New Year – New Challenges

Happy New Year! As we’re preparing for the new Congress and the new challenges it brings, we would like to once again thank you for your continued support of the S Corporation Association and to emphasize the important work we do in defense of the S-Corp community.

Perhaps the best that can be said about 2010 is that it showed consistent improvement. The year started with a horrible economy and policy clouds on the horizon. And though some of those policies were enacted – the new 3.8 percent tax on S corporation income, for example – many were defeated and the year ended in a much better place than it began.

Tax hikes were avoided, the rules governing S corporations were improved, and policymakers are better educated about the critical role that flow-through businesses play in creating jobs and economic growth. And through it all, the S Corporation Association was right in the middle, representing our members and protecting the community from policies that would harm our ability to invest and grow.

Key among these victories was the defeat of the $11 billion payroll tax hike on the incomes of certain S corporation shareholders. This policy passed the House earlier in the year and came within one vote of passing the Senate, too. Check out past Washington Wires for the full story, but the short version is the S Corporation Association rallied the business community and our friends and allies in the Senate and, led by Senators Olympia Snowe of Maine and Mike Enzi of Wyoming, was able to ensure that the provision was not included in the final bill. In the process, we helped save S corporation shareholders from higher taxes and higher compliance costs, and ultimately sent a message to the Hill that S corporations, as one of our members eloquently put it, were not to be treated like the government’s private ATM machine.

In addition, the Association successfully championed legislation temporarily reducing the built-in gains holding period from ten years down to five years. This provision has been a multi-year undertaking for us and it builds upon our previous success in lowering the holding period down to seven years in 2010. As a result, thousands of S corporations are free to sell underutilized assets in 2011 and put that money back to work. In an economy starved for capital, what makes better sense than allowing firms to access their own capital?

And finally, S corporations and all flow-through businesses got an early Christmas present when Congress passed a two-year extension of the lower tax rates, including the top marginal tax rates and the 15 percent rate on capital gains, this December. While we advocated for a permanent extension, two years is still one year longer than we hoped for, and it sets the stage for some serious tax policy work between now and the Federal elections in 2012.

Looking forward, our plate is full: extending the five-year built-in gains holding period into 2012 and beyond, fighting efforts to increase S corporation payroll taxes, advocating the repeal of the new 3.8 percent tax, and educating policymakers on the role of Main Street businesses in job creation will be no small task, but not one we’re about to shy away from.

One new issue emerging from the headlines is the push for corporate tax reform this year (see below). We are all in favor of improving the tax code for corporations– as long as it doesn’t hurt the five million or so employers who are not structured as C corporations. That, of course, is the challenge.

Another goal for this year is to pass the full array of reforms included in our S Corporation Modernization Act. This legislation includes several priority items, including allowing S corporations access foreign capital and expanded benefits for S corps that engage in charitable activities.

To champion this bill and our other priorities, we are fortunate that our House team remains intact, with Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) ready to reintroduce our modernization bill early in the 112th. Meanwhile, in the Senate, we are thrilled that our long-time S corporation supporter Orrin Hatch (R-UT) has taken over as Ranking Member on the Senate Finance Committee, and together with Senator Snowe, we are thankful that they will continue to champion our efforts.

Another S-CORP priority this coming year will be to preserve the IC-DISC and its benefits to small and closely-held exporters. Many of you have not heard of the IC-DISC, but if you export, then you know how critical the DISC is to ensuring competitiveness in those foreign markets. Despite being in law since 1984, the DISC has its critics and detractors, but nevertheless, the S Corporation Association will lead an inspired defense in 2011.

Those are the S Corporation Association goals for the 112th Congress. As always, we look forward to working with you in 2011 to defend the greatest vehicle for private enterprise ever invented — the S corporation.

Corporate Tax Reform Front and Center

We are hearing increasing noise that corporate tax reform may see an early push here in the 112th Congress:

  • Treasury Secretary Tim Geithner met with the CFOs of 20 major U.S. companies on Friday, discussing rates and the possibility of reform;
  • The House Ways and Means Committee will hold its first hearing of the year on tax reform and tax complexity on Thursday, January 20th; and
  • President Obama is being encouraged to highlight tax reform in his January 25th State of the Union Address.

