Highway Funding and Tax Extenders Update

Highway Debate Continues

Last week, we reported on the House’s adoption of a highway trust fund (HTF) extension through December. This extension is the first step of Chairman Paul Ryan’s plan to combine a longer term HTF extension with key international tax reforms.

Meanwhile, Senate leaders want to act now, not in December, on a longer-term extension.   Majority Leader Mitch McConnell, Sen. Barbara Boxer (D-CA), and Sen. Jim Inhofe (R-OK) support a six-year highway deal which has offsets for the first three years, but does not include international tax reform.  The Senate voted 62-36 Thursday morning to begin debate on the measure.

So both the House and Senate want a multi-year bill, but McConnell wants to pass something now and avoid revisiting the issue prior to next year’s election, while Ryan would like to leverage the highway issue to get international tax reforms.  A short-term HTF extension through December gives him more time to build support for the combo package.  Rumor is he will release a detailed plan, which should track closely with the Portman/Schumer International Working Group plan, as soon as next week.

So which is it?  Will it be a multi-year HTF extension now, or HTF extension plus international tax reforms later?  The current HTF authorization expires on July 31st  so we will know next week which view prevails, and whether Congress will be debating international tax reform this fall.

Senate Finance Moves Forward on Extenders

Good news!  The Senate Finance Committee voted this week 23-3 to send a tax extender package to the Senate floor. The extensions last for two years (2015 & 2016) and include S-Corp priorities built-in gains relief and charitable contributions basis adjustment. Relative to last year’s 11th hour retroactive one-year deal, early movement on a two year extension is welcome news.

The question now is how extenders will work its way through the Congress and ultimately to the President’s desk. There was some talk about attaching extenders to the highway bill being debated by the Senate right now, but that seems remote.  Outstanding issues regarding certain provisions, including the application of the solar tax credit, appear to stand in the way.

Regarding the post-August schedule, The Hill reports:

Congress will also have to deal with a number of big-ticket items when lawmakers return from their August recess, including a Sept. 30 deadline for government funding and the recent agreement the Obama administration struck with Iran. Hatch sounded skeptical after the markup that the package of tax breaks could be added to the Senate’s highway bill, which was released Tuesday.

Even though the timeline for passing extenders may be in flux, the fact that the bill has been reported out of committee is a good sign that Congress is moving and may act well in advance of last year’s last minute extension.

Senator Thune Supports Permanent BIG Relief!

Provisions like built-in gains have been part of extenders packages for years, and we’re still fighting to make them permanent. The good news is that we have friends in high places who share that goal.  Just this week, Senator Thune (R-SD) proposed an amendment that would do just that. During the extenders markup, Sen. Thune offered up his legislation to, among other items, make permanent the five year recognition period for built in gains.  He had this to say:

“I support this legislation to ensure that American families and businesses do not find themselves facing a higher tax bill come tax season,” said Thune. “However, I believe we can do better than simply preventing a tax increase in the short term. American taxpayers deserve the certainty and predictability that only comes from making tax relief permanent, something I intend to continue to pursue on their behalf.”

As we continue working to make built-in gains relief and charitable contribution provisions permanent, Sen. Thune’s amendment shows that there is a strong constituency in the Senate for our efforts. We expect that a permanent bill on built-in gains, similar to what was proposed last year, will be introduced soon in the Senate.

Thune Files S-CORP Amendment

More good news on the tax front.  Senator John Thune (R-SD) has filed an amendment making permanent two key S corporation reforms.  Joined by Senators Ben Cardin (D-MD) and Pat Roberts (R-KS), the Thune amendment would make permanent the shorter, five-year recognition period for built-in gains as well as an improved basis adjustment for charitable contributions by S corporations.

The text of the amendment is identical to the text of H.R. 4453 and H.R. 4454, legislation sponsored by Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) that passed the Ways & Means Committee earlier this month and are due to be considered by the House of Representatives in coming weeks.

As with the Reichert/Kinds bills, a large coalition of business organizations wrote in support of the Thune amendment.  The letter, signed by the American Trucking Association, the Associated Builders and Contractors, the S Corporation Associations, and twenty-one other organizations, closes, “On behalf of America’s Main Street business community, we respectfully ask that you support the Thune amendment and permanently extend the 5-year recognition period for built-in gains.”

The Thune/Cardin amendment would makes changes to the tax extenders package currently being considered by the Senate, That package already includes two-year extensions of the BIG and charitable provisions, but it faces an uncertain future.  Earlier reports suggested Republicans would vote en bloc against closing out debate to protest their on-going inability to offer amendments on the Senate floor.

The latest news, however, suggests that Republicans may support closing debate in order to ensure that the extender package keeps moving through the legislative process.  As National Journal reported earlier today:

Usually when Majority Leader Harry Reid prevents Republicans from offering amendments, GOP senators block the underlying bill. At least, that was how Republicans handled the recently dispatched energy-efficiency bill, which went down earlier this week.

