We’re tracking two key tax items at the moment – tax extenders and international reform. Here’s our outlook for both.
For extenders, Congress has once again ignored the needs of American businesses by delaying adoption of a multi-year extender package until the last possible moment. What’s the point of encouraging businesses to invest in new equipment if those provisions are enacted only retroactively? Not only does it undermine the policy, it creates a dynamic where pass through owners are required to overpay their taxes over the course of the year, draining money from their businesses and reducing their ability to hire new workers and invest in new equipment.
The most recent word from the Hill suggests these concerns may be resonating, and that there’s a vigorous effort afoot to:
Make as many of the extender provisions permanent as possible, including the R&E tax credit, small business expensing, and built-in gains relief;
Extend the other provisions for two years; and
Include EITC and child credit reforms important to the Administration.
In other words, we may see a reprise of the deal they nearly closed last fall. If true, this development would represent a significant early accomplishment in Ways & Means Chairman Brady’s tenure and help to set the table for more significant tax policies to come.
If the broader package fails, we’re hearing the Administration will push for a one-year extender package (2015 only) to give them one more chance to work on tax policy prior to the 2016 elections. Obviously, a one-year extension of policies that have already expired would simply prolong the extender roller coaster ride that we’ve been on for the past several years and should be vigorously rejected by Congress.
On the international front, we reported in October that Chairman Ryan had officially put on hold his efforts to fix our international tax code by attaching it to the highway bill. Ryan was unable to come to terms with Senator Chuck Schumer (D-NY) over highway funding levels and he faced a reform skeptic in Speaker Boehner.
Now that he’s Speaker, that effort may have new life. New Ways & Means Chair Kevin Brady’s remarks in the Wall Street Journal, where he adopted Ryan’s “step one, step two” approach to pursing international reform in 2016, suggest Ryan has an ally at the head of the Committee. Add to that Pfizer’s announced merger with Allergan in the largest inversion ever, the continued vocal support of Senator Rob Portman and other key policy makers for targeted international reforms, and the G-20’s endorsement of base erosion recommendations that are likely to hit US companies, and it all builds the case that something has to be done on the international front.
On the other hand, Speaker Ryan’s “60 Minutes” interview (see below) demonstrates he understands on-going tax rate disparity faced by pass through businesses. Successful pass through businesses currently pay tax rates significantly higher than their corporate and foreign competitors. That disparity would likely be made worse by reforms that focus on corporate concerns only. Meanwhile, the innovation box draft that was designed to stop corporate inversions has failed to garner widespread support in the corporate community (see below), reinforcing the perception that the business community is far from unified over exactly what international reform should look like.
So that pretty much leaves us where we’ve been for several months now – the need for reforming how we tax business income is obvious, but the path to getting there is not, particularly with a President who opposes restoring rate parity for pass through businesses.
Innovation Box Support
A coalition of large corporations has emerged to support the innovation box approach proposed by Ways & Means member Charles Boustany (R-LA). We offered comments on that draft last summer and have been waiting along with the rest of the tax community for a redraft. Rumor has it that the release of a new, improved innovation box draft is imminent, which explains the timing of this week’s announcement. As Politico reports:
BUSINESS RESPONDS TO BEPS: A corporate coalition featuring Apple, Boeing, Cisco and Intel is using the G-20’s adoption of the OECD BEPS recommendations to ramp up their international tax reform efforts. The group, American Innovation Matters, is releasing a statement this morning pushing for an innovation box, even in the heightened gridlock of a presidential election year.
American Innovation Matters (AIM) joins at least three other coalitions out there pushing corporate tax reform, including RATE, LIFT, and ACT. That’s a lot of corporate muscle in favor of reform. Now if they could just agree on what it looks like.
Speaker Ryan on “60 Minutes”
On Sunday, House Speaker Paul Ryan appeared on “60 Minutes” to discuss his new job and the challenges he faces:
I think you can walk and chew gum at the same time. I think you can oppose the president on some issue that you fundamentally disagree with, but also work with the other party on issues you do agree with. That’s what I’ve been doing. Look, if we can find common ground, we can on highways, we will on funding the government, hopefully we can on tax policy. Those are three things that will produce certainty in this economy in the next few months. Let’s go do that.
Our friends at Politico focused on the “next few months” line and what that might mean:
The “next few months” line there is interesting. A Ryan spokeswoman said the speaker was specifically referring to extenders, an area where practically everyone expects some sort of deal by the end of 2015. But Ryan has also left open the idea that international tax reform could happen in 2016, even though plenty of people see that as quite the longshot.
During the interview, Speaker Ryan also had the opportunity to lay out his vision for comprehensive tax reform:
Scott Pelley: You have proposed having only two tax brackets, 10 percent and 25 percent. That still your position?
