S Corp News Clips

Family Business Valuation under Attack?

In a development that could harm valuations of S corporations and other family-owned businesses, the Treasury Department appears poised to issue guidance limiting discounts under section 2704. Such action has been hinted at for a while, but people began to pay real attention following comments from Catherine Hughes, head of Estate and Gift Tax Attorney-Advisor at Treasury, before the ABA’s Estate Planning breakfast back in April.

It’s not exactly clear what the Treasury has in mind, but Hughes referred the ABA audience to proposals the Administration included in their annual budget offerings prior to 2014.  We took a hard look at those proposals back in 2013, and if you’re looking for an indicator of where Treasury is headed, that’s a good place to start.  MPI, a business valuation and advisory firm, has a nice overview on their blog.


Highway Funding

For months, we’ve been hearing that tax writers would like to couple some version of tax reform with a long-term highway bill. What the tax reform package would look like was unclear (international, patent box, extenders?) as was the funding source for the highway bill (deemed repatriation?).

Back-to-back hearings on highway funding next week should shed a little light on the latest thinking.  Both the House Ways and Means and Senate Finance committees are holding hearings exploring the various options Congress could use to pay for highways.  As Senator Hatch pointed out, “While many in Congress agree we should aim for a long-term highway bill, the problem is often agreeing on how to pay for it.”  As usual, it’s all about the payfors.


The Ying-Yang of Tax Reform

Senate Majority Leader Mitch McConnell and House Ways and Means Chairman Paul Ryan talked tax reform outlook this week.

McConnell focused on the challenges, particularly in bridging the policy gulf between President Obama and Republican Congress.  “The President is not interested in revenue neutrality, and he’s not interested in treating all taxpayers the same, so I don’t think we’ll get there on comprehensive [tax reform].”

Ryan, meanwhile, continued to accentuate the positive.  “The question is: Can we take a couple of steps in the right direction?” Ryan made clear he believes the answer is “yes”, particularly with international tax policy and extenders.  So international, extenders, and highways?  Something to watch.


Tax Foundation on Revenue Neutral Corporate Tax Reform

The Tax Foundation released another study on pass through businesses this week.  You’ll recall they put out a really great paper on pass-through taxation in January that focused on the state of the pass through business community.  Our summary – it’s large, dynamic, and employs a lot of people!

This new study dives right into the policy debate over corporate tax reform.  Should Congress enact deficit neutral legislation that cuts the rates for C corporations only?  According to the Tax Foundation, the answer is “no” unless you’re willing to raise taxes on pass through businesses in the process.  They conclude “the impact of the elimination of business tax expenditures for pass-through businesses with no rate offset could reduce the size of the economy by 0.5 percent [or $84 billion in the long-run].”


Small Business Confidence

There’s a growing number of small business confidence surveys out there.

The Grand Daddy is NFIB’s Small Business Optimism Survey, which has been reporting quarterly since 1973 and monthly since 1986. NFIB uses a sample of nearly 4,000 small businesses, typically with a 15% response rate, and releases the information on the second Tuesday of each month.

This week’s survey gives a lukewarm assessment of the economy—“it’s moving ahead, but at an uninspiring pace” while the outlook for Q3 is “more of the same.” Two bright spots came in earnings and wages, which posted their best survey readings since October 2005 and January 2008, respectively.

A second survey, from Wells Fargo and Gallup, has been released on a quarterly basis since 2003. Their data is drawn from over 600 phone interviews with small business owners. While optimism among small businesses recorded a slight decline this Spring, overall “there’s more certainty in today’s economy than at this time last year, and we’re seeing more promising trends,” according to Lisa Stevens, head of Small Business at Wells Fargo.

Finally, there’s a brand new survey from Thumbtack, which focuses on hard-to-reach businesses such as seasonal employers and large swath of sole proprietors. Using their online community of professionals, Thumbtack is able to receive over 10,000 responses to their survey. The populations might be different, but Thumbtack’s results mirror those of NFIB—business owners are “somewhat positive” about the economy. Exploring the state-level results reveals some interesting data, particularly the discrepancies in ease of hiring and doing business in states with low regulatory burden compared to those with more red tape, typically in the Northeast and on the West Coast.

We’ll be keeping track of these surveys in future posts.  Perhaps it’s time for a survey of the surveys?


Tax Foundation on Pass-Through Businesses

The Tax Foundation today released a great paper outlining the state of American pass-through businesses – S corps, partnerships, and sole props – and how the tax code currently treats those companies.  According to the Foundation, those businesses account for more jobs and more business income than traditional C corps, making them the major player in the American economy.  As the paper concludes:

One of the main goals of fundamental tax reform is to make U.S. businesses more competitive and to increase economic growth. This requires a reduction in taxes on businesses and investment. Most attention is given to traditional C corporations because they face high tax burdens by international standards and account for a large amount of economic activity. As a result, less attention has been given to pass-through businesses. Considering that pass-through businesses now account for more than half of the business income and employment in the United States, any business tax reform needs to address the individual income tax code as well as the corporate income tax code.

You can read the full paper here. But if you don’t have time, we recommend the map below (click to enlarge).  It shows pass-through business employment by state and makes clear that, with the exception of Hawaii, pass-through businesses are the major employer in every state in the country. In Montana, they represent two out of every three jobs.


