Legislative Update

It’s been a busy week.  First, Ways & Means Chair Paul Ryan yielded to a tremendous amount of peer pressure and agreed to run for Speaker.  The Republican Conference vote to replace departing Speaker John Boehner is set for October 28th and appears to be all but decided.

And now Boehner made good on his promise to clear off a bunch of “must pass” items before he left, announcing last night a deal with the White House to 1) raise the debt limit through March of 2017, 2) increase the spending caps on defense and non-defense discretionary for 2016 and 2017, 3) enact longer term reforms to prop up the Social Security disability program and 4) much, much more.

The House will vote on the package tomorrow, where a majority of Democrats are expected to provide the votes necessary to send it to the Senate.  The Senate needs to act before the November 3rd, when we run up against the debt ceiling.

The Boehner-White House package is by no means a clean legislative sweep.  Missing are the highway reauthorization, tax extenders, and the actual spending bills that make up federal funding.  Speaker Ryan will have to deal with those items in the next two months.

The current highway authorization runs out this week, but the House is already acting to extend highway authority through November 20th.  At that point, everybody expects them to adopt a 6-year reauthorization together with at least two or three years of funding.

Meanwhile, once the spending levels are set for 2016, the challenge of adopting the actual spending bills becomes much less contentious, so the odds of a government shutdown this winter just dropped sharply.  Those bills, or giant omnibus combining them, still need to be adopted, however, prior to December 11th when current funding runs out.

Which leaves extenders.  Once again, these tax items are left behind to fend for themselves.  With Ryan leaving Ways and Means and the Committee leadership in play – Brady, Tiberi, and Nunes are all vying for the chairmanship – we would be surprised if Congress gets around to extending these tax provisions before December, making this the second year in a row that Congress has allowed 179 expensing, the shorter BIG recognition period, the R&E tax credit and all the other provisions to expire for almost an entire year!  That’s unacceptable and a good argument for making as many of these provisions permanent as possible.

 

Survey of Business Tax Professionals

Last week, we updated you on three leading small business surveys, which sampled business owners from around the country to gauge the national mood on the economy. This week’s survey is a little different; it comes from The Tax Council (TTY) and Ernst & Young and focuses on business tax professionals looking at the tax policy environment. The sample includes 97 tax professionals, assessing their views on a variety of legislative issues. Here’s a snapshot of what they found:

  • 63 percent of respondents said that they think tax reform will happen in 2018 or earlier, with a plurality (28 percent) saying 2017 is most likely.
  • A plurality (45 percent) think that when reform occurs, it will be comprehensive, and another 21 percent think that it will include all businesses.
  • A majority of 54.7 percent believe that reform will be revenue-neutral, while around one-third believe it will raise revenue.
  • 91 percent of respondents think that extenders will pass this year, and two-thirds think the package will cover 2015 and 2016.
  • Since the survey was taken in early September, it also has an interesting perspective on international reform—65 percent of respondents thought it would hinder the possibility of passing a comprehensive package in the future.

So the EY survey suggests the broad outlook for tax policy is similar to the S-Corp view – expect a two-year extender package adopted this fall together with a window of opportunity for tax reform after the election. There’s also a telling consensus among professionals about what would constitute good tax policy—a comprehensive package that addresses both individuals and businesses, not just the largest corporations or those doing business overseas.  That’s good for tax policy and good for Main Street businesses.

A Tale of Two Speeches

The president gave his State of the Union speech last Tuesday, while his Secretary of Treasury spoke to the Brookings Institution the following morning.  The president didn’t mention tax reform, whereas Lew devoted nearly his entire speech to building the case for action this year.  It was a head-scratching juxtaposition that still has us wondering if Treasury and the White House are on speaking terms these days.

  • You can read the president’s speech here
  • You can watch the Lew speech here

Lew’s speech in particular is worth watching.  His focus was on the tax reform “framework” Treasury put forward three years ago coupled with a message that there are many areas of overlap between the Administration and Republicans.  That’s debatable, to put it mildly, but one obvious area where there is no overlap is the treatment of pass-through businesses.  Here’s Politico’s take:

Lew “glossed over a key area of contention: how to deal with small businesses that file on the individual side of the tax code. Many Republicans, including Senate Finance Chairman Orrin Hatch, and some Democrats say it is impossible to adequately address the needs of those businesses, which range from mom and pop stores to big law and financial firms.”

And:

Lew might have talked about “business tax reform” quite a bit on Wednesday, but he seems to be sending mixed messages to small businesses. Last week, he met with a group of small business trade groups to talk tax reform, and Reuters is reporting that Lew actually suggested some of them incorporate if they want to receive the benefits of a lower tax following a tax reform: “Lew’s answer was that some such firms, which are known as ‘pass throughs,’ would probably be better off becoming corporations, according to three people who were in the room and asked not to be named.”

