Tax Reform Statement & Pass Through Taxes

Just in time for the August recess, the House, Senate and the White House released a joint statement yesterday on the status of their tax reform talks and their plans moving forward.  You can read the statement here.  From our perspective, here are the key points:
“While we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”
A primary purpose of the statement was to pivot the tax conversation away from the House Blueprint and the border adjustment tax (BAT).  The BAT was controversial from day one, but it also was proving to be an obstacle towards getting a budget resolution enacted in early September.  The leaders of the House Freedom Caucus had stated they would oppose the budget resolution without a promise that the BAT was off the table.  No budget resolution, no tax reform, so the BAT had to go.
Will it work?  Unclear.  Freedom Caucus Chair Mark Meadows (R-NC) was quoted this morning as saying that taking BAT off the table was nice, but they want clarity on the rest of the tax package before they would support the budget.  That sequence of details first, process second is the reverse of how congressional budgeting is supposed to work, and is an indication of just how difficult it will be to get the Freedom Caucus on board with any plan in September.
“The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas. And we are now confident that, without transitioning to a new domestic consumption-based tax system, there is a viable approach for ensuring a level playing field between American and foreign companies and workers, while protecting American jobs and the U.S. tax base.”   
The underlined lines, coupled with the demise of the BAT, indicate the negotiators are also moving away from full expensing and towards more limited capital cost recovery improvements, such as permanent bonus depreciation and faster depreciation schedules.  Full expensing was a predicate for the BAT and a cash-flow tax system, but it faced its own challenges.  It was expensive, it was paired with the controversial provision to disallow deductions of net interest, and it was received by the corporate community with a giant yawn.
“The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.”
Temporary tax cuts are out and repatriation and territorial are in.  Both of these items are significant concessions by the Trump Administration, which had in the past made the case for temporary rate cuts and only lately embraced moving towards a territorial system.  The Blueprint relied on the BAT to enforce its territorial tax approach.  Now that it’s out, expect the tax writers to spend lots of time crafting more complicated “Camp Option C”-type rules to crack down on base erosion under a new territorial regime.
 “We also believe there should be a lower tax rate for small businesses so they can compete with larger ones, and lower rates for all American businesses so they can compete with foreign ones.”
This careful construction suggests that the tax negotiators have agreed to reduce rates for C corporations and pass through businesses alike (yea!) but have not settled on any other details, including whether the business provisions should be a tax cut or not.  Compare that language with the very specific “agreement that tax relief for American families should be at the heart of our plan.”  Meanwhile, White House advisor Steve Bannon has been busy selling a tax hike on high income earners.  As Bloomberg reports this morning:
“White House chief strategist Steve Bannon’s plan to raise the top income-tax rate for America’s highest earners could find some support among congressional Republicans as part of a populist message to sell a broader tax overhaul, according to one conservative lawmaker who has heard the proposal…. Automatic opposition isn’t a given among some GOP members, said the lawmaker who heard the proposal – especially if they’re made to understand how it could help publicly sell a plan that would include other changes to the tax code,” the lawmaker said.
These reports should act as a wake-up call for the Main Street community.  The Big Six (McConnell, Hatch, Ryan, Brady, Mnuchin, and Cohn) may have agreed that tax rates on all businesses should come down, but how that agreement squares with calls to raise rates on high income individuals, the majority of whom are business owners, is anybody’s guess.
So to sum up then, yesterday’s joint statement includes specific steps to advance the tax reform effort this fall.  Its call for ending the BAT and for considering tax reform under regular order are direct responses to criticisms that threatened to derail House consideration.  And the significance of all three actors – the House, Senate, and Administration – coming together to craft a joint statement should not be lost among the details either.  It is a commitment to get something done by the leaders of the government and should be taken seriously.
On the other hand, the brevity of the statement coupled with the Administration’s continued message muddle makes clear there’s lots of negotiating to come and many, many details to fill in.  As we have discussed in the past, those details are important – they could spell the difference between a tax package that treats Main Street fairly, and one that leaves it behind.  For that reason, we will be on the Hill pressing our case for fair treatment of all private businesses and the communities they serve.

Extenders Clear the Senate

Although it’s not ideal and expires in just two weeks, we are glad to report that the tax extenders bill finally passed in the Senate last night by a 76-16 vote and is on its way to the President’s desk.

Among the 55 provisions included in the bill are the reduced five-year built-in gains holding period and the basis adjustment fix for charitable contributions. The package, however, is a one year retroactive extension of the expired provisions through 2014, and will therefore expire at year’s end.

Interestingly, Senate Finance Chairman Ron Wyden (D-OR) voted against the bill, as did Sen. Rob Portman (R-OH), highlighting the ridiculous nature of a one-year retroactive extension for tax policy. (The 16 “no” votes were a bipartisan affair: 8 members of each party opposed the bill.) Speaking last night, Chairman Wyden said:

“This tax bill doesn’t have the shelf life of a carton of eggs…the only new effects of this legislation apply to the next two weeks.”

