August 21, 2015 by admin ·
Innovative Pass Thrus
Last month’s release of the “innovation box” proposal by Ways and Means Committee Members Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) started us thinking, “Exactly how much innovating do S corporations do?”
In our own membership we have lots of innovative companies with robust R&E operations, but is that a representative sample, or an outlier? Moreover, when you think of today’s most innovative companies – the real so-called “disrupters” – almost all of them began small and grew largely based on the quality of their ideas. Apple is the most notable example these days but certainly not the only one.
So is there good data out there that captures this dynamic and gives us an accurate assessment of how much innovation is being conducted in the pass through space? Not really.
Available data regarding usage of the Research and Experimentation tax credit (R&E credit) is dated and, in many instances, groups the usage of all pass through businesses together. Furthermore, this data may not present an accurate assessment of pass through innovation because of a variety factors, including the well-recognized compliance burden of claiming the R&E credit, the availability of other cost recovery mechanisms and the impact of the alternative minimum tax (AMT).
While we may struggle to quantify the amount of research, we’re confident that there is more innovation in the pass through community than the numbers suggest. The good news is that Congress knows this, too. This year, Rep. Kevin Brady (R-TX) sponsored the “American Research and Competitiveness Act of 2015” (H.R. 880), which passed the House in February. Aside from increasing the alternative simplified credit (ASC) from 14 percent to 20 percent, the bill would also allow the R&E credit to act as an offset to the AMT for businesses with less than $50 million in receipts.
We are not crazy about the $50 million threshold – why should Apple get full access to the R&E credit but not a mid-sized S corp? – but the general acknowledgement that today’s complex code produces undesirable outcomes for innovative businesses is healthy, and we plan to work with Mr. Brady’s office to make sure this provision, without the threshold, becomes law.
We are also going to make certain that pass through businesses are treated fairly under any international provisions considered by the Ways and Means Committee this fall, including their innovation box draft. More comments to follow on that front.
IRS Minority Discount Rule Pending
We have mentioned in previous Wires that the Treasury Department is considering new regulations to limit or scrap some minority discounts for valuations of family-owned businesses. The first rumors of this came back in May. It’s looking like Treasury is planning to announce the new rules within the next month. This is a big deal and there’s an increasing amount of noise on exactly what Treasury has in mind. This press release from Blank Rome LLP lays out the timeline for Treasury’s actions:
Recently, it has been reported that Treasury official Cathy Hughes said (without specifically addressing the Section 2704 Regulation project) that various Treasury initiatives are likely to be delivered prior to the September meeting of the American Bar Association’s Tax Section (which is September 17-19, 2015). It is therefore possible and perhaps likely that proposed regulations under Section 2704 could be issued before the end of the summer.
It is not clear at this time whether such regulations, when issued, will be prospective or retroactive (for example, to the date or the day after the date the proposed regulations are published in the Federal Register). The scope of these regulations and what safe harbors may be included are also areas of uncertainty. Some have suggested that minority discounts will be disallowed or restricted, although the legislative history indicates otherwise. Even so, discounts for lack of liquidity and lack of marketability will likely be impacted and could be significantly reduced.
Once these rules are proposed, we’ll be working with other business groups to make certain policymakers on the Hill are aware of their adverse impact on family businesses. Discounts for minority ownership stakes are well established both in the economic and the tax world, and the IRS has lost on this front many times in the past. Looks like history may be repeating itself here.
Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) unveiled their proposed “innovation box” legislation aimed at keeping intellectual property registered in the United States. The bill would lower the rate on qualified income from patents and intellectual property to 10 percent, but only for firms with domestic R&E expenses. Similar laws already exist in Europe, and there are signals that this could become part of a Ways and Means international tax package later this year. Here’s Chairman Ryan on the proposal:
The proposal from Reps. Boustany and Neal can help us stem the tide and protect good American jobs. It will also help ensure the United States continues to be the world’s leader in innovation. Their plan would allow American businesses to better compete with foreign companies and keep their research and development facilities here in the U.S. This is just one piece of international tax reform, but it’s an important one. I applaud Charles and Richie for their work, and look forward to refining the proposal as we move forward on a broader plan to make America more competitive and promote high-paying jobs.
