S-Corp Mod Bills Introduced! 

Good news on a hot day in July!  The 2016 version of the “S Corporation Modernization Act” has been introduced the House and the Senate.  Led by Senators Thune (R-SD) and Cardin (D-MD) and Representatives Reichert (R-WA) and Kind (D-WI), the bill includes a half-dozen provisions designed to improve the rules that govern S corporations.

  • You can see the entire bill here
  • You can see the section-by-section analysis here
  • You can see the S-Corp press release here

Yesterday’s introduction of companion bills is the first time in a while that the S corporation community has had this important legislation being championed in both bodies, and we really appreciate the hard work the members and their staffs put in to get the provisions just right.

Of particular note is the fact that Senator Thune is taking on the leadership of the bill from Finance Committee Chair and longtime S corporation advocate Senator Orrin Hatch (R-UT).  South Dakota has a ton of S corporations and ranks second nationally in pass-through employment, so this effort is important to Senator Thune and his state and we look forward to his enthusiastic leadership.  As he noted at the introduction:

Family owned small businesses are the backbone of the U.S. economy and can be located in every corner of the country.  Small towns and rural communities are oftentimes the ideal location for these small- and medium-sized businesses, which is why making these common-sense reforms to S corporations is so important to South Dakota.

Senator Ben Cardin added:

S corporation businesses are critical to the well-being of the Maryland economy and account for more than half of our state’s private-sector workforce.  Unfortunately, our federal tax code has not kept up with the increasingly important role that these types of companies play,” said Cardin.  “The S Corporation Modernization Act contains much-needed changes to the tax treatment of S corporations, allowing them to better attract capital, create jobs, and make charitable investments in their communities.

Key changes in this version relative to past efforts include:

  • Dropping the two provisions – BIG and charitable – that were made a permanent part of the Tax Code last December
  • Moving the Nonresident Alien provision up to the top slot – it is time for direct foreign investment to be available to S corporations; and
  • Including the new internal basis adjustment provision to ensure that S corporation assets receive similar treatment as partnerships.

So your S-Corp team has a new bill, new champions, and new priorities to accomplish in the coming months and years.  The legislative outlook is uncertain, with Congress preparing to break for the party conventions and then, after a short fall session, the November elections.  That doesn’t leave us much time, but as always we will be looking for opportunities to get something done.  With a terrific bipartisan set of advocates on the Hill, we are in a good position to do just that.

 

S-Corp Concerns Dominate 385 Comments

The comment period is closed and the verdict is in – just take S corps out.  That’s what numerous trade associations and other groups recommended to Treasury regarding the pending section 385 regulations.  Here’s what the National Association of Manufacturers had to say:

The proposed regulations also significantly impede the ability of businesses organized as subchapter S corporations to utilize their cash effectively. In particular, the bifurcation rule in the proposed regulations, which allows the IRS to treat a debt instrument as part debt and part stock, could cause a subchapter S corporation to lose its S status and become taxed as a C corporation.

In order to qualify as an S corporation, an entity must have only one class of stock (identical rights to distribution and liquidation proceeds) and must be owned only by eligible shareholders (examples of ineligible shareholders include C corporations, foreign corporations, partnerships, insurance companies and non-resident aliens). The reclassification to stock, or part stock, could inadvertently create an ineligible S corporation shareholder (e.g., if the debt reclassified to stock was held by a C corporation, the C corporation would become an ineligible S corporation shareholder); and/or the reclassification to stock could create a second class of stock via preferred return consideration on the debt instrument….

The proposed regulations do not apply to corporations filing a consolidated tax return. S corporations under common ownership, however, are not permitted to file a consolidated tax return and thus, the proposed regulations apply to commonly-owned S corporations, even those with solely domestic activity. The NAM strongly recommends that subchapter S corporations be exempted from the final regulations.

Other groups made similar arguments and their conclusions were just as strong.  Here’s just a sample:

American Bar Association

Exclude S corporations from the expanded group.

National Retail Federation

We recommend that S corporations be exempted from the application of the regulations.

American Institute of Certified Public Accountants

Provide exceptions to ensure that S corporations do not inadvertently terminate their status when debt is reclassified as equity.

Florida Bar

The rules should exempt S corporations which clearly cannot be a focus for the issues of concern regarding the Proposed Rules.

KPMG

Exclude S corporations, as well as certain other entities, from the ambit of the proposed regulations (i.e., revise Prop. Treas. Reg. § 1.385-1(b)(3)(i)(A) so that it only “turns off” paragraph (3) of section 1504(b)).

The IRS is holding a public hearing on the proposed rules today.  Of the 18 speakers listed, many of them are from groups that support excluding S corporations from the rule.  We’ll be watching closely to what, if any, reaction there is from the Treasury and IRS officials in attendance.  More to come.

