Small Business Tax Package Recap

With the Senate back in town this week, here’s a quick recap on the status of the S Corp reform tax title we’ve been advocating in Congress:

  • First, on January 10th, the House passed a clean minimum wage increase and sent the legislation to the Senate.
  • Second, on January 31st, the Senate added by voice vote $8 billion worth of small business tax provisions to the House wage increase, including an S Corporation Reform tax title incorporating several S Corp priorities.
  • Third, on February 16th, the House adopted its own $1 billion small business tax relief alternative to the Senate package. This package failed to include any S Corporation provisions.
  • Fourth, Senate Republicans insisted that the House meet them to “pre-conference” the differences between the Senate and House small business tax packages before they would allow the two bills to go to a conference committee for negotiation.
  • Fifth, on March 23rd, the House added its $1 billion small business tax package to the Iraq War supplemental spending bill, despite the fact that a veto threat currently hangs over that bill’s future.
  • Sixth, on March 27th, the Senate added its own, larger $12 billion small business package, including the S Corporation Reform tax title, to its version of the Iraq War supplemental spending bill.
  • Seventh, on March 29th, Senate Majority Leader Harry Reid appointed members of the Appropriations Committee to the House/Senate conference and did NOT appoint Senate Finance Committee Chairman Max Baucus signaling the potential for conference negotiators to drop the tax bill from the supplemental bill to deal with it separately, at a later date.

And that’s where things stand, awaiting the return of the House from recess next week and the appointment of House conferees to work out the differences between the House and the Senate on these bills.

It almost goes without saying that the S Corporation Association is continuing to press our friends on the Hill to end this stalemate and pass these much needed reforms to the rules governing S corporations. We remain confident that these provisions will be enacted, it’s just a question of how long the process will take.

S Corp Gets Some Ink in INC.

S Corp President Stephanie Silverman is quoted this month in INC. Magazine as part of a story on the new congressional leadership, “Learning to Love Nancy Pelosi.” As the story notes, business groups like the S Corporation Association are having to reconfigure their approach and expectations to reflect the new Democratically-controlled Congress. Here’s Stephanie:

    In the last Congress, there was a serious effort to abolish the estate tax. Today, Congress is considering bolstering the Internal Revenue Service’s budget for business audits and levying new payroll taxes on S corps. Stephanie Silverman, the president of the S Corporation Association, says the group’s members are nervous about the payroll tax idea. The group is currently scheduling meetings with members of the House Ways and Means Committee to discuss the plan. “We’re trying to make them aware of how many S corporations there are in their states,” Silverman adds.

Senate Jobs Bill First Out of the Chute

With health care reform in a state of political limbo, Senate leadership is busy assembling a job-creation package that is likely to be the chamber’s next significant legislative effort.

Just before Christmas recess, the House hastily assembled and adopted a $154 billion spending package. In response, the Senate Finance Committee is working on a package that focuses more on tax relief than the House counterpart. As reported by Dow Jones:

The package would be paid for largely by re-directing funds that were available for the government’s bank bailout program, according to an outline dated Friday of possible measures being considered for inclusion in the bill.

The Senate document put the total cost of economic stimulus measures in the bill at $82.5 billion. A Senate Democratic aide cautioned that the document doesn’t reflect the most recent conversations among leaders about the plan, and some elements may change considerably.

A broad outline pitched to the Democratic conference today included pension relief, SBA lending provisions, energy efficiency tax credits, export promotion (IC-DISC users take note) and a proposal that would “provide a tax credit for between 10%-20% of increased payroll to encompass both hiring of new workers and increasing part-time workers to full-time status.”

Tax policy veterans should recognize the employment tax credit idea from years past. Among others, Senator Kerry offered something similar as part of his Presidential platform in 2004. The proposal has been always been viewed skeptically, however, over concerns that it is poorly-targeted and only rewards those businesses that would hire new workers anyway.

Regarding timing, it’s still up in the air but we anticipate a Finance Committee markup in the next two weeks followed by floor consideration after the President’s Day holiday.

So what are your S-CORP takeaways? First, there’s an incredible amount of pent-up demand for tax policy in the Senate, and we expect this legislation to open the floodgates. It’s a tax vehicle, after all, so how can Chairman Max Baucus and Majority Harry Leader Reid keep extenders, energy tax incentives, and (perhaps less so) an estate tax fix on the sidelines once it starts moving?