Senators Rob Portman (R-OH) and Chuck Schumer (D-NY), who authored the Senate Finance Working Group report on international reform, were also supportive. You can read their respective statements here. With support in both chambers, it appears the innovation box will be a factor in international tax negotiations later this year.
As the proposal currently stands, it doesn’t appear as if innovative pass through businesses would be eligible for the innovation box. The sponsors have made clear that the legislative text released this week is a “draft” and that they are eager for input. We will be working with the rest of the pass through community to coordinate our comments and make sure S corporations are well represented.
Highway Bill & Patent Boxes
Why release the patent box draft now, just before the long August recess? We believe the goal was two-fold. First, it is a genuine effort to get feedback on the proposal, which is a new concept for the Ways and Means Committee and they’d like to get the policy right. Second, it helps to keep the ball moving on Chairman Ryan’s two step plan to getting international tax reforms done this year – pass a short term highway extension now and follow it up with a bigger package of highways and international tax reforms this fall. The innovation box idea is a key “sweetener” in the larger international package, so getting it out now helps to move the overall plan forward.
For the past year, Ryan’s goal has been to combine highways, international reforms, and tax extenders into one big package Congress would enact at the end of 2015. He believes the general desire by both parties to get a highway bill done can help push his international package over the finish line.
Senate Majority Leader McConnell, on the other hand, thinks any plan to reform taxes with this President in office is doomed to fail and wanted to get highways done and off the table at least through the elections. So McConnell proposed to do long-term highways now with little in the way of tax policy, while Ryan advocated for addressing highways in December with as much international reform as he can muster.
The three-month extension adopted by Congress this week represents a compromise between the two positions. It means Congress will have to revisit the issue prior to December, but it also keeps alive Ryan’s international reform efforts.
Built-In Gains Relief Introduced in Senate!
Good news! Sens. Pat Roberts (R-KS) and Ben Cardin (D-MD) introduced legislation Thursday to provide a permanent five-year recognition period for built-in gains (BIG) assets.
We’ve been advocating on BIG for years and, even after all of the leadership changes in Washington, DC over the past several elections, built-in gains relief continues to receive strong bipartisan support in both chambers. We are glad that Congress has recognized the importance of such relief by continuing to extend temporary relief – as included in the tax extender package recently adopted by the Senate Finance Committee. Permanent BIG relief, however, is the only way to offer business owners the certainty they need, so we’ll keep working to get the Roberts/Cardin bill across the finish line.
Also in the Senate this week, the Small Business Committee adopted a “Sense of the Committee” resolution endorsing legislation introduced by Committee Chairman David Vitter (R-LA) that includes “sting” tax repeal! Eliminating the “sting tax” has been a priority of the S Corporation Association for years and it’s a key part of the S Corporation Modernization Act introduced by Representatives Reichert (R-WA) and Kind (D-WI) last month.
Fixing this particular passive income rule has been long overdue—in fact, the Joint Committee on Taxation recommended the repeal of this termination rule back in 2001! As with permanent BIG relief, we plan to spend this fall pushing the tax writing committees to adopt Sting Tax relief as part of any tax legislation moving this year.
Hillary Clinton Proposes Tax Hikes on S Corps
In her bid to reform so-called “quarterly capitalism,” presidential candidate Hillary Clinton proposed this week to hike the capital gains tax on investments held less than two years to the top individual rate of 39.6% (plus the 3.8% net investment tax), or nearly double the tax today. Under her plan, the tax rate would gradually decline for investments held between two and five years, while investments held six years or longer would get the current 20% rate.
So while all of Washington, including the Obama Administration, is working on ways to reduce the tax on investment and encourage more companies to remain here in the US, candidate Clinton would increase the cost of domestic investment instead. Clinton did add that capital gains would be eliminated for select long-term investments in small businesses. That doesn’t sound bad, but it begs a few questions. What is her definition of “small business”? How long would the investment need to be held?