So what does this all mean for the prospects of tax reform?  Our friends at Cornerstone Macro made this observation:

President Obama has not held a single public event designed to promote tax reform. During the last few weeks, Obama held events across the country to promote free community college, tout lower FHA fees for homeowners, and discuss other administration priorities. Over the years, he has held hundreds of public events of one kind or another to push his legislative agenda. To the best of our knowledge, he has never held a single event designed to promote tax reform.

President Obama has made clear his primary interest in tax policy is to raise revenue to pay for new spending.  Unless that changes, and quickly, it is going to be very difficult for Congress and the Treasury to come together to reform the tax code this year.

 

S-CORP in WSJ

The Wall Street Journal featured an op-ed co-authored by S-CORP President Brian Reardon and Advisory Board Chair Tom Nichols last week. The piece calls on Congress and the Administration to make Main Street businesses an equal partner in tax reform by restoring the parity in the top tax rates paid by pass-through businesses and C corps.

The op-ed came the day before the President’s State of the Union address where, contrary to expectations, the President neglected to mention tax reform and instead proposed raising capital gains taxes on businesses and other taxpayers.  As Brian and Tom point out, while President Obama’s plan is offered under the guise of helping the middle class, these changes will ultimately hurt the middle class by increasing the already heavy tax burden shouldered by many employers.

S-CORP Clips | Week of December 12

A compilation of the business tax related stories that caught our eye

Hatch Tax Reform Report

For weeks, there had been K Street rumors of a “secret” tax reform plan being put together by in-coming Finance Committee Chairman Orrin Hatch (R-UT).  Apparently, the “Comprehensive Tax Reform for 2015 and Beyond” report released yesterday is it, although it’s not so much a plan as an analysis of the current code and the challenges policymakers will face in reforming it.  After a quick review, it’s obvious the Finance Republican staff spent an enormous amount of time and effort putting this together and it shows.  As our friends at Politico summarized:

Before lawmakers can reform the tax code, they need to understand it.

Towards that end, incoming Senate Finance Committee Chairman Orrin Hatch released a nearly 350-page report today on all-things tax reform.

It traces the history of the tax code, and efforts to reform it, as well as issues ranging from patent boxes to refundable credits to the case for moving to a territorial system, along with what, exactly, is a territorial system.

From the pass-through business community’s perspective, there’s lots to like here, particularly the report’s emphasis on integrating the corporate code with the individual code to eliminate the double tax on corporate income.  We’ve been advocating for corporate integration for years.

The report also advocates for comprehensive reform, another priority of the Main Street business community.  Here’s what it says:

Tax reform also needs to address the more than 90 percent of U.S. businesses organized as pass-through entities, such as partnerships, S corporations, limited liability companies and sole proprietorships. According to recent data, approximately 58 percent of all net business income in the United States is earned by pass-through entities.22 If real estate investment trusts and mutual funds are included as pass-through entities, then the percentage rises to 78 percent.23 Because of these numbers, it is important that we approach tax reform in a comprehensive manner, addressing both the individual and corporate tax systems. As the data show, both systems are intertwined and must be looked at in the whole.

On the other hand, the report does signal just how much work the pass through community has in educating policy makers on the importance of pass through businesses to jobs and investment.  The chapter on business tax issues is wholly dominated by corporate concerns, while the subchapter on pass through tax issues is only three pages long.  More on this to come. 

Inversions

Ryan Ellis of Americans for Tax Reform reminds us in his recent Forbes article that corporate inversions are driven by bad tax policy, not bad corporations.  He writes:

To say the least, the United States has not created a friendly tax environment for our largest employers.  They face the highest marginal income tax rate in the developed world (whether they are corporations with a 40 percent rate or flow-through firms with a nearly 50 percent rate).

…There should be a giant notice at the top of every business tax form released by the IRS which says, “Get out of our country, and take your jobs and capital with you.” Corporate inversions are a natural and a regrettable side effect of this treatment.”

Extender Recap

Last month, your S-Corp team was popping champagne corks when we learned that congressional leaders had reached an agreement to make permanent several of our priorities – including the five-year built-in gains holding period – as part of a broader extenders package.  We then had to put the corks back in the bottles (not easy) when a preemptive veto threat from the White House dismantled the deal.

We are now left with Plan B – an extension of expired provisions for tax year 2014 only.  The legislation, which was passed last week by the House, retroactively renews the provisions going back to the start of 2014 and would therefore expire just a few weeks after passage.  So starting January 1, we’ll be right back at it.

