S Corporations Featured in Presidential Debate

This week’s Presidential debate featured both of our recent S-Corp studies — the first highlighting how many Americans work for pass-through businesses, and the second making clear that the pending higher tax rates will result in fewer jobs, lower wages, and less capital investment.

On pass-through jobs:

Governor Romney: But let’s get to the bottom line. That is, I want to bring down rates. I want to bring the rates down, at the same time, lower deductions and exemptions and credits and so forth, so we keep getting the revenue we need. And you think, well, then why lower the rates? And the reason is, because small business pays that individual rate. 54 percent of America’s workers work in businesses that are taxed not at the corporate tax rate, but at the individual tax rate. And if we lower that rate, they will be able to hire more people.

On the impact of higher rates:

Governor Romney: Now, I talked to a guy who has a very small business. He’s in the electronics business in St. Louis. He has four employees. He said he and his son calculated how much they pay in taxes — federal income tax, federal payroll tax, state income tax, state sales tax, state property tax, gasoline tax. It added up to well over 50 percent of what they earned. And your plan is to take the tax rate on successful small businesses from 35 percent to 40 percent. The National Federation of Independent Businesses has said that will cost 700,000 jobs.

Washington Wire readers will recognize those statistics as coming from the two studies we’ve commissioned by Ernst & Young in the past two years. You can access these studies here:

The point of these studies was to arm policymakers with good information about how pass-through businesses like S corporations are a key source of jobs. Based on this week’s debate, we’d say they worked.

Small Business Sector Afraid of Fiscal Cliff

More evidence that the current environment of increased regulatory activity and looming higher tax rates are hurting private businesses and job creation: according to a new poll by the Tax Foundation, 55 percent of business owners and manufacturers would not have started their businesses in today’s economy, while 69 percent say that President Obama’s regulatory policies have hurt their businesses. Here’s the summary from Roll Call:

Of 800 small business and manufacturers surveyed, 55 percent said the national economy is in a worse position for them to succeed than it was three years ago.

The survey, which was released today, was commissioned by the National Federation of Independent Businesses and the National Association of Manufacturers and was conducted by Public Opinion Strategies.

The study showed that two-thirds of the respondents believe economic uncertainty in the market makes it hard for them to grow and to hire more workers, for which they hold the Obama administration or Congress responsible.

The finding that entrepreneurs would refrain from starting new businesses or hiring new workers in this lousy economy is reinforced by new research by Tim Kane at the Hudson Institute. According to Kane’s research:

  1. Startup businesses have historically been the source of all net new job creation; Startups create an average of 3 million new jobs a year, while established companies lose on average one million per year.
  2. Since 2006, startup job creation has fallen sharply, declining each year through 2011; and
  3. Startup job creation under President Obama is the lowest of any President in the last 24 years.

You might recognize this point from the Presidential debate. Governor Romney cited Tim’s work too:

Governor Romney: It’s small business that creates the jobs in America. And over the last four years, small business people have decided that America may not be the place to open a new business, because new business startups are down to a 30-year low. I know what it takes to get small business growing again, to hire people.

Obviously, the two studies are connected. Faced with an uncertain level of taxation and regulation, entrepreneurs are holding back on hiring and investment decisions. That’s what these studies are telling us, and that’s what we hear from our membership. Hopefully, Congress and the Administration will hear them as well and do something about it in the Lame Duck.

Business Community Opposes Tax Hike

Following yesterday’s comments by President Obama, the S Corporation Association joined together with more than 30 other business associations to make the case for action by Congress to avoid the massive tax hike on private enterprise looming next year. As the letter states:

Main Street businesses are America’s job creators. They are responsible for 60 percent of the net new jobs created in the last decade. But uncertainty about the economy and looming tax hikes have kept this sector from hiring new workers, resulting in a weak economic recovery and slow to nonexistent job growth. Until Main Street begins to hire, we fear the unemployment rate will remain unacceptably high.

Congress returns next week and the first order of business will be the much-delayed package of small business tax provisions. This legislation is the perfect vehicle for extending the tax rates and Congress should jump at the chance. According to the Joint Committee on Taxation, failure to take action would mean that taxes next year will rise on families and businesses by $227 billion.