“There’s probably a lot more support among Republicans for tax extenders than there perhaps was for energy efficiency,” said Sen. John Thune of South Dakota, the chamber’s No. 3 Republican.

The difference, according to lawmakers, is that some of the roughly 60 provisions in the tax-extenders package benefit constituents in some way. Thune also said that members view extending current tax policy differently than they do enacting new energy legislation.

“I just think you’re talking about tax policy,” Thune said. “You’re talking about extending tax policy. And many of them are things that our members are supportive of.”

The tax provisions that expired at the end of 2013 are extremely popular with the business community and, now that tax reform has been set aside, the only real opportunity to see them extended would be for the House and the Senate to come together on a package and send it to the President.  With strong leadership in both the House and the Senate, these two S corporation provisions are well positioned to be part of that package.

More on Extenders

The Finance Committee markup is scheduled to begin this morning and the amendment list just released shows there’s lots of pent-up demand for tax policy within the Committee.  Over 90 amendments have been filed, which begs the question, “When was the last time the Finance Committee held a markup on tax policy?” Answer – August of 2012.  As the old Wolf Brand Chili commercial used to say, “Well, that’s too long!”

There are lots of extenders that benefit S corporations along with other businesses, but two items in particular apply to S corporations only:

  • A two-year extension of the shorter, five-year holding period for built in gains; and
  • A two-year extension of the provision allowing the full deduction of appreciated property from an S corporation to a charity.

These provisions have long been part of S Corporation Modernization legislation championed by Senators Cardin (D-MD), Hatch (R-UT), and Roberts (R-KS) and S-CORP appreciates their hard work to see them included in the Senate package.  As we noted in the previous Wire, nearly the entire S Corporation Modernization bill [sponsored by S-Corp champions Reichert (R-WA) and Kind (D-WI)] was included in Ways and Means Chairman Camp’s discussion draft.

In a statement accompanying the hearing announcement, Chairman Wyden made clear his goal was to adopt a pared-back list of extenders through the end of next year and then use that time to develop and pass a more permanent reform of the tax code:

This bipartisan extenders package is the product of a Finance Committee that came together to provide needed certainty to the economy, protect jobs and maintain important priorities for working families,” Wyden said. “With that said, I am determined this will be the last extenders bill on my watch. It’s high time we focus on creating a new, 21st-century tax code, because the status quo is unacceptable.

Meanwhile, on the House side, the Ways and Means Committee just sent out a notice for a hearing next Tuesday, April 8th, to consider the “Benefits of Permanent Tax Policy for America’s Job Creators.”  According to the hearing advisory:

The hearing will explore the value in having stable, permanent tax policy for employers, as well as the problems caused by tax policies that frequently expire and are extended for short periods of time (and often retroactively).  To that end, the hearing specifically will consider those expired business tax provisions that are either made permanent or are provided long-term extensions under the discussion draft of the Tax Reform Act of 2014.

Our expectation is that this hearing will be followed by a Committee markup making permanent those “extender” provisions included in the Chairman’s discussion draft.

So the business community is confronted with two significantly different approaches to tax extenders.  The Senate approach would extend most of the package through 2015 with a commitment to reform the tax c ode before they need to be extended again, while the House eliminates most extenders and, consistent with the discussion draft, make the rest permanent.

Should be one interesting conference committee, which begs the question:  “When was the last time Congress conferenced a tax bill?”

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.

Camp Draft Released

Ways and Means Chairman Dave Camp (R-MI) released his long-awaited tax plan yesterday.  The Chairman has worked hard to put out a plan that addresses the biggest challenges faced by the tax code, and he should be applauded for keeping this effort alive.

From day one, Camp has been our lead in promoting comprehensive reform that addresses both the individual and the corporate tax codes.  Such an approach was needed if pass-through businesses like S corporations and LLCs were going to be treated in an even handed manner. This priority of leveling the playing field was embraced by our Main Street letter, signed by more than 70 business associations representing millions of employers, that called for equalizing the top rates on active income paid by all tax payers—individuals, pass through businesses, and corporations alike.

Somehow, however, that fairness message got lost in the drafting of the draft.  So did simplicity.

Consider the new rate structure.  The Committee says they reduced the rates from seven to just two – 10 and 25 percent.  But they also included a 10 percent (10 percentage points, that is) surtax on incomes above $450,000.  A surtax is really just another bracket by a different name.  Everybody knows that.  In fact, that’s how we got the current 39.6 percent bracket.  It started as a Clinton-era 10 percent “surtax” on the old top rate of 36 percent, and just evolved into what it really is – a new, higher tax bracket.