Charitable

This week the White House further demonstrated its aversion to permanent tax provisions when it issued a veto threat against legislation that would lock in three charitable provisions.  According to the Hill, the bill would “…permanently extend preferences for donations of excess food inventory; waive some limitations for donations of land to conservation easements; and make permanent a provision allowing tax-free donations from Individual Retirement Account funds.”  That package is now dead too.

 

Extenders Update

The tax extenders front has been busy in the last couple days.  First, there was the rumor Monday that negotiators were close to a deal.  Tuesday, details emerged of a $450 billion package mixing ten permanent items with a two-year extension (2014 & 2015) of most other items.  And then yesterday evening the White House issued a veto threat against the package, leaving its prospects very much up in the air.

What’s remarkable about the White House veto threat is that it occurred at all.  To our recollection, this is the first time in six years the White House and Senate Majority Leader Harry Reid have been publicly crosswise on legislative policy.  Reid negotiated the package with House Ways and Means Chairman Dave Camp and it includes several provisions – including making the state and local tax deduction and the mass transit benefit permanent – that Reid and other senior members of his caucus have historically supported.  So it’s obvious the Reid office and the White House are no longer in close communication, at least on tax matters.  As the Hill reported:

Democratic aides on Capitol Hill said that the White House quickly made it clear Tuesday that it was, in the words of one staffer, “livid” over a deal that would have indefinitely extended tax priorities for both parties. Senior administration officials reached out to Democratic lawmakers to get that message across, aides added, with even Obama and Lew trying to marshal opposition.  “This is a terrible deal for Democrats,” one aide said.

Moreover, we’re hearing that part of the White House’s motivation for blocking this package is their belief that doing so will generate momentum for corporate-only tax reform. This kind of reform has been roundly denounced for leaving out and penalizing a majority of the private sector businesses in this country, but the White House and Treasury have been much more active on that front and appear to believe that such a deal is possible.  (We don’t.)  Here’s what our friends at Capital Alpha had to say about that:

The President is making a deliberate and contemplated move to set the ground rules for discussions of fundamental tax reform and corporate tax reform next year with the incoming Republican majority. The President won’t talk about revenue neutral tax reform in a vacuum. His terms for tax reform include big payoffs for constituencies of the progressive left in terms of policy goals and economic benefits. Such has been his position all along, which is why we have always been skeptical of tax reform next year.

As to the package, it’s broad and includes lots for the pass-through community to like.  For starters, it would make permanent two S corporation specific provisions – the shorter holding period for built-in gains and the basis adjustment for charitable donations – as well as popular provisions like the R&E tax credit and small business expensing.   Here’s the complete summary from Tax Notes:

The deal would make permanent the following 10 provisions:

  • the research credit, simplified according to the provisions in a House-passed bill (H.R. 4438) to make the credit permanent but also including the provision from the Senate Finance Committee package providing start-up businesses the ability to claim the credit against payroll taxes;
  • section 179 expensing;
  • the state and local sales tax deduction;
  • the American opportunity tax credit, indexed to inflation after its renewal in 2018;
  • the employer-provided mass transit and parking benefits exclusion;
  • the reduced recognition period for built-in gains of S corporations;
  • the rules regarding basis adjustments to the stock of S corporations making charitable contributions of property;
  • the rule allowing some tax-free distributions from IRAs for charitable purposes;
  • the deduction for charitable contributions by individuals and corporations of real property interests for conservation purposes; and
  • the deduction for charitable contributions of food inventory.

The remainder of the package will mostly follow the extenders bill the Senate Finance Committee approved this spring to renew through 2015 all but two of the 55 traditional extenders that expired in 2013.

However, the deal will phase out the wind production tax credit, ending the incentive after 2017.

It also includes House-passed modifications to the bonus depreciation provision that would expand the definition of qualified property to include owner-occupied retail stores and lift restrictions to allow for more unused corporate alternative minimum tax credits, which businesses can claim in lieu of bonus depreciation, to be used for capital investment.

So where do things stand?  We are hearing conflicting reports.  One word from the Hill is that the deal is off and that negotiators will have to start over, probably with a one-year extension for 2014 only (Boo!).  Other reports, however, suggest that Senate Democrats are not backing down.  It is possible yesterday’s package could move through both the House and the Senate despite the White House’s objections, and we’re hearing some Senate offices are working the membership to make that happen.

With everybody home for Thanksgiving, we won’t have a better idea where the votes are and what Senate leadership decides to do until next week when everybody returns.  In the meantime, the tax world has more than just turkey to chew over this holiday!  Stay posted.

S-CORP Clips | October 1-10

A compilation of the business tax related stories that caught our eye

 

Administration on Tax Reform

The President’s economic advisors have been unusually busy in recent weeks.  National Economic Council Director Jeffrey Zients was firm in his conviction that tax reform could get done in the new Congress, citing the “remarkably overlapping” approaches of Obama’s plan and the Camp draft.

