Business Community Rallies around Aggregation

March 19, 2018 by · Leave a Comment 

Treasury has its hands full with the new tax overhaul.  As technical comments from the US Chamber, AICPA and S-Corp make clear, the list of necessary guidance for the business community is long and growing.

Common to all three lists is the issue of aggregation.  This technical sounding challenge looms large for businesses trying to calculate their pass-through deduction for 2018.  For many of them, the question of whether to aggregate or not could mean the difference between getting the full 20-percent deduction or not.

To emphasize the importance of this issue, more than 40 trade groups, including the US Chamber of Commerce, the National Restaurant Association, the Farm Bureau, and the S Corporation Association, wrote to the Treasury Department today and asked for rules granting pass-through business owners the ability to aggregate (or group) multiple legal entities together when calculating the new deduction.  As the letter notes:

Allowing taxpayers to aggregate or “group” legal business entities together for purposes of calculating the pass-through deduction is vital to making the deduction fair and workable.  Main Street businesses often utilize multiple legal entities for non-tax business reasons.  For example, family businesses are often organized in a “brother-sister” structure, where their operations are housed in one entity and their real estate in another.  Another common practice is for a business to place all its payroll, finances, and insurance in a “common paymaster” entity in order to streamline payroll operations, while housing actual production operations elsewhere.   

Section 199A permits owners of pass-through businesses to deduct up to 20 percent of qualified business income.  Certain services businesses are precluded from this deduction, however, while even eligible businesses are subject to two alternative limitations, one based on the businesses’ payroll and another on a combination of payroll and capital.  

Absent aggregation, the application of these limitations would treat similar businesses differently depending on how they are organized.  For example, a manufacturing business housed in a single S corporation may be eligible for the full deduction, while a similar business utilizing the common paymaster model described above may be eligible for none of it, despite having the same robust levels of payroll and investment.   

The illustration below highlights the challenge.  This brother-sister set-up is a common practice operating companies use to manage their risk, costs, and ownership needs.

In this example, Company A houses the operations and employees, while Company B houses the business’ capital assets.  This business is a real, operating company with robust levels of employment and investment.  It should get the full deduction.

When you combine this organizational structure with the employment and investment guardrails, however, the result is a smaller deduction than if all the businesses employment and assets were housed in a single legal entity.  Artificially limiting the pass-through deduction based on the unintended interaction of business structures and the new guardrails was clearly not Congress’ intent.  Treasury should establish broad grouping rules to address this challenge.

It has little to lose taking this approach.  Allowing businesses to aggregate or group under Section 469 would not open the door for gaming.  As the business community letter states:

Allowing aggregation or grouping will not open the new deduction to gaming opportunities because the wage and investment limitations provide a strict cap on the size of the deduction, regardless of how it is measured, while the new rules could ensure that income from excluded service activities is not taken into account for purposes of the calculation. 

On the other hand, blocking businesses from grouping is unlikely to save the Treasury revenues.  Pass-through businesses who are in danger of not getting the full deduction have options – they can reorganize their business operations in order to access the full deduction, or they can convert to C status and get the new 21 percent tax rate.  In either case, Treasury unlikely to gain any additional revenues, but the businesses themselves will be worse off.  Again, the business letter makes the case:

Failure to allow aggregation will force many affected businesses to reorganize, utilizing a different combination of pass-through structures or reorganizing as C corporations.  Moving business activity from one form to another, particularly a form that is going to be taxed at just 21 percent, will not save the Treasury revenues, but it will impose significant transaction costs on these businesses.  They will be forced to change not just their legal organization, but also how they operate and their ownership structure.  The net result will be less investment and job creation.

Now that the tax overhaul is enacted, Washington’s overriding concern should be to ensure the new law works for taxpayers and the economy.  Allowing pass-through businesses to group entities together under Section 469 would prevent a massive amount of dislocation in the economy, and allow real businesses with real operations to get the full deduction Congress voted them.

