S-Corp Comments on 2704

August 14, 2017 by · Leave a Comment 

Monday was the close of the comment period for Treasury Notice 2017-38, and the S Corporation Association joined several other trade groups in submitting our final comments on the pending Section 2704 rules, including our study highlighting the threat these rules pose to family businesses and their employees.
This comment period is the latest in a long saga and we hope it marks the beginning of the end.  To recap:
  • August, 2016 – Treasury issues Notice 2017-38 targeting proposed rules under Section 2704;
  • November, 2016 – The official comment period closes, with Treasury receiving a record number of comments in opposition to the rule (read S-Corp’s comments here);
  • December, 2016 – Treasury and the IRS host a hearing on the proposed rules, which lasts a record six hours (read S-Corp’s testimony here);
  • April, 2017 — Release of Trump Executive Order 13789directing Treasury to review all rules published since January 1, 2016 and identify those that are financially burdensome, unduly complex, or exceed Treasury’s authority; and
  • June, 2017 – Treasury targets eight rules for revision or repeal out of the 105 studied, including the harmful Section 2704 rules.
The study we submitted in this most recent comment period was authored by former Clinton economist Dr. Robert Shapiro makes clear that the Section 2704 rules violate all three of the criteria established in the President’s EO – they are financially burdensome, they are unduly complex, and they exceed Treasury’s authority.   They would also hurt the ability of these family businesses to grow and create jobs.  The study finds that:
  • Limiting valuation discounts under the Proposed Rule would increase estate taxes for large family businesses by $633.3 billion, in present discounted dollars, over the next 46 years.
  • To prepare for this additional burden, these businesses would divert resources, equivalent to the additional tax they will owe, from their normal business investments.
  • The projected reductions in their investments in equipment and machinery would reduce GDP growth, in 2016 dollars, by $2,476 billion from 2016 to 2062.
  • This slower growth also would reduce job creation over the next decade by 105,990 jobs.
The study was sponsored by the S Corporation Association and several other groups, including the Real Estate Roundtable, the Associated Builders and Contractors, and the Independent Community Bankers of America.
So now with numerous publications and comment periods behind us, the record is clear.  The proposed Section 2704 rules are harmful to family businesses and the people who work for them and need to be withdrawn.  Soon!  It has been just over a year since these rules were first published and it’s time to put them to rest.

S-Corp in the News

The Washington Examiner published a piece Monday on the implications the failed health care reform effort has for tax reform.  First among those is the continuation of the so-call Net Investment Tax that applies to investment and pass through business income.  As the Examiner notes:
And one of the taxes in particular, a tax on investments for high-income earners, hits many of the small businesses that Republicans have been trying to create new provisions to help. 
 
That would be the net investment income tax, a 3.8 percent tax surcharge on capital gains, interest and dividends for families making more than $250,000.  Repealing the tax would cut revenue by $172 billion over 10 years, according to Congress’ Joint Committee on Taxation. 
Although the tax applies to individuals, it also falls on businesses that file through the individual side of the code, a category that Republicans are hoping to privilege with a new special tax rate.
 
“It hits a broad swath of family businesses,” said Brian Reardon, President of the 
S Corporation Association. 
 
Nonmanagement partners in S Corporation businesses get hit with the 3.8 percent tax on the companies’ earnings, Reardon noted.  “It drains money from active businesses,” he said. 
 
S-Corp has been leading the charge to repeal this harmful tax since its inception seven years ago, most recently organizing a letter supporting the tax’s repeal signed by 40 national business trade groups.  The tax was initially presented during the Obamacare debate as a “Medicare” tax on high income investors, but it has nothing to do with Medicare and its burden falls on a large percentage of pass through businesses, as well as a majority of annual savings.  It’s a surtax on savings, pure and simple.
Failing to eliminate this tax as part of health care reform was a huge miss for the economy, so it must be done within the tax reform debate instead.  The business community is united around the idea of bringing down all business tax rates and moving towards rate parity, but that can’t happen with this tax in place.  It has to go.

Letter Leaves Pass Through Employers Behind

August 1, 2017 by · Leave a Comment 

For seven years, your S-Corp team has repeated the same mantra for tax reform – tax all income once, tax it at similar reasonable rates, and then leave it alone.  If Congress wants to make the tax code simpler and encourage more job creation, this is the place to start.