Paul Ryan: Yeah, I’ve always liked that plan. And our tax code really punishes our small businesses, which is where most of our jobs come from. I mean, look, we’re sitting here in Wisconsin, overseas, which to us means Lake Superior. You know, the Canadians are taxing their businesses at 15 percent. The top tax-rate on successful small businesses in America, here in Wisconsin, is 44.6 percent. How can you compete like that? How can you have jobs? How can working families get ahead with a tax system like that?
Scott Pelley: Give me three things you would do on tax reform. Very specifically.
Paul Ryan: Well, I’d simplify the code dramatically. I would collapse the rates down to two or three. And I would change the way we tax ourselves internationally, so businesses can take their money and bring it back home so American businesses stay American businesses. And we have to drop our rates on our businesses. I think those three things right there are what I would do.
Paul Ryan has always been a vocal advocate for Main Street businesses and he understands the challenge S corporations and partnerships face with top marginal tax rates of over 40 percent. The vision he outlined on “60 Minutes” meets the criteria outlined in our Pass Through Principles Letter signed by 120 of the largest and most active business trade groups in Washington DC. Now that he’s the Speaker, he has an opportunity to move tax reform the fits that vision through the House.
On Wednesday, the Republican Steering Committee tapped Rep. Kevin Brady (R-TX) to succeed Speaker Ryan as the committee’s chairman. Both he and his challenger, Rep. Pat Tiberi (R-OH), are strong allies of S corporations and pass-through businesses, so we excited to see him take on the gavel.
What does Brady’s ascension mean for tax policy? The Wall Street Journal has an interview with the new Chairman this morning, where Brady makes clear he wants to move a robust tax extender package (yea!) this fall then spend next year pushing the “step one, step two” plan for tax reform outlined by Paul Ryan in the past year:
Q: What’s the first thing you’re going to try to get accomplished this year?
A: We’re going to continue to tee up pro-growth tax reform. There’s two steps we can take that are real, one of them immediate, which is to negotiate a package of permanent provisions among those [expired tax breaks]. One, because it creates certainty for the economy. Two, you get a better bang for the buck for the tax provisions. And three, it’s honest scorekeeping. It identifies what truly are permanent parts of the code. I will pick that up and see if we can’t conclude a package that works for both parties.
The second one in 2016 is to conclude discussion on international tax reform and an innovation box. It could be a significant down payment on overall tax reform, done right, allow U.S. companies to bring those stranded profits home to reinvest in the U.S. and ensure America isn’t isolated on the innovation side of the economy.
We applaud the new Chair’s focus on extenders and pressing the case for making as many of these provisions permanent as possible. On the international front, everyone is waiting to see the revised “innovation box” proposal from Representative Charles Boustany (R-LA) and how willing the Administration is to seriously negotiate something the business community can support. Most everyone supports making our tax code more competitive, but exactly how much progress can be made with the current Administration remains to be seen.
White House Opposes Rate Cuts for Pass Thrus
Speaking of the White House, recent comments by the President’s chief economic advisor make clear the gulf between the White House and Congress approaches over tax reform continues to be the principal reason Congress has been unable to do anything meaningful this year.
Jason Furman, Chairman of President Obama’s Council of Economic Advisors, spoke to the Brookings Institute Tax Policy Center earlier this week and gave the Administration’s take on tax reform, identifying the key area of disagreement with Congress:
But there was an “impasse” over whether to lower individual rates, which some Republicans argued was necessary to maintain the competitiveness of large businesses that filed through the individual side of the code.
To cut the top individual tax rate as Republicans want is impossible without tilting the tax code in favor of the rich, Furman said at Tuesday’s event.
The continued opposition of the Obama Administration to rate cuts isn’t news, but the disconnect between their insistence on corporate cuts yet opposition to similar cuts for domestic pass through businesses is head scratching. Why is one important and economically necessary but the other just a give-away to the rich? Recall that those pass through businesses employ more people and contribute more to the national economy than their corporate cousins. Apparently, the opposition stems from the myth that private businesses don’t pay their fair share:
He also suggested that cutting the tax rates of businesses that filed as individuals would work against the purpose of tax reform. Furman cited Congressional Budget Office statistics indicating that the owners of those companies, known as “pass-throughs,” pay lower effective tax rates than do the owners of companies arranged as corporations, even though pass-throughs have lower rates on paper.
This is an argument the CBO has made in the past, as have recent papers from CRS and Treasury. We have a number of critiques of these papers, but the primary concern is that they fail to compare apples to apples or, in this case, businesses of similar size. When you do that, as our study from Quantria did, you find that large S corporations pay the highest effective rate of all business types. Policymakers need to be aware of that as they debate the future of tax reform.
Valuation Discount Update
Are you asking yourself what happened to those new regulations out of Treasury on minority discounts? We are.