Thune Files S-CORP Amendment

More good news on the tax front.  Senator John Thune (R-SD) has filed an amendment making permanent two key S corporation reforms.  Joined by Senators Ben Cardin (D-MD) and Pat Roberts (R-KS), the Thune amendment would make permanent the shorter, five-year recognition period for built-in gains as well as an improved basis adjustment for charitable contributions by S corporations.

The text of the amendment is identical to the text of H.R. 4453 and H.R. 4454, legislation sponsored by Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) that passed the Ways & Means Committee earlier this month and are due to be considered by the House of Representatives in coming weeks.

As with the Reichert/Kinds bills, a large coalition of business organizations wrote in support of the Thune amendment.  The letter, signed by the American Trucking Association, the Associated Builders and Contractors, the S Corporation Associations, and twenty-one other organizations, closes, “On behalf of America’s Main Street business community, we respectfully ask that you support the Thune amendment and permanently extend the 5-year recognition period for built-in gains.”

The Thune/Cardin amendment would makes changes to the tax extenders package currently being considered by the Senate, That package already includes two-year extensions of the BIG and charitable provisions, but it faces an uncertain future.  Earlier reports suggested Republicans would vote en bloc against closing out debate to protest their on-going inability to offer amendments on the Senate floor.

The latest news, however, suggests that Republicans may support closing debate in order to ensure that the extender package keeps moving through the legislative process.  As National Journal reported earlier today:

Usually when Majority Leader Harry Reid prevents Republicans from offering amendments, GOP senators block the underlying bill. At least, that was how Republicans handled the recently dispatched energy-efficiency bill, which went down earlier this week.

“There’s probably a lot more support among Republicans for tax extenders than there perhaps was for energy efficiency,” said Sen. John Thune of South Dakota, the chamber’s No. 3 Republican.

The difference, according to lawmakers, is that some of the roughly 60 provisions in the tax-extenders package benefit constituents in some way. Thune also said that members view extending current tax policy differently than they do enacting new energy legislation.

“I just think you’re talking about tax policy,” Thune said. “You’re talking about extending tax policy. And many of them are things that our members are supportive of.”

The tax provisions that expired at the end of 2013 are extremely popular with the business community and, now that tax reform has been set aside, the only real opportunity to see them extended would be for the House and the Senate to come together on a package and send it to the President.  With strong leadership in both the House and the Senate, these two S corporation provisions are well positioned to be part of that package.

New Tax Writers

The Senate last week announced the new members of the tax-writing Finance Committee. The announcement followed several weeks of negotiations over committee ratios of Democrats to Republicans, in addition to a related fight over amending Senate rules. The fact that committee assignments were announced on the same day that the Senate voted on some of those reforms is no coincidence.

As to the Finance assignments themselves, the Committee is getting one new Democrat and two new Republicans, bringing the Committee’s overall membership up to 24– an increase of one from last Congress, with 13 Democrats and 11 Republicans. The new members are:

o Senator Ben Cardin (D-MD)

o Senator Tom Coburn (R-OK)

o Senator John Thune (R-SD)

Generally speaking, the additions are a positive for S corporations and flow-through employers. Senator Cardin is one of the more business-friendly Democrats in the Senate (he has been a cosponsor of our S Corporation Reform bill in the past,) while Senators Thune and Coburn are strong S-CORP advocates. The loss of Senator Blanche Lincoln (D-AR) and her leadership on our issues will be hard to make up, but these additions to the Committee will certainly help our cause.

On the House side, the Ways and Means Committee also added some strong advocates of private enterprise. As we noted back in November, the switch to Republican control of the House meant that the committee ratio would have to flip too, from 26-15 Democrats to 25-15 Republicans. Of the new Committee members, several stand out as active champions for private businesses, including Erik Paulsen (R-MN) and Vern Buchanan (R-FL).

  • Rick Berg (ND)
  • Diane Black (TN)
  • Vern Buchanan (FL)
  • Jim Gerlach (PA)
  • Lynn Jenkins (KS)
  • Chris Lee (NY)
  • Erik Paulsen (MN)
  • Tom Price (GA)
  • Aaron Schock (IL)
  • Adrian Smith (NE)

Then, of course, there is the new Chairman of the Committee, Representative Dave Camp of Michigan. Camp’s district covering north-central Michigan is heavily populated with small and medium-sized enterprises, and his policies reflect it. His leadership should be a big change from former Chairman Rangel’s tenure, as the recent hearing on tax reform (see below) demonstrates.

