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.

Rate Debate Update

The rate debate continues. Last week, the Senate failed to extend all the current tax rates and policies by a vote of 45-54. Two Republicans voted against the measure because of a refundable credit issue and one Republican missed the vote due to illness, but even if you adjust for those votes, the Senate still came up short of a majority for not raising taxes on employers during a period of severely high unemployment.

Very disappointing and something pass-through businesses and the markets should pay sharp attention to.

We expect better results today and tomorrow when the House votes on two related bills. One, H.R. 8, would extend through 2013 all the current Bush tax cuts. The other, H.R. 6169, would create an expedited process for Congress to consider tax reform next year.

To help with the vote, the S Corporation Association and our allies drafted and helped circulate the following business community letter in support of the legislation. As the letter states:

Business owners in this country crave clarity. They do not know what the tax laws will be moving forward and this uncertainty is having a material and negative impact on investment and job creation. 

Absent action, the Congressional Budget Office has made clear the combination of higher taxes and lower spending will send the economy into a tailspin starting early next year. Our members report that the prospect of the country going over the fiscal cliff is discouraging them from making investment and hiring decisions right now, slowing our already sluggish economy.

To address this uncertainty, Congress needs to act quickly on tax legislation that would accomplish two critical goals. First, the legislation must shrink the fiscal cliff and provide employers with a clear sense of the tax rules for 2013 by extending all of the expiring tax provisions for one year. 

Second, because it is long past time for comprehensive reform to create a pro-business, pro-competitiveness and pro-jobs tax code, the legislation should outline exactly how and when Congress will consider a comprehensive rewrite of the individual, corporate and international tax codes. This legislation should instruct Congress to broaden the tax base while lowering overall rates, and include rules for expedited consideration of the legislation to prevent delay or filibuster to provide the long-term certainty our economy needs to flourish.

This letter has been signed by more than 100 business trade groups, which should send a strong signal to policymakers in both chambers that the employer community needs to see action. The House plan is the most responsive to the needs of our members, and we hope Congress will adopt it.

Finance Hearing on Pass-Through Businesses

The Finance Committee held a hearing on tax reform and business entities today. Entitled “Reform: Examining the Taxation of Business Entities,” the goal of the hearing was to:

“…explore the different taxation of business entities structured as corporations versus pass-throughs, and to consider proposals to alter those rules. Baucus and the witnesses will explore the history of the two-tiered corporate tax system, compare the U.S. taxation of pass-throughs to the systems of other countries and consider whether the current system distorts business decisions in ways that hurt job creation and economic growth.”

This topic is obviously of great importance to S corporations and we submitted some excellent testimony from S-Corp Advisor Tom Nichols that outlines our views on tax reform and entity choice. His testimony is consistent with last fall’s trade association letter signed by 47 major business organizations that outlines three key priorities pass-through businesses would like to see under tax reform:

  1. Reform needs to be comprehensive and include the individual and corporate codes;
  2. The top rates for individuals, pass-through businesses, and corporations should stay the same; and
  3. Congress should continue to reduce the double tax on corporate income.

The final priority here is particularly important. If the goal of tax reform is to improve incentives for domestic job creation and investment, it needs to address the burden of the double tax on American corporations. Congress has proactively worked to reduce this burden for the past three decades, and that progress should continue in any future tax reform. As our Ernst & Young study authors observed in the report they did for us last year:

In addition, the flow-through form helps mitigate the economically harmful effects of the double tax on corporate profits, in which the higher cost of capital from double taxation discourages investment and thus economic growth and job creation. Moreover, double taxation of the return to saving and investment embodied in the income tax system leads to a bias in firms financing decisions between the use of debt and equity and distorts the allocation of capital within the economy. As tax reform progresses, it is important to understand and consider all of these issues with an eye towards bringing about the tax reform that is most conducive to increased growth and job creation throughout the entire economy.

We’re grateful that a number of today’s witnesses sounded the same theme, but remain concerned that Finance Chairman Max Baucus continues to suggest that large pass-through businesses should pay taxes as C corporations. From his opening statement:

While a valuable tool for small businesses, we should examine if the use of pass-throughs have disrupted the level playing field for larger non-public companies and their public competitors.

Ideally, our tax code should cause as few distortions in business as possible. Businesses should plan and organize based on growth and job creation - not the tax code.

One of my main goals of tax reform is to make the system more competitive, but also keep it fair.

These comments build on remarks he made last year, stating that, “We’re going to maybe, have to look at pass-throughs, and say they have to be treated as corporations if they earn above a certain income.”

As we said, most of the witnesses and Members supported the notion that tax reform done right would reduce the double tax on corporate income, not increase. As the Chairman’s remarks make clear, however, that goal is not universally agreed to and the pass-through community needs to be on watch.

Good News on BIG!

In other Finance news, the Committee announced last night that it would mark up tax extender legislation tomorrow. You can read the description of the bill here, coupled with the score by the Joint Committee on Taxation. Major provisions in the legislation include:

  • A one year extension of the AMT patch (2012);
  • A two-year extension of the R&E tax credit (2012 and 2013); and
  • Higher limits under Section 179 expensing (2012 and 2013).