For S Corporations, partnerships, and sole proprietorships, the challenges of tax reform were best highlighted by the 2007 bill H.R. 3970 — termed the “Mother of all Tax Bills” by its sponsor Representative Charlie Rangel (D-NY). That legislation would have broadened the tax base for corporations while reducing the top tax rate they pay from 35 to 30.5 percent.

What many did not realize is that the base broadening would have also affected partnerships and S corporations while their rates were scheduled to go up as well! As a result, the Rangel “Mother” bill would have resulted in a dramatic tax burden increase on smaller, privately-held businesses.

The effects of the recent report from the President’s National Commission on Fiscal Responsibility are less clear. Although the Commission called for cutting both corporate and individual rates – a welcomed proposal - it appears that, overall, the report also proposes to shift the tax burden from public companies to individuals and smaller businesses.

As you can imagine, this negative outcome for S corporations has caught our attention, and we are working with other business groups around town to make certain policymakers understand the implications of any reform proposals out there.

Tax reform is great in theory, but if it is used as a cover to raising the overall tax burden, or to shift the tax burden from one sector to another, then policymakers need to be made aware.

Senate Passes Built-In Gains Relief

After months of maneuvering, the Senate today adopted H.R. 5297, the Small Business Jobs and Credit Act.B This legislation includes a number of business-friendly provisions, including the built-in gains tax relief so important to the S Corporation Community.B This is a big (excuse the pun) victory for S corps everywhere!

The bill now moves back to the House, where it could take two paths.B On the first path, the House takes up the Senate version, passes it intact, and sends it to the President for his signature.B The second path would include House amendments and more floor debate.B At that point the bill would return to the Senate, taking up time Congress simply doesnbt have.

For that reason, we expect the House to take the first path, so we should have a signing ceremony–and a five year BIG holding period starting next year–by the end of the month.B Good news indeed.

Payroll Tax Dropped from Extenders

During consideration of the small business bill, Finance Chairman Max Baucus (D-MT) sought to add a new package of btax extendersb to the bill.B Republicans blocked the effort, pointing out that this was a wholly new package and that once again the minority was being blocked from offering amendments on the Senate floor.

The core of this package (the fourth or fifth version he has put together over the past year) would extend for 2010 all the provisions that expired at the end of 2009 — the R&E tax credit, state sales tax deduction, the S corporation charitable deduction, etc.; it also includes a number of unrelated spending items.

More good news for S corporations: the payroll tax hike included in earlier versions of the extender package is not included here.B With the short calendar we donbt expect this issue to return this year, but it will return.B Webll continue to work to make certain any provision drafted to address this issue is well constructed and doesnbt target law-abiding S corporations.

House Moderates Oppose Tax Hike on Private Employers

As we mentioned in the last Washington Wire, a letter in support of extending all the expiring tax provisions was circulating among moderate Democrats in the House.B If enough Democrats signed on, the letter had the potential to change the legislative prospects of blocking the pending tax hikes in the House.

Well, the letter is out, and 31 moderate Democrats signed on– more than enough to signal a tipping point on the issue.B As the letter concludes:

We urge quick passage of legislation to extend the tax cuts so that American families and businesses have the certainty required to plan and make informed decisions.B The sooner we act, the sooner our nationbs economy will benefit.

Added to the base of Republican support, this level of support from Democrats puts proponents of a full extension within spitting distance of majority support and increases the odds of a stalemate on this issue. B After all, how does the Speaker limit extending the tax relief to the middle-class only if a majority of House members support a full extension?

This difficulty was reflected in the Speakerbs comments earlier this afternoon.B As The Hill reported:

Pelosi argued at length for allowing the tax cuts on the top brackets to expire, but she could not say whether she had the votes to do so. Asked if there was any chance the top rates would be extended, even temporarily, the Speaker dodged.B bThe only thing I can tell you is tax cuts for the middle class will be extended this Congress,b Pelosi said.

Meanwhile, our friends on the Senate side are telling us nothing is likely to happen before November, at the least.B The House is unlikely to move on this issue until the Senate acts, and the Senate lacks the necessary 60 votes to move anything, so itbs off to the blame duckb we go.