Despite the President’s opposition, momentum for extending all the expiring rates appears to be growing. In recent weeks, senators Ben Nelson (D-NE), Kent Conrad (D-ND) and Evan Bayh (D-IN) have all expressed support for extending all of the rates. Meanwhile, former OMB Director Peter Orzag wrote in the New York Times earlier that, given a choice between doing nothing and extending everything next year, Congress should extend everything.

Each of these Senate defections is significant since any effort to extend current tax policy will need 60 votes, and the Democrats only control 59 prior to the elections. As The Hill noted today:

Senate Democrats would need all 59 Democrats and at least one Republican to pass the Obama administration’s plan to extend tax cuts for the middle class while allowing the tax breaks for the highest-income tax brackets to expire. That plan could be a non-starter in the Senate without Nelson’s support, since another GOP vote would be needed for passage.

Moreover, the Democrat’s majority may shrink immediately after the November elections. Three states — Delaware, Illinois, and West Virginia — will immediately seat their new Senators after the elections in November rather than wait until January, which means if any of those seats change parties, support for a full extension would grow.

As before, we continue to believe the most likely outcome is continued stalemate on extending the rates and no action by Congress this year, followed closely by Congress choosing to extend all of the rates for at least a year. Each additional defection, combined with any Republican victories in Delaware, West Virginia, and Illinois, increases the odds that the latter option becomes law.

S-CORP on Fox Business News

S Corporation Association Executive Director Brian Reardon appeared on Fox Business News last week to discuss the Obama Administration’s newest stimulus proposals.

As discussed above, if the Obama Administration wants to see some real stimulus, it should seek to remove the policy uncertainty hanging over the private sector and support extending all of the current tax provisions that either expired last year or are scheduled to expire next year.

While some of the specific tax items offered up — particularly expensing and a permanent R&E tax credit — are attractive to members on both sides of the aisle, finishing the existing “honey-do” list of tax items is more important.

The amount of capital available to the private sector — and currently buried in money market funds and ridiculously low-interest Treasuries — completely dwarfs the $180 billion package proposed by the President, even without the offsetting tax hikes that are planned to accompany the package. Getting that capital off the sidelines is the first step towards helping the job market recover.

Tax Policy on the Table for September

Members of Congress are back home and set to return mid-September for a final three week session before the November elections. Add in two or three weeks of possible “lame duck” session, and that’s the extent of time available to tax writers to address the numerous items on their honey-do list:

  • Preventing the 2011 tax hikes (including AMT);
  • Adopting the small business tax bill;
  • Extending the extenders that expired last year;
  • Extending the extenders that will expire this year; and
  • Something on the estate tax.

Given that these issues have been before Congress the entire year, it’s difficult to conceive how Congress would suddenly jump into action on all these items before the clock runs out. And while recent statements by leadership suggest they will make a concerted effort to address most of these items before adjourning for good, the Senate continues to be hamstrung in its ability to move anything. Here’s our take on the where we go from here:

  • Small Business Tax Bill: The bill itself is non-controversial and has bipartisan support. What’s holding it up is a fight over the process — will amendments be allowed and, if so, how many — and on-going debates over extraneous tax items like the future of the estate tax. Majority Leader Reid was very close to a deal with  Minority Leader McConnell just prior to the break. We expect further progress and ultimate adoption of this package in September.
  • Tax Hikes: Last week, Finance Committee Republicans issued a statement calling on the Committee to hold a markup on extending current rates “as soon as possible to bring certainty of continued tax relief.” Meanwhile, House Majority Leader Steny Hoyer is calling for extending only those provisions for taxpayers making less than $200,000. And several Senate Democrats — notably Senators Kent Conrad (D-ND) and Evan Bayh (D-IN) — have expressed support for a one-year extension of everything. No clear path out of this challenge, but we continue to believe a one-year extension of everything is most likely, followed by failure of Congress to pass anything. A one year extension of the middle-class relief is a close third.
  • Extenders: Extenders will likely move as part of the small business tax bill in September, which is good news for manufacturers and families living in states with no state income tax. The bad news is the extension would last just until the end of this year, so another bill would have to follow soon.
  • Estate Tax: We’re now four months away from seeing the estate tax rise from the dead (55 percent top rate and $1 million exemption) with no apparent solution in view. Senators Jon Kyl (R-AZ) and Blanche Lincoln (D-AR) are pressing for lower rates and a higher exemption (35 percent and $5 million) while others support adopting the rules in place in 2009 (45 percent and $3.5 million). Still a third camp is happy to see the estate tax return in full force. Time is short, and no side appears to have the 60 votes necessary to prevail, which means current law has the upper hand.