More on Tax Reform

Last week, the President used part of his State of the Union Address to call for reform of the corporate tax code. Based on recent conversations we’ve had, the Administration has set three overall objectives for its reform effort:

  1. Enhance economic growth;
  2. Increase investment in the United States; and
  3. Raise at least the same amount of revenue.

At its most basic level, tax reform (a la 1986) encompasses eliminating certain deductions and credits in exchange for lower overall rates. For example, one of the “expenditure” provisions often identified as something to be eliminated under the auspices of tax reform is the Section 199 manufacturing deduction (enacted in 2004) to help manufacturers survive and grow by lowering their taxes. A simple reform might be to eliminate Section 199 and use the resulting revenue savings to reduce the corporate rate slightly.

But not all C corporations use Section 199 — only manufacturers do. And most manufacturers are organized as something other than C corporations. Yet, in this corporate tax reform scenario, only C corporations would see lower rates, while all manufacturers would lose the use of Section 199. Therefore, this reform would have the effect of raising the effective tax burden on manufacturers — and particularly those organized as S corporations or LLCs as they would not see any benefit from a reduction in the corporate tax rate.

If we were just talking about eliminating Section 199, this would be a small challenge. But tax reform implies greater “base broadening” than just one provision — LIFO accounting, depreciation, the R&E tax credit and other provisions would all be on the chopping block. The net effect of such base broadening efforts would be significantly higher tax burdens on the very manufacturing sector we’re trying to preserve.

We support reforming the entire tax code to make it more efficient and family- and business-friendly. But reform that looks only at the corporate side while insisting on budget neutrality (or, worse, reform that increases tax revenue) should set off all sorts of alarm bells within the broader business community. It means higher taxes for somebody, and that somebody is us.

Thankfully, we have numerous allies on the Committee on Ways and Means who have highlighted this significant challenge. In his response to the State of the Union Address, Chairman Dave Camp (R-MI) said,

“While the President focused on the need for corporate tax reform to make our employers more competitive, 75 percent of America’s job creators are small businesses. Moving our economy forward and creating a climate for job growth requires a tax code that empowers all job creators – large and small. Tax reform should address the entire tax code and find ways to help America’s job creators and families deal with the complexity and cost burdens of the current code.”

This message was repeated by several members during the January 19th Ways and Means hearing on tax reform, particularly by S-CORP champions Reps. Ron Kind (D-WI) (at the 1:36:54mark) and Dave Reichert (R-WA) (at the :58 mark). The hearing discussion also revealed several other potential Committee allies. Rep. Vern Buchanan (R-FL) revealed that he is a former S corporation owner:

When you talk of in terms of business roundtable, the fact of the matter is — and I was a C corporation, I moved to an S, and now I’ve got a bunch of LLCs that my family runs. But the bottom line is, half the tax revenue I understand is through pass through entities. So when you look at lowering the tax rate or the discussion of tax rate for corporations, what are you going to do about all those employers that have 500, 100 employees, 50 employees that are LLCs? I hope that’s got to be taken into consideration. You can’t do one without the other because, otherwise, you end up with a competitive advantage over someone else that happens to be a large family-run business.

Meanwhile, Rep. Earl Blumenauer (D-OR) also weighed in on behalf of privately-held businesses:

I guess I just have one question that I would offer to Ms. Olson, Mr. McDonald, can we do this successfully if we disconnect the individual tax provisions from business or do they need to be done concurrently?

OLSON: Well, I think that although the business and the individual issue — they present different issues and different questions, but I do not think you can do them separately. In part, because so many businesses are pass-through entities and you still have to deal with the individual side.

BLUMENAUER: Mr. McDonald?

McDONALD: Yes, sir, I agree with that as well. Many of those pass through entities are suppliers of ours. And they’re very critical to our business all over the world, so it has to be done together.

BLUMENAUER: Great. Thank you

All in all, a good start to the year. Our primary concern is that the push for corporate reform moves forward without policymakers fully understanding the implications for families and non-corporate firms. The Ways and Means hearing made clear several key policymakers, including the Chairman, understand this challenge. Our job now is to educate the rest.

A Brief Revisit to the Payroll Tax Fight

Washington Wire readers know that Team S-CORP was right in the middle of fighting efforts by the Congress to hike payroll taxes on S Corporations by $11 billion last year. We won that fight, but bad ideas never go away, and we expect this issue will rise again.

To keep everybody current, Laura Saunders at the Wall Street Journal Tax Report highlighted the recent case of an Iowa CPA who underpaid himself for a number of years and was caught by the IRS. You can read about the whole story here, but the lesson we take away is that the IRS can and does have the ability to go after taxpayers who use the S corporation to block payroll taxes.

Oh, and if you want to know why this issue is often referred to as the “John Edwards Shelter,” Laura has a really nice history of how this issue came to light and played a role in the 2004 Presidential election.

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