As we previously reported, for the past year Treasury has been working on new rules limiting the ability of family-owned businesses to apply minority discounts under certain circumstances. Exactly what those regulations would do and when they would be released, however, has always been a mystery.
Now BNA reports that a senior IRS official this week provided a little clarity on both fronts.
Guidance on restrictions on estate valuation discounts for certain corporations and partnerships is expected very soon and won’t be based on previous administration proposals, Leslie Finlow, an IRS senior technician reviewer, said today.
Tax code Section 2704(b) gives the Treasury Department the power to issue new regulations disregarding additional restrictions on liquidations of interests if the restrictions reduce the value of the transferred interest but not the value of the interest to the transferee.
However, Finlow told certified public accountants at the American Institute of CPAs Fall Tax Division Meeting, that the Internal Revenue Service isn’t looking to a 2013 Obama administration proposal that called for further restrictions on valuations of family business interests. Instead, she said the guidance will focus on “the statute as it looks now.”
So the rules are due soon, but it appears they won’t be as expansive as previous Obama Administration budget proposals. Something to keep an eye out for.
Speaker Boehner had a three step plan at the beginning of October: 1) Resign at the end of the month; 2) Clear the legislative decks of controversial and difficult items; 3) Turn the gavel over to a new Speaker to begin their tenure with a clean slate.
Looking back, he pretty much pulled it off. Sure, the Speakership went to Paul Ryan, not Kevin McCarthy, and not all the tough legislative items cleared Congress, but the simple fact is that Speaker Ryan begins his term with a much more manageable set of issues than the laundry list of must pass items that confronted Boehner at the beginning of October:
Medicare Premium Hike
Social Security Disability Fund
Of these, the deal brokered by Boehner, McConnell and the White House takes care of the debt limit, the looming Medicare premium hikes, and the depletion of the Social Security Disability Fund. It also raises spending caps for discretionary funding next year by $50 billion, making the job of passing all those spending bills – most likely in the form of a single, massive omnibus spending bill – before the December 11th deadline much, much easier.
Which means between now and the end of the year, the remaining must pass items are largely limited to three – 2016 spending bills, highway reauthorization, and tax extenders. The House highway bill is up this week, and appropriators are busy working to have appropriation bills ready for consideration later this month. Other items, like Ex-Im Bank reauthorization, may likely catch a ride on one of these vehicles.
Which leaves extenders. Once again, Congress has waited until the last days to adopt extensions of tax provisions that have already expired.
That to-do item will fall on the plate of the incoming Ways & Means Committee Chairman. The election to replace Ryan will take place on Wednesday and Politico has a terrific story this AM on the race. Here’s the key paragraph:
With just days left, lots of people think that the race between Kevin Brady of Texas and Pat Tiberi of Ohio to replace Ryan as Ways and Means chairman remains too close to call. Both Brady and Tiberi are well-liked by colleagues, and have pretty similar policy views on the issues under Ways and Means’ jurisdiction. That means this contest could be decided on issues more on the margins, like fundraising prowess and even sheer geography.
For S corporations, both candidates are terrific and have a long history of supporting independent businesses and their communities. Let’s hope whoever wins, their first action item is to markup a tax extender package that makes as many provisions permanent as possible. A little tax certainty would go a long way at a time when the economy looks iffy at best, and it would be a terrific start to a new era at the tax writing committee.
Rubio on Pass Thrus
Senator Marco Rubio did a post-debate interview with CNBC last week where he made a vigorous defense of his tax proposal, as well as the importance of S corporations and other pass through businesses to the economy and jobs:
“…I think we also need to lower taxes on pass-throughs, which is where the vast majority of American business activity is happening. You know, I have gentleman–I mentioned him last night–he’s the dry cleaner where I take my clothes in Miami. He’s an S-corp and he’s a small business and he’s probably paying a much higher rate, in fact almost guaranteed he’s paying a higher rate than a chain-owned company down the street somewhere, and that’s unfair. I think we have to make an equal playing field for pass-through companies, where a lot of working Americans are drawing their income, and have been placed at a competitive disadvantage now because of regulations, because they don’t have access to community banking the way they once did, and because of the tax code that actually treats them differently…”
As readers know, we initiated the “Pass Through Principles” letter four years ago in an effort to define what sort of tax reform the pass through business community would support. This year, 120 groups signed the letter, which calls for making tax reform comprehensive, restoring tax rate parity for all businesses, and reducing or eliminating the double corporate tax.
The Rubio tax plan comes very close to meeting those three priorities. It would eliminate the harmful double tax on corporate profits while leveling the tax rates paid by pass through businesses and their C corporation competitors. Senator Rubio’s team spent an enormous amount of time working with the business community to craft their plan, and it shows.