Second, lots of other items are likely to catch a ride as well. Extended UI and Cobra benefits expire at the end of February, as does the temporary Doc Fix for Medicare payments. The timing of this package suggests those provisions stand a good chance of being included.

Finally, expect lots of message amendments regarding the expiring Bush tax relief. It all goes away at the end the year, after all, and none of the provisions listed above address this underlying policy challenge.

CBO Updates Budget Outlook

The CBO issued itsB outlook for 2010-20 today. Here’s the CBO on the short-term outlook:

CBO projects, that if current laws and policies remained unchanged, the federal budget would show a deficit of $1.3 trillion for fiscal year 2010. At 9.2 percent of gross domestic product (GDP), that deficit would be slightly smaller than the shortfall of 9.9 percent of GDP ($1.4 trillion) posted in 2009. Last year’s deficit was the largest as a share of GDP since the end of World War II, and the deficit expected for 2010 would be the second largest. Moreover, if legislation is enacted in the next several months that either boosts spending or reduces revenues, the 2010 deficit could equal or exceed last year’s shortfall.

And the longer term outlook:

Under current law, the federal fiscal outlook beyond this year is daunting: Projected deficits average about $600 billion per year over the 2011-2020 period. As a share of GDP, deficits drop markedly in the next few years but remain high, at 6.5 percent of GDP in 2011 and 4.1 percent in 2012, the first full fiscal year after certain tax provisions originally enacted in 2001, 2003, and 2009 are scheduled to expire. Thereafter, deficits are projected to range between 2.6 percent and 3.2 percent of GDP through 2020.

And the impact on debt:

Under current law, the federal fiscal outlook beyond this year is daunting: Projected deficits average about $600 billion per year over the 2011-2020 period. As a share of GDP, deficits drop markedly in the next few years but remain high, at 6.5 percent of GDP in 2011 and 4.1 percent in 2012, the first full fiscal year after certain tax provisions originally enacted in 2001, 2003, and 2009 are scheduled to expire. Thereafter, deficits are projected to range between 2.6 percent and 3.2 percent of GDP through 2020.

And none of this includes the cost of health care reform, the so-called Medicare Doc fix, extending some or all of the Bush tax relief, the new stimulus provisions, or any of the other expiring provisions. Ouch.

With a deficit outlook like this, the Obama Administration is being pushed in two directions these days. They face demands to increase federal spending in the short run to help the economy while also being told they need to cut spending in the long-term to address the deficit and debt.

One way to deal with this conflict is to substitute smaller, less expensive proposals for the broad, macro reforms that have characterized the Administration’s agenda. President Clinton adopted this approach for many of his State of the Union addresses. As CNN reported after his 1999 address:

President Bill Clinton’s 1999 State of the Union address was classic Clinton. It was another long laundry list of proposals, some conservative, some liberal. Clinton’s 77-minute speech was so overflowing with proposals that by the time it ended it was almost hard to remember that Social Security was the first and most important proposal of the evening. In previous years, commentators criticized Clinton for this approach, complaining that the State of the Union should be more focused. But this year, most commentators simply gushed.

So did viewers, who typically gave Clinton’s annual State of the Union speeches higher marks than professional commentators.

President Obama’s proposal to increase the child credit is a worthy successor to the Clinton approach. The proposal would increase the value of the credit, but not as much as one might expect. It’s not going to be refundable, which means most families with children would not benefit until their incomes rise above $40,000 or so. And it’s capped, so families above a certain income level don’t get it either. Nonetheless, offering middle class families extra child care assistance sounds great in a speech.

Given the current economic and deficit picture, we expect tomorrow’s State of the Union address to place more emphasis on proposals like the child care credit expansion, and less on health care reform and cap and trade.

Estate Tax Fix Poses Threat for Family Businesses

As we have noted, the stars appear to have aligned for a big estate tax compromise later this year, most likely to be focused on freezing the 2009 rules for at least a year. This means the current top tax rate of 45 percent and $3.5 million exclusion will stay the same for a while. But there’s lots of mischief that can take place under those broad levels.

