S Corporations Hit by Tax Hikes

October 20, 2014 by · Leave a Comment 

Our friends at McGladrey LLP have a new survey out of mid-market firms showing just how hard those companies have been hit by the tax rate hikes championed by President Obama and his allies in Congress.

Recall that in the run-up to the Fiscal Cliff, Ernst & Young released a paper on our behalf that predicted the higher rates set to begin in 2013 would hurt investment and job creation by significantly hiking taxes on mid-sized employers.  Over the long-term, E&Y estimated the U.S. would lose 710,000 jobs.

Now McGladrey’s survey shows just how those job losses and lower investment levels emerge.   According to them:

While middle market companies are adding jobs, and have been for several years, some have had to reduce their workforces over the past year. More than 50 percent of the middle market companies that reported having cut jobs (56 percent) said the 2013 tax reform bill was a factor in their decision to take these actions.

McGladrey defines “mid-market” as businesses with revenues between $10 million and $1 billion.  Census Department statistics make clear that firms in that revenue range are a huge source of employment in the U.S. and an important part of the economy.  Raising tax rates on these employers made little sense back in 2012 and even less sense now.

Another key finding in the survey provides additional support to the Harvard study on bonus depreciation we highlighted last week.  As you’ll recall, the study found that US companies responded strongly to the investment incentive, with privately-held companies responding strongest of all.

The McGladrey study reveals the other side of that coin.  When investment incentives are allowed to expire, as Section 179, the R&E tax credit, and bonus depreciation are right now, then firms respond by reducing their investments.  According to McGladrey:

Half of all companies that reported cutting back on research and development (R&D) said that the reform law had influenced their decision to do so. Not surprisingly, the manufacturing industry – a key component of the middle market – reported the most severe impacts. More than three-quarters (78 percent) of middle market manufacturers said that the R&D tax credit’s expiration had led to an increase in their tax bills, and 63 percent of manufacturers that reported having cut R&D over the past year said  the tax credit’s expiration contributed to their decisions to do so.

So there you have it.  We now have prospective and retrospective evidence that hiking rates on Main Street employers hurts investment and job creation.  With the debate over tax reform focused almost wholly on large multinational companies, the McGladrey survey is a solid reminder that tax reform needs to embrace the whole business community, not just publicly traded companies.

S-CORP Clips | October 1-10

October 10, 2014 by · Leave a Comment 

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.

 

Lew Punts on Tax Reform, Inversions

September 8, 2014 by · Leave a Comment 

Secretary Lew gave his tax reform speech this morning.  It lasted maybe 10 minutes and he didn’t take questions afterwards.  Given the buzz the speech’s announcement created on Wall Street and in tax policy circles, the event itself was a major disappointment.

The Obama Administration is beginning to resemble an old Brian Regan comedy routine about how passengers on an airplane get excited when the pilot comes on the intercom, even though the pilot never has anything good to say.  Just a variation on the same old theme that the flight will be delayed because….

This Administration never appears to say anything new either.  Faced with a raft of inversions, Lew used this speech to plug the Administration’s two-year old “business tax reform” outline that went nowhere two years ago, and has even less momentum today.

Raising the overall tax burden and increasing the penalty of our worldwide system is a non-starter for both political and policy reasons.  From the pass through perspective, the Administration’s “business tax reform” plan is nothing more than corporate tax reform in disguise, with little or nothing to help S corporations and partnerships.  The plan appears to offer lower tax rates for C corporations and higher tax burdens for everybody else.

Lew did tamp down expectations that Treasury would take strong administrative action to address inversions.  In the speech, Lew announced Treasury would act “in the very near future” but also made clear whatever action they took would not be sufficient to fix the problem.  Congress must act, he cautioned.

But action by Congress is also in doubt.  Majority Leader Harry Reid earlier had signaled the Senate might take up inversion legislation when the Senate returns this week, but disagreements among key Democratic tax writers over the best approach may kill that effort.

So there you have it – after the President took ownership of the tax inversion issue by announcing his Treasury Department would address them administratively, Secretary Lew is now lowering expectations and attempting to toss the ball back into Congress’ court, where most observers believe it belonged the entire time.