Moreover, if lower capital gains for small businesses would stimulate long-term investment, why limit it to small businesses? Why not reduce or eliminate the capital gains rate on all domestic investments, as Senator Rubio has proposed? As the Wall Street Journal points out, this proposal may do little more than distort investment decisions in the short-term and prevent the efficient allocation of capital:
A high and sliding tax-rate scale also harms the efficient allocation of capital by expanding what economists call the “lock-in effect.” If owners of capital must wait years to pay a lower tax rate, many will decline to realize their gains solely for tax purposes. This artificially reduces the mobility of capital.
Economic growth is enhanced when capital is able to efficiently find its highest return. “Buy and hold” often works well for individual investors in specific stocks. But no economic theory says one- or two-year investments are worse than 10-year, and sometimes they’re better.
Worst of all, this would leave owners of pass-through businesses on the hook for corporate “quarterly capitalism.” Since many pass-throughs are family-owned through multiple generations, they’re already making the kinds of long-term investments that Clinton is looking to promote. Her campaign has said she is committed to producing a full tax plan, and we’ll be sure to analyze it when it becomes public.
Highway Debate Continues
Last week, we reported on the House’s adoption of a highway trust fund (HTF) extension through December. This extension is the first step of Chairman Paul Ryan’s plan to combine a longer term HTF extension with key international tax reforms.
Meanwhile, Senate leaders want to act now, not in December, on a longer-term extension. Majority Leader Mitch McConnell, Sen. Barbara Boxer (D-CA), and Sen. Jim Inhofe (R-OK) support a six-year highway deal which has offsets for the first three years, but does not include international tax reform. The Senate voted 62-36 Thursday morning to begin debate on the measure.
So both the House and Senate want a multi-year bill, but McConnell wants to pass something now and avoid revisiting the issue prior to next year’s election, while Ryan would like to leverage the highway issue to get international tax reforms. A short-term HTF extension through December gives him more time to build support for the combo package. Rumor is he will release a detailed plan, which should track closely with the Portman/Schumer International Working Group plan, as soon as next week.
So which is it? Will it be a multi-year HTF extension now, or HTF extension plus international tax reforms later? The current HTF authorization expires on July 31st so we will know next week which view prevails, and whether Congress will be debating international tax reform this fall.
Senate Finance Moves Forward on Extenders
Good news! The Senate Finance Committee voted this week 23-3 to send a tax extender package to the Senate floor. The extensions last for two years (2015 & 2016) and include S-Corp priorities built-in gains relief and charitable contributions basis adjustment. Relative to last year’s 11th hour retroactive one-year deal, early movement on a two year extension is welcome news.
The question now is how extenders will work its way through the Congress and ultimately to the President’s desk. There was some talk about attaching extenders to the highway bill being debated by the Senate right now, but that seems remote. Outstanding issues regarding certain provisions, including the application of the solar tax credit, appear to stand in the way.
Regarding the post-August schedule, The Hill reports:
Congress will also have to deal with a number of big-ticket items when lawmakers return from their August recess, including a Sept. 30 deadline for government funding and the recent agreement the Obama administration struck with Iran. Hatch sounded skeptical after the markup that the package of tax breaks could be added to the Senate’s highway bill, which was released Tuesday.
Even though the timeline for passing extenders may be in flux, the fact that the bill has been reported out of committee is a good sign that Congress is moving and may act well in advance of last year’s last minute extension.
Senator Thune Supports Permanent BIG Relief!
Provisions like built-in gains have been part of extenders packages for years, and we’re still fighting to make them permanent. The good news is that we have friends in high places who share that goal. Just this week, Senator Thune (R-SD) proposed an amendment that would do just that. During the extenders markup, Sen. Thune offered up his legislation to, among other items, make permanent the five year recognition period for built in gains. He had this to say:
“I support this legislation to ensure that American families and businesses do not find themselves facing a higher tax bill come tax season,” said Thune. “However, I believe we can do better than simply preventing a tax increase in the short term. American taxpayers deserve the certainty and predictability that only comes from making tax relief permanent, something I intend to continue to pursue on their behalf.”
As we continue working to make built-in gains relief and charitable contribution provisions permanent, Sen. Thune’s amendment shows that there is a strong constituency in the Senate for our efforts. We expect that a permanent bill on built-in gains, similar to what was proposed last year, will be introduced soon in the Senate.