Good news on a hot day in July! The 2016 version of the “S Corporation Modernization Act” has been introduced the House and the Senate. Led by Senators Thune (R-SD) and Cardin (D-MD) and Representatives Reichert (R-WA) and Kind (D-WI), the bill includes a half-dozen provisions designed to improve the rules that govern S corporations.
- You can see the entire bill here
- You can see the section-by-section analysis here
- You can see the S-Corp press release here
Yesterday’s introduction of companion bills is the first time in a while that the S corporation community has had this important legislation being championed in both bodies, and we really appreciate the hard work the members and their staffs put in to get the provisions just right.
Of particular note is the fact that Senator Thune is taking on the leadership of the bill from Finance Committee Chair and longtime S corporation advocate Senator Orrin Hatch (R-UT). South Dakota has a ton of S corporations and ranks second nationally in pass-through employment, so this effort is important to Senator Thune and his state and we look forward to his enthusiastic leadership. As he noted at the introduction:
Family owned small businesses are the backbone of the U.S. economy and can be located in every corner of the country. Small towns and rural communities are oftentimes the ideal location for these small- and medium-sized businesses, which is why making these common-sense reforms to S corporations is so important to South Dakota.
Senator Ben Cardin added:
S corporation businesses are critical to the well-being of the Maryland economy and account for more than half of our state’s private-sector workforce. Unfortunately, our federal tax code has not kept up with the increasingly important role that these types of companies play,” said Cardin. “The S Corporation Modernization Act contains much-needed changes to the tax treatment of S corporations, allowing them to better attract capital, create jobs, and make charitable investments in their communities.
Key changes in this version relative to past efforts include:
- Dropping the two provisions – BIG and charitable – that were made a permanent part of the Tax Code last December
- Moving the Nonresident Alien provision up to the top slot – it is time for direct foreign investment to be available to S corporations; and
- Including the new internal basis adjustment provision to ensure that S corporation assets receive similar treatment as partnerships.
So your S-Corp team has a new bill, new champions, and new priorities to accomplish in the coming months and years. The legislative outlook is uncertain, with Congress preparing to break for the party conventions and then, after a short fall session, the November elections. That doesn’t leave us much time, but as always we will be looking for opportunities to get something done. With a terrific bipartisan set of advocates on the Hill, we are in a good position to do just that.
S-Corp Concerns Dominate 385 Comments
The comment period is closed and the verdict is in – just take S corps out. That’s what numerous trade associations and other groups recommended to Treasury regarding the pending section 385 regulations. Here’s what the National Association of Manufacturers had to say:
The proposed regulations also significantly impede the ability of businesses organized as subchapter S corporations to utilize their cash effectively. In particular, the bifurcation rule in the proposed regulations, which allows the IRS to treat a debt instrument as part debt and part stock, could cause a subchapter S corporation to lose its S status and become taxed as a C corporation.
In order to qualify as an S corporation, an entity must have only one class of stock (identical rights to distribution and liquidation proceeds) and must be owned only by eligible shareholders (examples of ineligible shareholders include C corporations, foreign corporations, partnerships, insurance companies and non-resident aliens). The reclassification to stock, or part stock, could inadvertently create an ineligible S corporation shareholder (e.g., if the debt reclassified to stock was held by a C corporation, the C corporation would become an ineligible S corporation shareholder); and/or the reclassification to stock could create a second class of stock via preferred return consideration on the debt instrument….
The proposed regulations do not apply to corporations filing a consolidated tax return. S corporations under common ownership, however, are not permitted to file a consolidated tax return and thus, the proposed regulations apply to commonly-owned S corporations, even those with solely domestic activity. The NAM strongly recommends that subchapter S corporations be exempted from the final regulations.
Other groups made similar arguments and their conclusions were just as strong. Here’s just a sample:
Exclude S corporations from the expanded group.
We recommend that S corporations be exempted from the application of the regulations.
Provide exceptions to ensure that S corporations do not inadvertently terminate their status when debt is reclassified as equity.
The rules should exempt S corporations which clearly cannot be a focus for the issues of concern regarding the Proposed Rules.
Exclude S corporations, as well as certain other entities, from the ambit of the proposed regulations (i.e., revise Prop. Treas. Reg. § 1.385-1(b)(3)(i)(A) so that it only “turns off” paragraph (3) of section 1504(b)).
The IRS is holding a public hearing on the proposed rules today. Of the 18 speakers listed, many of them are from groups that support excluding S corporations from the rule. We’ll be watching closely to what, if any, reaction there is from the Treasury and IRS officials in attendance. More to come.
Last Friday, longtime S-CORP allies Rep. Dave Reichert (R-WA) and Rep. Ron Kind (D-WI) introduced two pieces of legislation – H.R. 629 and H.R. 630 – to extend tax provisions critical to America’s 4.6 million S corporations.