As tax reformers will tell you, the base is just as important in determining your tax burden as the rates.

With that in mind, several S-Corp allies have pointed out legislation introduced by Congressman Pomeroy (D-ND) earlier this year — H.R. 436 — and asked us whether the base broadening included in this bill might get considered later this year. The answer is a definitive “Yes.” According to our quick read, H.R. 436 would do the following:

  • Freeze the tax rate and exclusion at 45 percent and $3.5 million;
  • Restore the step-up in basis;
  • Restore the recapture of graduated rates; and
  • Limit the use of minority discounts for family businesses.

To put the total impact of these provisions in perspective, here’s a simplified example of a family business where current rules would value the business at $7 million, but under H.R. 436 the value would be $10 million. For comparison’s sake, we included the tax burden on that estate under the rules in place in 2000, this year, in 2010 when the estate tax repeal takes place, and under the Pomeroy bill.

2000 2009 2010 H.R. 436
Top Rate 55% 45% 0 45%
Exclusion $1 million $3.5 million NA $3.5 million
Estate Tax Base/Basis $7 million $7 million $650,000 $10 million
Estate/Capital Gains Tax $2.9 million $1.45 million $1.4 million $2.8 million

As you can see, eliminating planning techniques used for closely-held businesses results in an estate tax under H.R. 436 that is nearly the same as the estate tax under the pre-2001 rules, and about twice as much as the current tax.

This is obviously a simplified example that doesn’t include many of the nuances associated with estate planning. Moreover, a smaller estate would experience less of an impact from changes to the valuation rules whereas larger estates would see a substantial increase.

For both, however, changing the rules under which estates are valued seriously threatens the ability of family-held businesses to survive one generation to the next, and should be treated very carefully by policymakers.

So while business groups are focused on the rates and exclusion, we should be just as worried about proposals that would affect the base. Be prepared to see this issue gather more ink in coming months.

So What’s Next?

With Washington focused like a laser on the stimulus package for the past few months, a natural question is: “What’s next?” Your S-CORP team has been asking around, and here’s what we’ve come up with:

Energy Bill: Both the House and the Senate will consider energy legislation this year that, among other items, will include a tax title extending and modifying expiring energy tax items like the Section 45 production tax credit. Many of these popular provisions are scheduled to expire at the end of the year and need to be extended. The Senate may move as early as March on a stand-alone bill, while the House looks like it will pair traditional energy issues — a renewable electricity standard, energy efficiency standards, and tax items — with a carbon cap-and-trade bill.

Housing & Financial Services: Congress is geared up to take up President Obama’s housing plan this spring together with a rewrite of the rules governing what’s left of Wall Street and the mortgage markets. The housing plan will cost money, so we expect a tax title to offset the revenue loss.

Rangel “Mother Bill”: Remember the “Mother of All Tax Bills” introduced in 2007? It swapped the AMT for higher income tax rates, cut the corporate rate while broadening the business tax base, and targeted benefits at low and middle-income families. Word is Mr. Rangel has been redrafting and could reintroduce the package sometime this spring. Once again, his goal would be to encourage an active discussion over the future of tax code. Actual action will likely wait until 2010 or later.

Middle-Class Tax Relief: Senator Baucus has made noises about moving legislation to provide permanent middle-class tax relief. Such relief could include an effort to permanently extend the middle-income tax rates, the child tax credit, and marriage penalty relief.

Estate Tax: An estate tax compromise is on the table and likely to be considered before the kids go back to school next fall. (See above)

Health Care Reform: We expect a push to provide Americans with more health insurance options at some point this summer. While most of the bill will be focused on Medicare, Medicaid, and an expansion of health coverage, we expect changes to the current tax treatment of health benefits to be included. Swapping the current health care deduction with a tax credit would not only balance the tax treatment of health care consumption, it would also raise lots of money that could be used to expand coverage.

As you can see, Congress’ plate is full. Even if only half of these items get addressed this year, it is a full agenda with lots of opportunities for mischief.

Moreover, with the deficit approaching $2 trillion and Congress done with the $800 billion stimulus package, its focus should shift to budget neutral reforms and deficit reduction, placing even more pressure on the tax code and taxpayers.

We’ll keep watch and make sure closely-held businesses are represented.

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