The highlight for the S corporation community is the two-year extension of the shorter, five-year holding period for built-in gains.  Extending the five-year period has been one of our priorities for the past year. The current, overly long ten-year holding period prevents companies from accessing their own capital at a time when capital is scarce. What make more sense than extending the more reasonable five-year period?

The bill announced yesterday does not include 18 provisions that had been previously extended by Congress, and more provisions could potentially be added or deleted tomorrow during the mark-up. So, there’s still a lot of work to do before important built-in gains relief is enacted into law.

Fortunately, we have plenty of allies in the Senate on this provision from both sides of the aisle — Senators Cardin, Snowe, Hatch, Landrieu, Grassley, and Roberts have been key advocates on this issue through the years — and we’ll be working closely with them to get this provision across the finish line! Stay tuned.

Rate Debate Begins

Majority Leader Harry this week filed a motion to proceed to the Senate Democratic bill (S 3414) to extend the Bush tax cuts for all taxpayers except the top two brackets. A procedural vote is scheduled for tomorrow.

Senate Republicans will push to have a vote on their own version which will extend current tax policies for all brackets. If an agreement is not reached on allowing alternatives, Republicans could try to block consideration of the Democratic bill.

So we now have competing proposals before the US Senate, which begs the question, does Leader Reid have the votes? He starts with 53 Democratic votes in the Senate, so he should be able to block the Republican plan even if he is unable to move forward on his own, but a number of Democratic Senators have either expressed explicit support for extending all the rates, including Joe Lieberman and Jim Webb, or have kept quiet on exactly what their position is.

As to the specifics, the Democratic bill would extend all the 2001 and 2003 Bush tax cuts with the following exceptions:

The top two income tax rates;

  • The top rates on capital gains and dividends for taxpayers making more than $250,000 ($200,000 for singles);
  • The rates and exemption for the estate tax; and
  • The repeal of limits on itemized deductions.

One key difference between the Senate Democratic legislation and the Administration’s position is that the Democratic bill would raise dividend tax rates to 25 percent, rather than the 45 percent under the President’s budget.

While not an exact fit, the Ernst & Young study released last week should give policy makers a clear idea of the long-term consequences of allowing the top rates to rise on income earners and business owners. It would mean fewer jobs, lower wages, and a smaller economy.

House Introduces Plan

Meanwhile, the House has released their own plan to keep tax rates stable while putting into place a process for tax reform. Encompassed in two bills — HR 8 and HR 6169 — the legislation would:

Extend for an additional year, through 2013, the tax reductions originally enacted in 2001 and 2003;

  • Provide a two-year AMT patch (covering 2012 and 2013); and
  • Provide for expedited consideration of tax reform in the 113th Congress.

As to what tax reform would look like, the legislation calls on Congress to take up a bill that contains at least each of the following proposals:

(1) a consolidation of the current 6 individual income tax brackets into not more than two brackets of 10 and not more than 25 percent;

(2) a reduction in the corporate tax rate to not greater than 25 percent;

(3) a repeal of the Alternative Minimum Tax;

(4) a broadening of the tax base to maintain revenue between 18 and 19 percent of the economy; and

(5) a change from a “worldwide” to a “territorial” system of taxation.

In other words, the legislation outlined here appears to be fully consistent with the principles included in our Pass-Through Coalition Letter sent up to the Hill last fall and are something the business community, particularly those who represent a significant number of pass-through businesses, should support.

Taxing Employers

One key statistic that emerged from last week’s roll-out of the Ernst & Young study was something we had overlooked from the Treasury report on small businesses, published last August. Our friends at NFI pointed it out.

The study, entitled “Methodology to Identify Small Businesses and Their Owners,” was prepared by the Office of Tax Analysis with an eye towards redefining away small business, but many of its numbers have been extremely helpful in defending business owners, including this one:

  • 28 percent of business employers in the United States have incomes exceeding $200,000.

You read that correctly — more than one in four business employers has income high enough to be subject to the higher tax rates at the center of the rate debate.

How exactly does this number compare to the favorite talking point of the other side — that these rates apply to less than three percent of small business owners? Here are a couple differences:

  • The larger number includes employers only — people who create jobs. The three percent number includes taxpayers reporting any level of business income, no matter how small.
  • The larger number includes taxpayers with more than $200,000 in income, while the smaller number is restricted to those who pay the top two rates.
  • And finally, the larger number includes those employers who pay the Alternative Minimum Tax. They may have income high enough to pay the top two rates, but they pay the AMT instead.

This latter point is something that came out our of Ernst & Young study. More than half the business owners who would otherwise pay the top two rates are actually captured by the AMT instead (1.2 million out of a total 2.1 million) and are not counted in estimates of how many business owners would be affected. If Congress were to reform or eliminate the AMT, they would suddenly become part of the pool.

So what is our take-away? This is a debate about jobs and investment, and the Treasury estimate above suggests that proposals to raise the top two rates will directly impact a large number of employers, and has the potential to impact even more — just more evidence that raising rates on private businesses will be bad for jobs and investment.

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