The bills would make permanent the five-year built-in gains holding period as well as a basis adjustment fix for S corporations making charitable contributions. They build off the momentum from last Congress when identical bills successfully passed the House with broad bipartisan support. These provisions are ones that we’ve championed for years, and go a long way towards making the tax rules for Main Street businesses fair and predictable.
In a joint press release, Rep. Reichert had this to say:
S Corporations are proven job creators and it is our job as legislators to make sure the tax code helps them to access the capital they need to grow, remain competitive and help get Americans back to work. I am pleased to introduce these bipartisan pieces of legislation with my colleague Congressman Kind, because our tax code should encourage growth rather than stifle it. I look forward to working with my colleagues to advance policies that help our small businesses create jobs and support families across the country.
Rep. Kind also added:
These commonsense, bipartisan bills will bring stability and simplicity to the tax code to make it easier for many small businesses to create good jobs and help sustain local communities. There are nearly 60,000 S Corporations in Wisconsin alone, so supporting these job creators is a top priority as we work to strengthen the economy in Wisconsin and across the country.
The broad support these provisions have garnered from the business community and lawmakers reflects the sentiment that these outdated tax rules just don’t make sense and permanent changes need to be made. H.R. 629 would allow S corps increased access to their own capital by providing for a permanent, five-year BIG holding period, rather than the current ten-year period these businesses must endure before they can dispose of appreciated assets without paying a prohibitive tax. As S-Corp Advisor Jim Redpath testified before the Ways and Means Committee last 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.
H.R. 630 is another common sense reform that would encourage S corporations to give back by permanently ensuring S corporations are able to deduct the full value of the stock they donate to charity. This provision would level out the tax treatment of such donations between S corporations and partnerships.
Improving and making permanent the rules for the businesses that drive our economy is critical and we applaud Reps. Reichert and Kind for once again introducing this legislation. We are looking forward to seeing the bills considered and adopted by the House!
It’s a big day for S corporations! Earlier today, the House voted to adopt HR 4453, the S Corporation Permanent Relief Act of 2014, by a count of 263 to 155. The bill, sponsored by Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) makes permanent the five year built-in gains holding period, and contains a basis adjustment fix for charitable contributions made by S corporations.
These S corporation provisions received strong bipartisan support. All but two Republicans supported the measure, while forty-two Democrats parted with their leadership and the Administration and voted yes. Ways and Means Committee Chairman Dave Camp kicked off the day by offering these remarks on the House floor:
The bill we have before us today is the right step forward to level the playing field between the small businesses on Main Street and big businesses. If a small business chooses to operate as an S corporation for tax purposes, we should ensure that they have the ability to access certain capital without tax penalties.
…This is a bipartisan, commonsense bill that will give small businesses some much needed relief from the burdens of the tax code, and allow them to make new investments and create new jobs.
Washington State Congressman and S-Corp ally Dave Reichert had this to say:
The BIG tax is a double tax on S corporations who want to sell their assets after converting from C corporation status.
…As we’ve heard from Jim Redpath…who testified before one of our Ways and Means hearings…the BIG tax causes S corporations to hold onto unproductive or old assets that should be replaced. He gave the example of a road contractor which is holding onto old equipment that is sitting in the junkyard…because if he sold them, they would be subject to the BIG, double tax.
Instead of selling the assets and using the proceeds to hire new workers or invest in new equipment, the business owners sit on the sidelines. This is a perfect example of the tax code influencing business decisions and needs to stop.
Opposition focused on the fact that the legislation included no offset. The Joint Committee on Taxation estimated the bill would cost $2.1 billion over ten years. The Democrats offered a motion to recommit – also lacking an offset – that would have extended the two provisions for two years only. This “no offset” argument also was at the heart of the veto threat articulated by the White House yesterday.
We strongly disagree with these concerns. JCT may score tax legislation on a current law basis but taxpayers, including business owners, live in a current policy world. Offsetting the cost of extending tax rules these businesses already use, and have used for years, makes little sense. Moreover, as the motion to recommit demonstrates, many of those opposed to making these provisions permanent were willing to incur the revenue loss of extending them temporarily. What is the difference between voting once to extend these items without an offset, and doing so repeatedly every year or two?
As far as next steps, the tax world now shifts it gaze to the Senate side, where new Finance Committee Chair Ron Wyden (D-OR) and Majority Leader Harry Reid (D-NV) are working out how to best move forward on their extenders package, which includes two year extensions of these to S corporation provisions. Our best guess is we will have to wait until after the November elections before we see further movement on these items, but that doesn’t detract from the success of the day and it certainly won’t prevent us from continuing to press these issues when we’re up on the Senate side!