A competing view is one where the largest corporations pay very low rates while everybody else – individuals and pass through businesses alike – pay rates significantly higher.  Recall that pass through businesses are taxed via the individual tax rates of their owners.  The idea is that while US corporations can always move someplace else and therefore need lower rates to stay, US citizens and private companies are less mobile.  They are effectively trapped, and we can tax them accordingly.

This view of imposing higher tax rates on individuals was embraced in a letter signed by 45 of the 48 Senate Democrats sent to President Trump, Senate Majority Leader Mitch McConnell, and Finance Chair Orrin Hatch today.  You can read the whole letter here.  According to Politico:

The Democrats who signed onto Tuesday’s letter, spearheaded by Minority Leader Chuck Schumer (D-N.Y.) Schumer and Oregon Sen. Ron Wyden, the top Democrat on the tax-writing Finance Committee, also made two blunt demands on taxes: They will not back any bill that gives new breaks to the wealthiest individuals and will not back any legislation that adds to the deficit.

“Tax reform cannot be a cover story for delivering tax cuts to the wealthiest,” the senators wrote. “We will not support any tax plan that includes tax cuts for the top 1 percent.”

The Democrats added that they “will not support any effort to pass deficit-financed tax cuts, which would endanger critical programs like Medicare, Medicaid, Social Security, and other public investments in the future.”

Our concern is that this push against rate reduction for high income individuals could end up hurting pass-through businesses, where Senate Democrats support cutting rates on the largest multinational companies, but oppose rate reduction for the successful S corporation down the street.  Keep in mind, that large S corporations already pays higher marginal rates than do C corporations – 40-plus percent versus 35 percent – and also likely pays higher effective rates as well.  Our 2013 study on effective tax rates found that large S corporations pay the highest effective tax rate of any business type – 35 percent.

And while the letter targets high-income tax payers, workers at pass through businesses could be affected too.  The burden of business taxation falls on owners and workers alike.  Here’s CRS on the issue back in 2012:

The analysis above found that the majority of pass-through income accrues to higher income earners. The income these individuals receive is the result of an ownership stake in either a sole proprietorship, partnership, or S corporation. But there are other taxpayers, namely the employees at these firms, who receive income from pass-throughs as well. If taxes are increased on passthroughs, it is possible that pass-through owners could lower wages, scale back benefits, or reduce employment in an effort to reduce the burden of the tax increase on themselves. Thus, although the majority of pass-through income is concentrated at the upper-end of the income distribution, the tax burden could be shared with lower- and middle-income taxpayers who work at these businesses.

An Analysis of Individual Tax Return Data on who bears the corporate tax burden can be utilized to understand who would bear the burden of increased pass-through taxation generally0owners (capital), or workers (labor).  The traditional analysis of the corporate tax indicates that it is capital that bears the burden. In contrast, a number of more recent theoretical studies find labor bearing the majority of the corporate tax burden. These results, however, appear to rely critically on particular assumptions (e.g., an open economy with highly mobile capital) which drive the results. When these assumptions are relaxed the burden of the corporate tax is found to fall mostly on capital, in line with the traditional analysis. (Emphasis added)

But we do live in an “open economy with highly mobile capital.”  That’s why so many US corporations are able to move their profits, IP, and headquarters overseas.  Which means the burden of the corporate tax falls increasingly on workers through lower wages and lost jobs.

We suspect this is the reason the Senate Democrat letter doesn’t oppose lowering rates on C corporations.  The letter implicitly concedes that for the US to be competitive and improve our jobs base, tax rates on corporate employers need to come down.  What is missed is that same argument applies to pass through employers as well.

For a clearer view of how much pass through employment would be affected by this approach, refer to the Treasury Department 2011 report entitled “Methodology to Identify Small Businesses and Their Owners.”  Table 15 reports that two-thirds of the income earned by pass through employers is earned by individuals making more than $500,000.  Those are the individuals targeted for high rates under the Senate Democrat letter.

How many jobs are we talking about?  There is no direct measure, but the Tax Foundation reported back in 2015 that “a significant number of employees work at large pass-through businesses. According to 2011 Census data, a combined 27.5 percent (18.1 million) of pass-through employment was at firms with more than 100 employees, and 15.9 percent (10.3 million) of pass-through employees work at large firms with 500 or more employees.”

So if the point of tax reform is to bring jobs and investment back to the US, pass through businesses – all of them – need to be part of the reform.  Successful pass through businesses employ millions of workers, and excluding them from rate cuts puts those jobs at risk.