Regarding the floor situation, Senate Majority Leader Reid set up the small business bill to be pending business as soon as they get back on September 13th. He introduced yet another substitute before they left and filled the amendment tree to block other amendments. He then filed cloture on several democratic amendments to the bill as well as the underlying legislation, setting up a series of 60-vote threshold cloture votes in the first couple days when they return.

While it’s possible these votes take place and fail along party lines, it’s more likely the two leaders come to an agreement on allowing a limited number of amendments — including adding the extender package to the mix - for the bill to move forward. At least that’s what we hope, since there are some very good provisions in the small business bill that should help investment and job creation.

Regarding the other items, including Extenders v. 2011, we’re expecting the rest of the to-do list to get pushed into a lame duck, with some sort of omnibus bill that includes federal funding and tax provisions presented to members in November or December. No idea how that battle royale turns out, but we’ll be sitting in the front row to watch.

More on S Corporations and Employment

The ongoing battle over the pending tax hikes has a tendency to devolve into a debate over the definition of “small” business and other random characteristics a firm needs before it be considered “real” by some policymakers. For example, proponents of the tax hike appear to believe a manufacturer is more “real” than a law firm, even though both are taxed as flow-through entities and both might be defined by the SBA as small.

But this debate over which types of business activity are “real” is silly and misses the point. The point is that a large percentage of the pending tax hike will be imposed on employers and investment. One half of all business income is taxed at the individual tax rates. One quarter to one-third of all business income is subject to the top two rates. That’s a lot of economic activity subject to the pending tax hikes.

Consider this debate from the perspective of the employee: whether your job comes from a large S corporation or a small S corporation makes no difference to you; both are employers, and your job is your job. So why should policymakers care whether you work at a 500 employee manufacturing plant or a 12 person law firm? Why do some policymakers believe one job worth saving but the other not?

One challenge we face in this debate is that while the folks at the Statistics of Income break down firms by structure, they don’t include employment numbers, so it’s difficult to tell how many employees work for S corporations. One way to back out an estimate is to look at their payroll and executive compensation numbers. If we assume the average compensation of an American worker is $40,000 (admittedly a rough estimate) then it appears S corporations employed about 21 million workers back in 2007.

Moreover, S corporation employment gets bigger the more revenue and income a firm makes (as you’d expect). Firms with more than $50 million in revenues employed about 4.5 million workers, while firms with $10 to $50 million in revenues employed 4.4 million workers.

Firms that size have average business income per shareholder exceeding $335,000, which means more often than not, their business income is taxed at the top two rates. Are the nine million employees who work at these firms less deserving than the employees who work at the local coffee shop? Obviously not, but for some reason the other side of this debate spends an enormous amount of time trying to minimize the value of those employees and the firms they work for.

Again, these numbers are just rough estimates, but the point they make is valid nonetheless: flow-through businesses — including S corporations — represent the majority of employers in this country and raising their taxes is not going to help the economy or the job picture.

Joint Committee Estimates Tax Hikes

In response to a request from the Ways and Means Committee, the Joint Committee on Taxation released some estimates last week on who would benefit from foregoing the rate hikes and other tax increases next year. You may have seen related stories focusing on how much “millionaires” would benefit. A couple thoughts:

First, while the JCT estimates that taxpayers earning over $1 million would see an average tax break of $103,834, they also estimated this break would reduce their tax burden by only 11 percent, suggesting that these taxpayers will pay nearly $1 million in income taxes next year on average.

Second, the revenue “cost” of avoiding all the tax hikes next year is not substantially more than the cost of avoiding those for taxpayers making less than $200,000 — $227 billion versus $202 billion.

That’s not as much as we would have expected, and in our view raises the odds that Congress extends for one year all the 2001 and 2003 tax cuts. It’s not a done deal, of course, and total inaction by Congress is also possible, but with the weak job market and pending elections, the legislative equivalent of a punt — a one year extension of everything — is looking increasingly likely.

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