So really there are three tax brackets – 10, 25, and 35 percent.

Then there is all that other stuff.  The Obamacare 3.8 percent investment surtax is still there.  For some reason, tax reform couldn’t address that atrocity.  A new tax applied to a new definition of income, it taxes most forms of investment income above $250,000, including the S corporation income of passive shareholders.

There’s also a new, broader application of payroll taxes to S corporation income, including income from capital intensive businesses like manufacturers.  Years ago, Congressman Charlie Rangel (D-NY) proposed to apply payroll taxes to income earned by S corporations in the personal services industries.  Senator Max Baucus (D-MT) proposed a similar plan several years later.  The rationale was to crack down on tax cheats, but the proposals went much further than that and would have raised taxes on businesses that were fully complying with both the spirit and the letter of the law.  The Camp proposal would take the Rangel-Baucus idea even further by applying payroll taxes (in this case, SECA) to 70 percent of S corporation income earned by all active S corporation shareholders, regardless of what industry they are in.  That appears to add 11.6 percentage points to the tax rate of S corporations below the FICA cap and another 2.7 points to income above that.

Then there’s the disparate application of the new 35 percent bracket depending on which industry your business is in.  President Obama proposed several years ago to cut corporate tax rates to 28 percent for all C corporations, but if you were in manufacturing, you got a special lower rate of 25 percent.  The Camp draft takes this “winners and losers” approach a step further, offering pass-through businesses with production income a 25 percent top rate while other forms of income (retail, engineering, services, etc.) pay a top rate ten percentage points higher.

Finally, there are the recaptures and cliffs.  A cornerstone of “reform” has always been to eliminate thresholds and phase-outs as much as possible.  A key part of the Bush tax reforms in 2001 and 2003 was to eliminate the notorious phase-outs known as PEP and Pease.  Nothing makes the code more complicated than loading it up with one income phase-out after another.  Low-income families today face a potent combination of phase-outs from the EITC, the child tax credit, and the new health care reform subsidies.  The marginal rate cliff resulting from these phase-outs is the reason the CBO estimated the health care reform subsidies would encourage 2 million workers to stay home.  The Camp draft invents several new ones that will impact pass-through business income.  There’s the recapture of the 10 percent bracket, standard deduction, and child credit.  That starts at $300,000.  Then there’s the application of the new 10 percent surtax to previously untaxed employer-provided health benefits.  That starts at $450,000.

The net result is a bewildering array of rates and thresholds for pass-through businesses, with at least 11— not two—different marginal rates.  This chart is based on our first look at a very complex plan, so it might have some of the details wrong, but gives you a general idea of what we’re up against.

See the rate schedule on the right side for C corporations?  That’s what tax reform looks like.  Rational and even-handed.  The rate schedule for individuals looks pretty good too, especially if you ignore the effect on marginal rates of payroll taxes and low-income credits, as this table does (we simply didn’t have the time to figure it all out).

The rate schedule for S corporations, on the other hand, is a mess.  Why should it matter what industry you are in, or how involved you are in the business?  Business income should be business income.

This is not to say that there aren’t good items in the plan.  There are lots of them, including the lower marginal rates on labor and business income, the repeal of the individual AMT, the repeal of a zillion miscellaneous special-interest tax credits, the handful of provisions to improve S corporation governance, and more.

But each of these victories for fairness and simplicity is offset by a provision that moves in the opposite direction, like raising the tax burden on capital expenditures, increasing taxes on retirement savings, and increasing the top tax rate on capital gains and dividends.

The net effect of all this is that, even with the sharp reduction in corporate tax rates, the Camp draft increases the cost of investing in the United States!  That’s not our assessment.  That’s the assessment of the economic analysis circulated by the Committee to promote the plan.

So how did we get to this result?  The main culprit has got to be the remarkable number of constraints the Committee placed on its efforts before they began crafting the plan, including:

  1. Budget neutrality;
  2. Neutrality with respect to income classes;
  3. Establishing a top rate of 25 percent for individuals, corporations and pass through businesses;
  4. No cross-subsidization between individuals, pass-through businesses and corporations; and
  5. Excluding health care from the plan, including health care taxes.

Einstein couldn’t have drafted a reasonable reform plan under these constraints; neither could the capable staff at the Ways and Means Committee.  The result is that they neither stayed within their constraints – 3, 4, and 5 were all sacrificed to one degree or another – nor did they achieve the level playing field or simplicity at the heart of any real tax reform.

This is a discussion draft, so we’ll be working with the Committee to identify our concerns and work on changes.  Our message to the Committee will be focused on what’s in this post.  We will encourage them to return to first principles and remember why they started down the path of tax reform in the first place.  The outlook for reform moving through the Congress may be bleak, particularly the Senate, but the ideas put forward by plans like this live on forever.  It’s important to get them right.

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