Reichert, Buchanan Present S Corp Tax Relief to Ways and Means

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:

Reichert

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“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:

Buchanan

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“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.

S Corp Modernization Introduced!

Just in time for our annual Board meeting, S-Corp Champions Dave Reichert (R-WA) and Ron Kind (D-WI) introduced legislation to improve the rules governing S corporations!  Entitled the S Corporation Modernization Act of 2015 (HR 2788), the legislation would help ensure that the more than 4.6 million S corporations are able to compete and thrive today’s economy.

Back in 2013, a coalition of key business organizations supported similar legislation, noting that many of the rules that govern the day-to-day management of S corporations date back more than half a century.   These outdated rules hurt the ability of existing S corporations to grow and create jobs.  Many family-owned businesses would like to become S corporations, but are unable to get around some of the existing restrictions.  Other S corporations are starved for capital, but find the rules limit their ability to attract investors or even utilize the value of their own appreciated property.  HR 2788 would help address these challenges.  Specifically, the bill would:

  • Modernizing the rules that apply to firms that have selected S corporation status;
  • Increasing the ability of S corporations to access much-needed capital; and
  • Easing and expanding S corporations’ ability to make charitable donations.

In a joint press release, Rep. Reichert described his legislation in these terms:

“There are more than 95,000 S corporations in Washington State,” said Reichert. “And with 1 in 4 workers being employed by these small businesses nationwide, it is absolutely critical that we ensure these businesses have the tools that will promote their growth, not stifle it. This is a common-sense bill, and I am proud to introduce it with my colleague Mr. Kind. We must continue to support our small businesses and allow these proven job creators to access the capital they need to grow, compete, and get Americans back to work.”

Rep. Kind made the following comment:

“It is critical that we ease the tax burden on our small and family owned Wisconsin businesses who are driving our economic growth.  Under this legislation, S corporations will be better able to access credit, invest in their business, and create the good paying jobs that we need.”

With the S-Corp Board in town, we’ll be up on the Hill visiting key tax writers and building support for modernizing the S corporation rules.  Congress needs to pass tax extenders and give certainty to America’s employers, but it is also important for the tax writing committees to seek new provisions that help improve the tax rules governing Main Street businesses. The S Corporation Modernization Act of 2015 includes a number of those improvements, and we’re looking forward to working with our sponsors and other supporters to get them enact this Congress.

Moving on Extenders

Extenders are back in play in the House and Senate.  Finance Chairman Ron Wyden (D-OR) plans to release his package Monday, with amendments due on Tuesday and markup to begin on Wednesday.

Details of the Wyden plan are not available, but early indications are that his package will include most of the tax provisions that expired at the end of 2013 and that they will be extended for both 2014 and 2015.  It doesn’t appear that the Chairman plans to offset the revenue loss of the package unless there are more modifications to the language than a simple date change.

Meanwhile, on the House side, Ways and Means Chairman Dave Camp (R-MI) sent a letter to his colleagues outlining his plan for addressing extenders.  As the letter states:

As such, beginning in April, the Committee will continue its work by going policy by policy to determine which extenders should be made permanent.  That process will include both hearings and markups. Specific dates and topics will be forthcoming.   

Reading between the lines, it appears the Ways and Means Committee will hold hearings on extenders beginning in April to examine the provisions more closely, followed by the introduction of an extender package and consideration by the Committee.  After the examination, we should expect a package that focuses on permanent extensions – keeping in line with the principle of tax reform.

For S corporations, there are a couple items at play here.  First is the extension of built-in gains (BIG) relief, which expired at the end of 2013.  With the expiration of the 5 year BIG holding period, thousands of S corporations that have converted from C corporation status now have to hold on to their appreciated assets for an entire decade or face the BIG corporate-level tax. This causes a prohibitive tax burden where the applicable federal, state and local shareholder taxes exceed 60 percent in many states.   This punitive tax effectively forces these businesses to “lock-up” their assets and capital, inhibiting future investments in the business and employees, as well as potential job creation.

Our Senate champions, including Sen. Ben Cardin (D-MD) and Sen. Pat Roberts (R-KS) who recently introduced legislation together to permanently extend the 5 year recognition period (S. 1855), are steadfast in their support and have called for BIG relief to be part of any extender package that moves forward.  As the snap-back to 10 years is an excessive amount of time to reasonably ask a company to hold a particular asset, Congress has agreed to extend the 5 year period several times and we have had strong bipartisan support for this important relief for many years.

The second item is the extension of the basis adjustment to stock of S corporations making charitable contributions of property, a provision that also expired at the end of last year. With flow-through entities, charitable deductions flow through to the individual tax returns of partners or shareholders.  Prior to the Pension Protection Act (PPA) of 2006, however, if an S corporation made a contribution of appreciated property to charity, its shareholders’ deductions were limited to their basis in the S corporation.  To encourage more charitable giving by S corporations, the PPA temporarily removed this limitation, allowing shareholders to take into account their pro rata share of charitable deductions for contributions of appreciated property.  The provision has been extended with bipartisan congressional support ever since.  It brings consistent treatment of charitable contributions between flow-through businesses, and would allow for America’s S corporations to be more active and supportive of needed charitable activities.

Permanent extensions of these provisions have, of course, been included as part of the S Corporation Modernization package for several congresses – most recently introduced by Reps. Dave Reichert (R-WA) and Rep. Ron Kind (D-WI), as H.R. 892 in the House last year.

Both permanent extensions were included in Chairman Camp’s tax reform discussion draft, along with other S Corporation Association priorities.  The draft would also increase access to capital by extending ownership of an S corporation to non-resident aliens through an electing small business trust (ESBT), ensuring payment of tax at the trust level (at the highest individual tax rate), easing punitive restrictions that apply to converted S corporations regarding passive income limitations, and punishing the unwary with S corp status termination.  Lastly, the draft would encourage philanthropy from S corporations by conforming the rules applicable to ESBTs and individual shareholders of an S corporation.

We plan to keep a close eye on this extender process – particularly our S Corp priorities – and look forward to seeing Chairman Wyden’s package on Monday.

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