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.

BIG Tax Relief on House Floor

It’s a big week for S corporations!  The House is scheduled to vote on several small business tax items, including permanently higher section 179 expensing limits and S corporation modernization legislation too!

The S corporation bill, newly-named the S Corporation Permanent Tax Relief Act of 2014, will bundle together HR 4453 (permanent 5-year BIG period) and HR 4454 (basis adjustment for charitable contributions). We expect the bill to be considered by the Rules Committee later today with debate and a vote on the bill to take place Thursday.

Making the five-year recognition period for built in gains permanent has been an S-CORP priority for years, and while we have been successful at enacting temporary reductions in the past, this week’s action marks the first time either the House or the Senate has considered a permanent fix.

By way of background, here are some of the documents we have developed over the years to support the shorter holding period as well as the charitable donation provision:

The case for the shorter five-year recognition period is strong and is certain to help encourage business investment.  As Jim Redpath testified early this year:

I find the BIG tax provision causes many S corporations to hold onto unproductive or old assets that should be replaced. Ten years is a long time and certainly not cognizant of current business-planning cycles. Many times I have experienced changes in the business environment or the economy which prompted S corporations to need access to their own capital, that if taken would trigger this prohibitive tax. This results in business owners not making the appropriate decision for the business and its stakeholders, simply because of the BIG tax.

We are recirculating the business community letter to allow additional groups to sign on is support of BIG tax relief.  We’ll post the letter tomorrow and we will be working with our House allies to ensure the vote on Thursday is as broad as possible.

Senate to Vote on Buffett Tax

While the House is working to reduce the tax burden for S corporations, the Senate is seeking to raise them.  This week, the Senate will consider legislation to provide student loan relief paid for with our old friend, the so-called “Buffett Tax”.

We’ve criticized both the theory and execution of the Buffett tax in the past (here, here and here), and all those arguments still apply:

  • The federal tax code is already steeply progressive;
  • The tax code already has three distinct income taxes – the regular income tax, the Alternative Minimum Tax, and the Affordable Care Act investment tax.  The Buffett Tax would be a fourth!
  • Much of the Buffett tax will fall on the owners of pass-through businesses; and
  • For sales of S corporations, the Buffett tax would eliminate the benefit of the lower tax on capital gains.

The Tax Foundation agrees with our concerns, and posted a nice analysis of the provision when it was introduced last month.   Here’s what they had to say about the structure of the tax:

Besides the 30 percent effective tax rate in the Buffett rule, there is a phase-in of the tax over $1,000,000 of AGI. This phase-in creates a spike in taxpayer’s marginal tax rate of over 50 percent. Our current tax code is no stranger to hidden marginal tax rates caused by phase-ins and phase-outs. However, these are not positive aspects of the code. They obscure peoples’ true tax burden, add unnecessary complexity, and create marginal tax rate cliffs that incentivize people to change behavior to avoid them.

The Buffett Tax vote is tomorrow.  We doubt it will receive the 60 votes necessary for this poorly thought out policy to move forward, but it will be interesting to see who votes to raise taxes on Main Street businesses in order to increase federal spending.

Latest on Payroll Tax Hike and Extenders

Earlier today, the Senate voted earlier on its version of the “extenders plus” bill passed by the House a few weeks back. The vote, on a motion to waive a Budget Act point of order, failed miserably (45-52), indicating the Senate Leadership has a long way to go before they gather the sixty votes necessary to move forward.

With this morning’s vote behind us, the process moving forward is becoming clearer–Finance Chairman Max Baucus (D-MT) is expected to introduce a new substitute today. According to BNA:

Baucus is expected to draw up a new substitute amendment that will be a slimmed-down version of what the Senate defeated. That plan would have added $84 billion to the federal deficit, a figure that Republicans, and some Democrats, said was too high to stomach. Baucus has previously said that he would continue to work with senators of both parties to find 60 votes. Issues that could be modified to secure votes include Medicare reimbursement rates for physicians, unemployment insurance benefits, Medicaid funding to states, and possibly language making it more difficult for S corporations to avoid paying employment taxes.

As BNA indicates, the new effort will likely include a modified payroll tax hike. As with the House-passed provision, however, the new tax has been written behind closed doors and without the benefit of public scrutiny. It might be better than the flawed House effort, but we simply won’t know until it’s offered.

The next key vote will take place tomorrow, when the Senate considers Senator John Thune’s (R-SD) alternative “extender plus” package. This package includes all the tax extenders the business community wants, but strikes all the tax hikes the business community opposes (including striking the $11 billion payroll tax hike). Instead, all the tax relief and spending in the package are offset with spending cuts. As with today’s vote, Senator Thune is not expected to get 60 votes tomorrow, but we’re betting he does better than the 45 votes Senator Baucus got today.

Meanwhile, Senator Olympia Snowe (R-ME) continues her fight on behalf of S corporations. As CongressDaily reported this morning:

Snowe is upset about an $11 billion tax increase on small services firms organized as S corporations; Baucus is preparing some tweaks to that provision, and the chamber’s 63-33 adoption of an amendment she co-sponsored to establish an office within the Treasury Department to help homeowners struggling with mortgage payments can’t hurt. Democratic aides said they still have some work to do on their side of the aisle before working to assuage GOP holdouts.

The S corporation community owes Senator Snowe a big debt. Meanwhile, with the first Baucus substitute gone and the second version to be introduced, we will just have to wait to see what they have in mind.

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