Rest assured we will be sharing this map and the full Tax Foundation paper with our friends on the Hill.

The Importance of Pass Throughs

Put on your “must read” list a new paper from our friends at the Tax Foundation highlighting the importance of pass-through businesses to jobs and employment. It’s the best written and most comprehensive summary of the issue we’ve seen to date. Here’s how it starts:

Support for lowering the corporate tax rate – now the highest in the OECD – has been expressed by both Democrats and Republicans in order to improve the competitiveness of American businesses. However, they differ in their plans for the individual tax code. While Republicans have proposed lowering the top individual rate from 39.6 percent to 25 percent, in parity with the proposed corporate tax rate, Democrats are less willing to consider lowering the individual tax rate.

The implications of these policy differences are considerable because of the tremendous growth in non-corporate business forms over the past thirty years. Today, there are vastly more non-corporate businesses than traditional corporations and they now earn more net income than traditional corporations. These businesses face top marginal tax rates higher than 50 percent in some states. Thus, ignoring the top individual tax rate – even while lowering the corporate rate – means the United States will continue to expose a broad swath of business to high tax burdens.

And how it ends:

As lawmakers consider policies to improve the competitiveness of American businesses, they should not forget that individual income tax rates are just as important to business activity as the corporate rate. The various proposals to raise income taxes on high-income earners, either by increasing the top marginal rate, closing “loopholes,” limiting deductions, or implementing a minimum tax, would fall very heavily on America’s non-corporate businesses. Pass-through businesses are currently facing top marginal rates on average between 44.5 percent and 47.5 percent and as high as 51.8 percent in California. These pass-through businesses account for a large percentage of business income and employment in the United States. Raising taxes on them could curtail their hiring and other investment plans, putting more strain on an already struggling economy.

The paper adds something new to the defense of the pass-through structure. Past arguments in support of a strong pass-through sector include:

  • Best Tax Policy: S corporations are the way business income should be taxed. It’s taxed once, when the business earns the money, and then that’s it.
  • High Effective Tax Rates: As our recent Quantria study demonstrates, pass-through businesses already pay a high level of tax, and they pay it when the income is earned.
  • More Progressive: By taxing business income using the progressive individual tax rates, policymakers ensure that business income is taxed in a progressive manner, with high income shareholders paying a higher rate, and lower income shareholders paying a lower one.
  • Diversification: Pass-through businesses spread investment and employment decision making across the country and into local cities and communities. As the recent financial crisis makes clear, diversification of these actions is critically important.

Thanks to the Tax Foundation, we can now add to that list “Economic Stability.” As the Tax Foundation notes:

It is also interesting to note the relative stability of pass-through business income to the volatility of C corp income. The period between 1999 and 2010, shown on Figure 2, is a good example of how volatile corporate income can be. After the tech bubble burst in 2000, C corp income plunged 24 percent over the next two years, after adjusting for inflation, and then rebounded 119 percent by 2005. After this temporary peak, C corp income fell again by nearly 33 percent over the next five years.

By contrast, pass-through income has not experienced such wild gyrations. After the tech bubble burst in 2000, pass-through business income actually increased in 2001. In 2002, net income fell by just 2 percent but then rebounded by 5 percent in 2003. In the four years after the 2003 tax cuts, the net income of pass-through businesses grew by nearly 60 percent, after adjusting for inflation. In 2010, pass-through business income exceeded C corp receipts by 40 percent.

Is there anybody remaining in Washington who still doesn’t understand the importance of pass-through business to our economic health? If you find them, please send them this Tax Foundation paper!

Breaking Up Tax Reform

Last week, Politico Pro is reporting something we’ve been concerned about for a while:

PATH TO PASSAGE? SENATE FINANCE COULD USE SMALL BILLS TO APPROVE TAX REFORM: The universal truth of tax reform is that it is, and always will be, hard to pass. But the folks over at the Senate Finance Committee are considering various ways to more easily push tax reform legislation through Congress – including splitting a comprehensive reform bill into smaller measures. Our Kelsey Snell reported for Pros that “separating business tax reform from the more contentious individual tax code would allow [Senate Finance Committee Chairman Max] Baucus to continue debate on corporate taxes, the international tax code and the treatment of some benefits for small businesses – where there’s more agreement between the parties – without opening a battle over how much revenue should be raised through changes to the individual code.”

The news outlet subsequently filed a couple corrections that left the story’s ultimate meaning in doubt, but the notion that you can split tax reform into small bites is definitely out there. Comprehensive is just too hard, some say, so let’s do a corporate bill where there’s more agreement.

Our concern with this approach is two-fold: First, we reject the idea that you can separate out the corporate tax code without doing significant harm to the pass through business sector. Corporate-only proposals to date would either raise taxes significantly on pass through businesses or they would treat them like second class citizens, instead of the majority source of employment and business income in the United States (see story above).

Second, the “consensus” on corporate reform is less than it appears and it will depend on the same, top line question confronting comprehensive reform — should it be budget neutral or raise revenue? Until that question is answered (and you know where we stand on that), any reform effort is going to face an uphill climb.

We support corporate tax reform, but only as part of a broader effort to reform the entire tax code.

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