Recap of a Busy Week in Tax Policy

Patent/Innovation Box

Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) unveiled their proposed “innovation box” legislation aimed at keeping intellectual property registered in the United States. The bill would lower the rate on qualified income from patents and intellectual property to 10 percent, but only for firms with domestic R&E expenses. Similar laws already exist in Europe, and there are signals that this could become part of a Ways and Means international tax package later this year. Here’s Chairman Ryan on the proposal:

The proposal from Reps. Boustany and Neal can help us stem the tide and protect good American jobs. It will also help ensure the United States continues to be the world’s leader in innovation. Their plan would allow American businesses to better compete with foreign companies and keep their research and development facilities here in the U.S. This is just one piece of international tax reform, but it’s an important one. I applaud Charles and Richie for their work, and look forward to refining the proposal as we move forward on a broader plan to make America more competitive and promote high-paying jobs.

Senators Rob Portman (R-OH) and Chuck Schumer (D-NY), who authored the Senate Finance Working Group report on international reform, were also supportive. You can read their respective statements here. With support in both chambers, it appears the innovation box will be a factor in international tax negotiations later this year.

As the proposal currently stands, it doesn’t appear as if innovative pass through businesses would be eligible for the innovation box. The sponsors have made clear that the legislative text released this week is a “draft” and that they are eager for input.  We will be working with the rest of the pass through community to coordinate our comments and make sure S corporations are well represented.

 

Highway Bill & Patent Boxes

Why release the patent box draft now, just before the long August recess? We believe the goal was two-fold.  First, it is a genuine effort to get feedback on the proposal, which is a new concept for the Ways and Means Committee and they’d like to get the policy right.  Second, it helps to keep the ball moving on Chairman Ryan’s two step plan to getting international tax reforms done this year – pass a short term highway extension now and follow it up with a bigger package of highways and international tax reforms this fall.  The innovation box idea is a key “sweetener” in the larger international package, so getting it out now helps to move the overall plan forward.

For the past year, Ryan’s goal has been to combine highways, international reforms, and tax extenders into one big package Congress would enact at the end of 2015.  He believes the general desire by both parties to get a highway bill done can help push his international package over the finish line.

Senate Majority Leader McConnell, on the other hand, thinks any plan to reform taxes with this President in office is doomed to fail and wanted to get highways done and off the table at least through the elections.  So McConnell proposed to do long-term highways now with little in the way of tax policy, while Ryan advocated for addressing highways in December with as much international reform as he can muster.

The three-month extension adopted by Congress this week represents a compromise between the two positions.  It means Congress will have to revisit the issue prior to December, but it also keeps alive Ryan’s international reform efforts.

 

Built-In Gains Relief Introduced in Senate! 

Good news!  Sens. Pat Roberts (R-KS) and Ben Cardin (D-MD) introduced legislation Thursday to provide a permanent five-year recognition period for built-in gains (BIG) assets.

We’ve been advocating on BIG for years and, even after all of the leadership changes in Washington, DC over the past several elections, built-in gains relief continues to receive strong bipartisan support in both chambers. We are glad that Congress has recognized the importance of such relief by continuing to extend temporary relief – as included in the tax extender package recently adopted by the Senate Finance Committee.  Permanent BIG relief, however, is the only way to offer business owners the certainty they need, so we’ll keep working to get the Roberts/Cardin bill across the finish line.

Also in the Senate this week, the Small Business Committee adopted a “Sense of the Committee” resolution endorsing legislation introduced by Committee Chairman David Vitter (R-LA) that includes “sting” tax repeal!  Eliminating the “sting tax” has been a priority of the S Corporation Association for years and it’s a key part of the S Corporation Modernization Act introduced by Representatives Reichert (R-WA) and Kind (D-WI) last month.

Fixing this particular passive income rule has been long overdue—in fact, the Joint Committee on Taxation recommended the repeal of this termination rule back in 2001!  As with permanent BIG relief, we plan to spend this fall pushing the tax writing committees to adopt Sting Tax relief as part of any tax legislation moving this year.

 

Hillary Clinton Proposes Tax Hikes on S Corps

In her bid to reform so-called “quarterly capitalism,” presidential candidate Hillary Clinton proposed this week to hike the capital gains tax on investments held less than two years to the top individual rate of 39.6% (plus the 3.8% net investment tax), or nearly double the tax today. Under her plan, the tax rate would gradually decline for investments held between two and five years, while investments held six years or longer would get the current 20% rate.

So while all of Washington, including the Obama Administration, is working on ways to reduce the tax on investment and encourage more companies to remain here in the US, candidate Clinton would increase the cost of domestic investment instead.  Clinton did add that capital gains would be eliminated for select long-term investments in small businesses. That doesn’t sound bad, but it begs a few questions. What is her definition of “small business”? How long would the investment need to be held?

Moreover, if lower capital gains for small businesses would stimulate long-term investment, why limit it to small businesses?  Why not reduce or eliminate the capital gains rate on all domestic investments, as Senator Rubio has proposed? As the Wall Street Journal points out, this proposal may do little more than distort investment decisions in the short-term and prevent the efficient allocation of capital:

A high and sliding tax-rate scale also harms the efficient allocation of capital by expanding what economists call the “lock-in effect.” If owners of capital must wait years to pay a lower tax rate, many will decline to realize their gains solely for tax purposes. This artificially reduces the mobility of capital.