S Corporation Association Member Survey

February 27, 2018 by · Leave a Comment 

2018 will be a pivotal year for Main Street businesses and the trade groups that represent them.  The 20-percent pass-through deduction is helpful to those businesses that qualify, but it’s availability is limited by income, industry, location, and other “guardrails” so complicated even tax experts are scratching their heads.

Meanwhile, the new federal law precludes most pass-through businesses from deducting their state and local income taxes.  And finally, the 20-percent deduction is scheduled to sunset in a few years, threatening many pass-through businesses with a tax hike in future years.

To help provide policymakers with a better sense of how the Main Street business community is affected by the new law, we are asking you to fill out the short survey below.  It will only take about 5 minutes and the information you provide will be invaluable to us in our advocacy efforts.

  • Click here to begin survey.

Important Note:  All responses to this survey are anonymous and will not be traced to any member or business.  The goal of this survey is to develop a clear picture of Main Street’s response to the tax overhaul, not to gather information about specific companies.


S-Corp at Brookings—Making the Case for Tax Parity

February 14, 2018 by · Leave a Comment 

On Tuesday the Urban-Brookings Tax Policy Center held a forum on the new tax bill entitled “The Tax Cuts and Jobs Act: The new business tax landscape.”  The forum focused on two of the more confusing aspects of the new law – the treatment of pass-through businesses and the treatment of international income.

S-Corp was represented on a panel discussion devoted to the pass-through issues, with S-Corp President Brian Reardon joining Lilian Faulhaber of Georgetown Law and Joseph Rosenberg of the Tax Policy Center.  Reardon made a strong case for the pass-through structure as a preferred mode of business taxation, and highlighted the opportunities and challenges presented by the new deduction for S-Corp members (see below).

You can view the entire event, including Senate Finance Committee Chairman Orrin Hatch’s opening remarks, here.  (Brian’s portion begins around the 47-minute mark.)

SALT & the States—Connecticut Leads the Way

One S-Corp 2018 priority is to level the playing field with C corporations on the ability to deduct state and local tax deductions.

Under the federal tax overhaul, C corporations can continue to deduct these taxes as a business expense, whereas S corporations, as pass-throughs, generally cannot.  Only those taxes paid at the entity level are deductible, and since most S corporation income is “passed through” to their shareholders, they don’t get the deduction.  This result violates basic fairness.  If a C corp down the street can take the deduction, why not the S corp next door?

S-Corp is working at the federal level to get this fixed, but a tax bill like that is unlikely to move through Congress anytime soon.  But what about the states?  Can they help?  If only entity-level taxes may be deducted, why not collect state income taxes at the entity level?  It’s a solution S-Corp and its allies have been pushing since the beginning of the year and states are beginning to respond.

First out of the box is Connecticut, where the Governor has proposed legislation to allow partnerships and S corps to pay their state income taxes at the entity level.  As Tax Notes reported:

The Tax Cuts and Jobs Act allows corporations and pass-through owners and investors to continue deducting state and local taxes paid or accrued in carrying on a trade or business. Connecticut’s proposal would impose a 6.99 percent income tax on the net receipts of partnerships, S corporations, and limited liability companies that are partnerships for federal purposes. [Revenue Commissioner] Sullivan said that because the new limits on SALT deductions do not apply to businesses, pass-throughs could claim the amount as an expense for deduction purposes, “so they are made whole for the tax, essentially, by getting it back from the federal government.”

For Connecticut S corps that get the new 20 percent deduction, regaining the lost deduction will reduce their effective marginal rate by more than two percentage points.  S corps that don’t get the deduction will save 2.6 percent.  That may sound like an accountant’s quibble, but if we increased the C corp rate from 21 to 24 percent, do you think they would notice?  You bet they would, and pass-through businesses in Connecticut and elsewhere have noticed this stealth tax hike too.

For S-Corp, we’re working to see that other states take up this challenge, and make sure it’s done effectively.  The best SALT fix would make the entity-level tax an election rather than a mandate, and the effort must be coordinated with other states to ensure that taxes paid in one state are credited to shareholders living in another.

Those details matter, but the headline from Connecticut is positive and makes clear the effort to level the playing field for pass-through businesses on SALT is underway.  We’re confident it’s going to spread.

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