Sen. Portman also took to the floor to vent his frustration:

“This is ridiculous because we’re not extending it beyond the tax year and by the time we get back here, it will already be expired for a week or two…it is a failure of Washington again to get its act together and do what should be done.”

That said, we are pleased our S-CORP provisions were included in the package and expect to pick up again next year, as the tax policy conversation will have an early start. Congress is now adjourned for the holidays and will start up again January 6th.

Our thanks go out to all our S-CORP champions, both on and off the Hill, for your continued commitment to the Main Street business cause. We hope that you have very happy holidays and we look forward to our work together in 2015!

 

Extenders Update

The tax extenders front has been busy in the last couple days.  First, there was the rumor Monday that negotiators were close to a deal.  Tuesday, details emerged of a $450 billion package mixing ten permanent items with a two-year extension (2014 & 2015) of most other items.  And then yesterday evening the White House issued a veto threat against the package, leaving its prospects very much up in the air.

What’s remarkable about the White House veto threat is that it occurred at all.  To our recollection, this is the first time in six years the White House and Senate Majority Leader Harry Reid have been publicly crosswise on legislative policy.  Reid negotiated the package with House Ways and Means Chairman Dave Camp and it includes several provisions – including making the state and local tax deduction and the mass transit benefit permanent – that Reid and other senior members of his caucus have historically supported.  So it’s obvious the Reid office and the White House are no longer in close communication, at least on tax matters.  As the Hill reported:

Democratic aides on Capitol Hill said that the White House quickly made it clear Tuesday that it was, in the words of one staffer, “livid” over a deal that would have indefinitely extended tax priorities for both parties. Senior administration officials reached out to Democratic lawmakers to get that message across, aides added, with even Obama and Lew trying to marshal opposition.  “This is a terrible deal for Democrats,” one aide said.

Moreover, we’re hearing that part of the White House’s motivation for blocking this package is their belief that doing so will generate momentum for corporate-only tax reform. This kind of reform has been roundly denounced for leaving out and penalizing a majority of the private sector businesses in this country, but the White House and Treasury have been much more active on that front and appear to believe that such a deal is possible.  (We don’t.)  Here’s what our friends at Capital Alpha had to say about that:

The President is making a deliberate and contemplated move to set the ground rules for discussions of fundamental tax reform and corporate tax reform next year with the incoming Republican majority. The President won’t talk about revenue neutral tax reform in a vacuum. His terms for tax reform include big payoffs for constituencies of the progressive left in terms of policy goals and economic benefits. Such has been his position all along, which is why we have always been skeptical of tax reform next year.

As to the package, it’s broad and includes lots for the pass-through community to like.  For starters, it would make permanent two S corporation specific provisions – the shorter holding period for built-in gains and the basis adjustment for charitable donations – as well as popular provisions like the R&E tax credit and small business expensing.   Here’s the complete summary from Tax Notes:

The deal would make permanent the following 10 provisions:

  • the research credit, simplified according to the provisions in a House-passed bill (H.R. 4438) to make the credit permanent but also including the provision from the Senate Finance Committee package providing start-up businesses the ability to claim the credit against payroll taxes;
  • section 179 expensing;
  • the state and local sales tax deduction;
  • the American opportunity tax credit, indexed to inflation after its renewal in 2018;
  • the employer-provided mass transit and parking benefits exclusion;
  • the reduced recognition period for built-in gains of S corporations;
  • the rules regarding basis adjustments to the stock of S corporations making charitable contributions of property;
  • the rule allowing some tax-free distributions from IRAs for charitable purposes;
  • the deduction for charitable contributions by individuals and corporations of real property interests for conservation purposes; and
  • the deduction for charitable contributions of food inventory.

The remainder of the package will mostly follow the extenders bill the Senate Finance Committee approved this spring to renew through 2015 all but two of the 55 traditional extenders that expired in 2013.

However, the deal will phase out the wind production tax credit, ending the incentive after 2017.

It also includes House-passed modifications to the bonus depreciation provision that would expand the definition of qualified property to include owner-occupied retail stores and lift restrictions to allow for more unused corporate alternative minimum tax credits, which businesses can claim in lieu of bonus depreciation, to be used for capital investment.

So where do things stand?  We are hearing conflicting reports.  One word from the Hill is that the deal is off and that negotiators will have to start over, probably with a one-year extension for 2014 only (Boo!).  Other reports, however, suggest that Senate Democrats are not backing down.  It is possible yesterday’s package could move through both the House and the Senate despite the White House’s objections, and we’re hearing some Senate offices are working the membership to make that happen.

With everybody home for Thanksgiving, we won’t have a better idea where the votes are and what Senate leadership decides to do until next week when everybody returns.  In the meantime, the tax world has more than just turkey to chew over this holiday!  Stay posted.

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