It is true there are some common themes in the Camp and Administration proposals, but also there are major – and fatal – differences as well, including:

  • The Camp Draft is budget neutral while the Administration’s plan would raise revenue;
  • The Camp Draft adopts a territorial tax system while the Administration appears to strengthen our world-wide system; and
  • The Camp Draft is comprehensive while the Administration plan would reduce rates on corporations only – an approach rejected by Democrats and Republicans alike.

Add to those differences the fact that the Administration’s draft landed with a thud when it was released back in 2012 and has barely been discussed since, and the idea of House Republicans and the Obama Administration coming together on tax reform in the next Congress seems laughably remote.

Meanwhile, Council of Economic Advisers Chair Jason Furman spoke in New York the other week on tax reform, offering additional context to the Administration’s tax reform proposal and addressing some of the concerns that have been raised.  We’ll have more to say about this later, but this paragraph caught our eye:

On the economic merits, it is important to remember that C corporation income is partially taxed at two levels while pass-through income is only taxed at one level. As a result, today C corporations face an effective marginal rate that is 6 percentage points higher than that on pass-through businesses. Although the President’s Framework would cut and simplify taxes for small business, including small pass-through entities, for larger businesses we should be moving towards greater parity—with the goal of equal effective rates on an integrated basis, a goal that would not be served by parallel reductions in individual and corporate tax rates.(Emphasis added)

That’s not exactly true.  Recall that our study on effective tax rates released last year found that S corporations face the highest effective tax rate of any business type.  Those estimates were based on real businesses and actual tax returns.

The numbers Jason is referring to are based on hypothetical future investments.  They can be found in a three-year-old Treasury analysis under the heading of “Effective Marginal Tax Rates on New Investment.”  Jack Mintz authored a comprehensive critique of these estimates for the Tax Foundation last February, some of it pretty damning.

For our purposes, we will just point out that Treasury’s analysis, correctly done, would be appropriate if you wanted to measure the tax burden on marginal investment decisions – should we build that new facility, should we buy that piece of equipment, should we use debt or equity? – but it doesn’t support the notion that C corporations today pay a higher effective rate than pass-through businesses.  You need to estimate average effective tax rate to make that claim, which is what our study does.

Jason is right to point out that the double tax on corporations hurts US competitiveness.  That’s the reason the pass-through business community advocates for its reduction as an essential goal of tax reform.  There’s little point in reforming the tax code if the result doesn’t reduce the tax on investing in the United States, and the best path to achieving that is to tax business income once at reasonable rates and then leave it alone.  That’s how S corporations are taxed today, and real reform would move C corporations in that direction.

 

Ryan on S Corporations

Contrast the Administration’s approach with that of Representative Paul Ryan (R-WI), a leading contender to take the gavel as the next Chairman of the Ways and Means Committee.  He recently gave a speech at an event hosted by the Financial Services Roundtable in which he made clear the importance of improving the tax code for all businesses, including S corporations and other pass-through businesses. Here’s what he had to say:

“Tax reform is one of those things that we don’t know if we’re going to be there at the end of the day, because we want to make sure that, as we lower tax rates for corporations, we do the same for pass throughs.

You know, a lot of people in the financial services industry – banks – are subchapter S corporations.

Where Tim [Pawlenty] and I come from, “overseas” is Lake Superior, and Canadians are taxing all of their businesses at 15 percent. And our subchapter S corporations, which are 90 percent of Minnesota and Wisconsin businesses, are taxed at as high as a 44.6 percent effective rate.

So we have to bring all these tax rates down, but we have a problem with the Administration being willing to do that on the individual side of the tax code.”

We’ve been beating the “comprehensive tax reform” drum for three years now and it’s nice to see key policymakers embrace the message.

 

American Progress on S Corp Payroll Taxes

Meanwhile, Harry Stein of the Center for American Progress is out published a report with broad recommendations on how to best reform the tax code. Among its suggestions is one to close the “Edwards-Gingrich loophole,” an issue we’ve covered extensively in the past. On that subject, the S Corporation Association has developed the following position:

  1. We don’t support using the S corporation structure to avoid payroll taxes.  We represent businesses that comply with the law, not sneak around it.
  2. It’s not a loophole, its cheating.  This issue is often described as a loophole, but that’s not accurate.  Underpaying yourself in order to avoid payroll taxes is already against the rules.
  3. The IRS has a long history of successfully going after taxpayers who abuse the S corporation structure.  The current S corporation rules on this have been in place since 1958.
  4. Any “fix” needs to improve on the current rules.  That means they need to be easier to enforce and they need to target wage and salary income only.  Employment taxes should apply to wages only, not investment (including business) income.

 

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