After the elections, we continue to believe that of the three possible outcomes — no action, protecting the middle class only, or protecting everybody — the most likely outcome is bno actionb this year.B The next most likely outcome is a temporary extension of all the tax rates.

Legislation limited to extending the middle class provisions was always unlikely to move.B This letter makes it less so.

Volcker Report Released. On a Friday. In August.

The headline says it all. The long-awaited Volcker Tax Reform Commission report was released last Friday and was immediately put on a shelf someplace in the basement of the Ways and Means Committee. According to the Commission members:

The Board was asked to consider various options for achieving these goals but was asked to exclude options that would raise taxes for families with incomes less than $250,000 a year. We interpreted this mandate not to mean that every option we considered must avoid a tax increase on such families, but rather that the options taken together should be revenue neutral for each income class with annual incomes less than $250,000.

In general, the report’s authors sought to provide “helpful advice to the Administration” on “options for changes in the current tax system to achieve three broad goals: simplifying the tax system, improving taxpayer compliance with existing tax laws, and reforming the corporate tax system.” The Board was not asked to consider major tax reforms.

Just how helpful this advice is remains to be seen, but the low-key manner in which the report was released suggests the Administration does not see the report itself as a useful message vehicle. Proposals to raise taxes seldom are.

For S corporations, two recommendations stand out:

Payroll Tax Provision: The report suggests that payroll tax policy could be changed so that all active S corporation shareholders, LLC members and limited partners pay payroll taxes on all distributions from their businesses. Under the heading of “Disadvantages,” the report states:

The revenues raised from the proposal would come primarily from owners of small businesses. Moreover, it would impose employment taxes on income that is partially a return on capital rather than a return on labor.

Our point exactly.

Business Structure Neutrality: As a part of corporate tax reform, the report states that “a goal of reform in this area is tax neutrality with respect to organizational form” including these two options:

One option would be to require firms with certain “corporate” characteristicsb – publicly traded businesses, businesses satisfying certain income or asset thresholds, or businesses with a large number of shareholders “to pay the corporate income tax. In effect, this would broaden the corporate tax base by applying the corporate tax to more businesses.”

An alternative option would eliminate the double taxation of corporate income and harmonize tax rates on corporate and non-corporate income through “integration” with the individual income tax. In one example of such a system, individual investors would be credited for all or part of the tax paid at the corporate level against their individual taxes.

 

In other words, you could harmonize the tax treatment of business income by either imposing the corporate tax on more entities or by reducing the double tax currently paid by C corporation shareholders. Again, the disadvantages of option one highlighted by the Commission speak volumes:

Achieving neutrality between corporate and non-corporate businesses by subjecting more businesses to the corporate tax would increase the cost of capital and thus decrease investment in those businesses.

Yep.

More on Pending Tax Hikes

 

Our friends on the Hill pointed out a new survey of the National Association of Business Economists membership on the pending tax hikes. The survey found that more than half of NABE economists support extending all the marginal tax rates (including the upper brackets) while six out of ten support keeping the rates on capital gains and dividends at 15 percent. Other interesting results:

  • Three quarters support promoting economic growth over reducing the deficit;
  • Three quarters oppose further fiscal stimulus; and
  • A large plurality support “clarity on future regulation and tax policy” over other ways in which the government can best “encourage increased employment.”

 

We are hearing this last point repeatedly these days — the best thing Congress can do is provide a little policy certainty to the markets. Congress is not doing the things it is supposed to (budgets, tax extenders, etc.) while it is considering and adopting dramatic changes to rules by which businesses relate to their employees, their customers, and their government. Markets do not like uncertainty, yet the current policy climate here in D.C. is rife with it. CNN points out that in the area of tax policy alone, more than 100 tax relief provisions affecting just about everybody are waiting to be extended.

 

Finally, on the National Commission on Fiscal Responsibility and Reform, four out of five respondents did not believe the Commission would produce a credible plan that could pass Congress. On that one, we’re not so sure.B A growing number of smart folks around town are suggesting the Commission may be the best chance we have in the next couple years to get the federal deficit under control. Maybe; but either way, we’re guessing that report won’t be released on a Friday.

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