Economic growth is enhanced when capital is able to efficiently find its highest return. “Buy and hold” often works well for individual investors in specific stocks. But no economic theory says one- or two-year investments are worse than 10-year, and sometimes they’re better.

Worst of all, this would leave owners of pass-through businesses on the hook for corporate “quarterly capitalism.” Since many pass-throughs are family-owned through multiple generations, they’re already making the kinds of long-term investments that Clinton is looking to promote. Her campaign has said she is committed to producing a full tax plan, and we’ll be sure to analyze it when it becomes public.

S Corporation Modernization Bill Reintroduced in House

Good news! Last week, S-Corp champions and Ways & Means Committee members Dave Reichert (R-WA) and Ron Kind (D-WI) introduced the latest version of the S Corporation Modernization Act of 2013. Designated H.R. 892, the bill seeks to improve the rules governing S corporations by making permanent the five years BIG holding period, allowing non-resident aliens to invest in S corporations through an EST, and reducing the sting of the “sting tax”, among other provisions.

Specifically, H.R.B 892 would make needed changes to keep S corporations competitive and ensuring continued success of America’s predominant private business model by:

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

Said Congressman Reichert of the bill in a press release,which also cites our 2011 Ernst & Young study, issued on Thursday:

This tax relief proposal that would make it easier for S corporations to access capital, compete, and hire new workers by modernizing outdated rules that currently stifle their growth. A 2011 independent study revealed tax law dealing with S corporations affects 31 million Americans as S corporations employ one out of four workers in the U.S. private sector.

“S corporations and similar businesses are responsible for more than half of the jobs in Washington State and across America,” Rep. Reichert said. “As our economy continues to struggle to regain sound footing, I’m proud to introduce bipartisan legislation to help these proven job creators access the capital needed to grow, compete, and get Americans back to work. Working with the Ways and Means Committee toward comprehensive tax reform, I am committed to supporting these small businesses by advocating for pro-growth tax policies.”

The Reichert-Kind legislation presents a realistic set of reforms that would improve the ability of 4.5 million S corporations to access much-needed capital and increase their hiring capabilities. These reforms would improve the ability of S corporations to respond to the current business environment and remove impediments that prevent them from competing on a level playing field at home in the United States.

The bill is consistent with legislation introduced in the past, and we’re confident several of these provisions will be seriously considered this Congress. Thank you Mr. Reichert and Mr. Kind!

Congressman Kind Introduces S Corp Modernization Bill

Just before Congress left for the holiday break, Congressman Ron Kind (D-WI) introduced legislation to help improve the rules under which S corporations operate. The bill, H.R. 4840, is entitled the “S Corporation Modernization Act of 2007″ and was cosponsored by a strong bipartisan set of members, including Representatives Jim Ramstad (R-MN), Stephanie Tubbs Jones (D-OH), Allyson Schwartz (D-PA), Phil English (R-PA), Sam Johnson (R-TX), and Steve Kagen (D-WI).

Congrats to the Kind office for introducing this important legislation and putting together this impressive list of cosponsors. Given that most of our S corporation challenges are tax-related, the fact that six of these cosponsors are also members of the powerful Ways and Means Committee is particularly important.

In addition to the S Corporation Association, seven other national business organizations have endorsed the legislation, including the National Federation of Independent Business, the American Council of Engineering Companies, the Associated Builders and Contractors, the Associated General Contractors of America, the National Beer Wholesalers of America, the Independent Community Bankers of America and the Printing Industries of America.

The bill itself includes reforms important to keeping S corporations competitive in coming years, including built-in gains reforms, expanding S corporation ownership through small business trusts and relief from the so-called “sting tax” passive investment rules. As the “Dear Colleague” letter Representatives Kind and Ramstad circulated yesterday outlining the legislation noted:

“Absent change, America’s 3.8 million S Corporations will be handcuffed with outdated rules that hinder their ability to grow and create jobs. That is why we recently introduced, along with our colleagues Reps. Stephanie Tubbs Jones, Sam Johnson, Schwartz, English, and Kagen, H.R. 4840, the S Corporation Modernization Act of 2007. Our legislation would make needed changes to the tax code to keep S Corporations competitive and would help ensure the continued success of America’s predominant small business model by:

 Modernizing the rules that apply to firms that have selected S corporation status;

 Increasing the ability of S Corporations to access needed capital; and

 Encouraging S Corporations to support charity through small business trusts.

These reforms would improve the ability of S Corporations to broaden their ownership and remove impediments that prevent them from competing on a level playing field here in the United States.”

On the Senate side, Senators Lincoln and Hatch have been working on a companion bill. S-Corp is looking forward to seeing that legislation introduced in the coming session. Given the strong support of these offices on S corporation issues in the past, we believe it is safe to say the S corporation community has never had a more active and broad based set of friends on Capitol Hill.

How can you help? S corporations are going to need all the highly-placed friends they can find in the coming years. Let your members of Congress know how these reforms are important to the success of your business and your ability to continue to grow and create jobs, and ask them to cosponsor HR 4840 as well.

Happy Holidays!