatically. The result is that the effective marginal tax on business investment today is significantly higher than it was just a few years ago.
No wonder companies and capital are fleeing the United States.
In recent months, however, we have seen signs of hope. First, Finance Chair Orrin Hatch (R-UT) announced he was working on a plan to eliminate the double corporate tax. His plan isn’t due out until June so we haven’t seen the details, but the fact that the Chairman and his staff are spending time and resources pursing policies to create a single layer business tax is promising. A properly constructed integration plan has the potential to address many of the ills the business community faces.
And just this week, Congressman Vern Buchanan (R-FL) introduced legislation on the issue of rate parity. Entitled the Main Street Fairness Act, the bill would cap the top pass through business tax rate at the top corporate rate. Under the Buchanan bill, the same 35 percent top rate that applies to corporate income would also apply to successful pass through businesses. If Congress reduces the corporate rate next year, pass through businesses would get the new lower rate too.
Groups weighing in on the Buchanan bill include the National Association of Manufacturers, the National Retail Federation, and the Associated Builders and Contractors. You can read more about the Buchanan bill here. You can read the S Corporation Association letter on the bill here.
We would like to see the Buchanan bill expanded to apply to all active pass through income, and Congress still needs to repeal the 3.8 percent Affordable Care Act tax that applies to some S corporations and other businesses. We don’t want those concerns, however, to detract from the fact that of the three core Main Street Business principles we outlined five years ago – tax reform should be comprehensive, restore rate parity, and end the double tax — two of those principles are being actively pursued by senior members of the tax writing committees.
That’s a positive sign, and something we plan to build upon in the coming months.