That’s the reason we have kept the same mantra going for seven long years.  Tax all income once, tax it at similar reasonable rates, and then leave it alone.  It’s a recipe for success for C corporations and pass-through employers alike.  The business community has embraced this approach.  It is time for tax writers to do the same.

Tax Reform Statement & Pass Through Taxes

August 1, 2017 by · Leave a Comment 

Just in time for the August recess, the House, Senate and the White House released a joint statement yesterday on the status of their tax reform talks and their plans moving forward.  You can read the statement here.  From our perspective, here are the key points:
“While we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”
A primary purpose of the statement was to pivot the tax conversation away from the House Blueprint and the border adjustment tax (BAT).  The BAT was controversial from day one, but it also was proving to be an obstacle towards getting a budget resolution enacted in early September.  The leaders of the House Freedom Caucus had stated they would oppose the budget resolution without a promise that the BAT was off the table.  No budget resolution, no tax reform, so the BAT had to go.
Will it work?  Unclear.  Freedom Caucus Chair Mark Meadows (R-NC) was quoted this morning as saying that taking BAT off the table was nice, but they want clarity on the rest of the tax package before they would support the budget.  That sequence of details first, process second is the reverse of how congressional budgeting is supposed to work, and is an indication of just how difficult it will be to get the Freedom Caucus on board with any plan in September.
“The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas. And we are now confident that, without transitioning to a new domestic consumption-based tax system, there is a viable approach for ensuring a level playing field between American and foreign companies and workers, while protecting American jobs and the U.S. tax base.”   
The underlined lines, coupled with the demise of the BAT, indicate the negotiators are also moving away from full expensing and towards more limited capital cost recovery improvements, such as permanent bonus depreciation and faster depreciation schedules.  Full expensing was a predicate for the BAT and a cash-flow tax system, but it faced its own challenges.  It was expensive, it was paired with the controversial provision to disallow deductions of net interest, and it was received by the corporate community with a giant yawn.
“The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.”
Temporary tax cuts are out and repatriation and territorial are in.  Both of these items are significant concessions by the Trump Administration, which had in the past made the case for temporary rate cuts and only lately embraced moving towards a territorial system.  The Blueprint relied on the BAT to enforce its territorial tax approach.  Now that it’s out, expect the tax writers to spend lots of time crafting more complicated “Camp Option C”-type rules to crack down on base erosion under a new territorial regime.
 “We also believe there should be a lower tax rate for small businesses so they can compete with larger ones, and lower rates for all American businesses so they can compete with foreign ones.”
This careful construction suggests that the tax negotiators have agreed to reduce rates for C corporations and pass through businesses alike (yea!) but have not settled on any other details, including whether the business provisions should be a tax cut or not.  Compare that language with the very specific “agreement that tax relief for American families should be at the heart of our plan.”  Meanwhile, White House advisor Steve Bannon has been busy selling a tax hike on high income earners.  As Bloomberg reports this morning:
“White House chief strategist Steve Bannon’s plan to raise the top income-tax rate for America’s highest earners could find some support among congressional Republicans as part of a populist message to sell a broader tax overhaul, according to one conservative lawmaker who has heard the proposal…. Automatic opposition isn’t a given among some GOP members, said the lawmaker who heard the proposal – especially if they’re made to understand how it could help publicly sell a plan that would include other changes to the tax code,” the lawmaker said.
These reports should act as a wake-up call for the Main Street community.  The Big Six (McConnell, Hatch, Ryan, Brady, Mnuchin, and Cohn) may have agreed that tax rates on all businesses should come down, but how that agreement squares with calls to raise rates on high income individuals, the majority of whom are business owners, is anybody’s guess.
So to sum up then, yesterday’s joint statement includes specific steps to advance the tax reform effort this fall.  Its call for ending the BAT and for considering tax reform under regular order are direct responses to criticisms that threatened to derail House consideration.  And the significance of all three actors – the House, Senate, and Administration – coming together to craft a joint statement should not be lost among the details either.  It is a commitment to get something done by the leaders of the government and should be taken seriously.
On the other hand, the brevity of the statement coupled with the Administration’s continued message muddle makes clear there’s lots of negotiating to come and many, many details to fill in.  As we have discussed in the past, those details are important – they could spell the difference between a tax package that treats Main Street fairly, and one that leaves it behind.  For that reason, we will be on the Hill pressing our case for fair treatment of all private businesses and the communities they serve.

error: Content is protected !!