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Election Outlook

October 21, 2022|

The elections are less than a month out, and the implications for S corporations are huge.  If Democrats retain control, we can expect two more years of policy risk, with the threat of higher rates and increased estate tax levies looming large. If Republicans take either the House or the Senate, we can expect two years of divided government, with limited opportunities for tax policy to move and the focus shifting to the policy cliff taking place at the end of 2025.

So what will it be?  Here’s how we think things will play out.

Macro Trends

Let’s start with macro trends. Earlier this month, the New York Times ran a piece entitled, “It’s Time to Take Democrats’ Chances in the House Seriously.” Their thesis centered on a couple generic congressional ballots showing that voters in the aggregate slightly prefer Democrats over Republicans for Congress.  But those ballots appear to be an outlier.  Real Clear Politics publishes an average of three key metrics – the generic ballot, Presidential approval, and right track/wrong track, with each showing Republicans are ahead:

So the macro outlook favors Republicans.  So does the history of mid-term elections, where the President’s party has gained seats in the House only twice in the last century.  As NPR observed during the 2014 elections, “History tells us that midterm elections are bad — sometimes very bad — for the party that controls the White House.”  There are exceptions, but this year doesn’t appear to be one of them.

House

In the House, Democrats face a challenging landscape ­­and will need to significantly outperform the current outlook if they are to hold on to the majority. Here’s the latest summary from Cook Political Report:

According to Cook, 211 seats at least “Lean Republican,” including 9 Democratic seats. Compare that to the 193 seats that at least “Lean Democrat,” only two of which are Republican seats. That suggests the Democrats would need to win 80 percent of the 31 “Toss Up” races (24 out of 30) in order to hold onto their current majority.

FiveThirtyEight offers similar projections, with their model generating the following odds of a Republican majority come next year:

So their model says there’s a 80 percent chance Republicans take the House, with the most common scenario resulting in Republicans controlling between 225 and 230 seats.

Finally, Real Clear Politics shows an even larger Republican advantage.  They start with 221 solid or Republican-leaning seats, with 38 toss-ups.  Split those down the middle and you have Republicans with somewhere between 235 and 245 seats next year. If this is a wave election (as many predicted earlier this year), then the toss up seats will mostly break one way, meaning 245-250 seats for Republicans.

The bottom line here is that even absent a “Red Wave”, it’s hard to plot out a scenario where Democrats emerge with their majority intact. The betting markets agree, showing the odds of Republican control at 88 percent.

Our take: Republicans net 33 seats, for a 245-190 majority

The Senate is where things get a little more interesting. Cook lists four seats as “Toss Ups,” split evenly between both parties: Pennsylvania and Wisconsin for the Republicans and Georgia and Nevada for the Democrats.  Cook also ranks the three battleground races in Arizona, Colorado, and New Hampshire as “Lean Democrat” with two races – North Carolina and Ohio – as “Lean Republican.”

That’s about as close as it gets. Yet FiveThirtyEight puts the Democrats’ odds of holding onto their 50-seat majority at nearly six-in-ten:

We think that’s a stretch, and that 538 is in danger of repeating its misses in recent cycles.  Instead, our view is more consistent with the RCP outlook, showing Republicans starting with 47 safe, likely or leaning seats and winning 5 more, resulting in a three-seat gain overall.

How does RCP get there?  They start with their average of current polls, but then adjust those results to reflect polling misses in the past three cycles. For example, Pennsylvania polls at this point showed presidential candidate Hillary Clinton with a 6.2 percentage point lead over Donald Trump, but Trump eventually won the state by 0.7 percent.  Similar misses occurred in 2018 and 2020, suggesting the Pennsylvania polls are off by an average of 4.8 percent.  That adjustment would give Dr. Oz a 2.4 percent lead on election day.

The table above shows similar adjustments in other battle ground states.  What’s interesting is that while the polls laughably undercounted Republicans in North Carolina and Ohio, the math works the other way in Nevada, where recent polls have tended to undercount Democrats.  After the adjustment, challenger Laxalt still shows a small lead, but it’s going to be very close.

If the RCP analysis is accurate, and we think it is, then expect Republicans to have a good election night and come away with a comfortable Senate majority.

Our take: Republicans net a total of 3 seats, for a 53-47 majority

So that’s our outlook for the upcoming elections.  We’re three weeks out and lots could change, but our base case for now is Republicans win the majority in both bodies and we have divided government for the next two years.  We’ve been wrong before, so you never know, but for Democrats to retain control they would have to overcome recent polling, the current macro outlook, and the history of mid-terms.  That’s a tall order, and it doesn’t appear likely.

Our next update will focus on the policy implications of the elections, and what divided government might mean to Main Street.

 

Talking Taxes in a Truck Episode 22: Tax Girl

October 7, 2022|

Our latest podcast guest is Kelly Phillips Erb, managing shareholder at the Erb Law Firm, Team Lead for Insights and Commentary at Bloomberg Tax and Accounting, and the face behind the excellent @TaxGirl Twitter account and taxgirl.com blog. Kelly kicks things off with an overview of the ENABLERS Act, and explains how the broadly-written bill could put millions of law-abiding businesses and employees in the Treasury Department’s crosshairs. Later, Kelly and Brian do a deep dive on the $80 billion in new IRS funding, discuss the issues keeping Kelly’s clients up at night, and lay out the prospects for a lame duck tax package.

This episode of Talking Taxes in a Truck was recorded on October 5, 2022, and runs 55 minutes long.

Main Street Opposes ENABLERS Act

September 29, 2022|

The S Corporation Association joined with dozens of associations today to oppose the ENABLERS Act, legislation that would adversely affect millions of businesses, charities, and foundations, as well as their employees and investors. More than 75 organizations signed onto the effort, including NFIB, the American Farm Bureau Federation, the U.S. Chamber of Commerce, and the Real Estate Roundtable.

The ENABLERS Act seeks to dramatically expand the reporting requirements put in place by the Corporate Transparency Act, despite the fact that final regulations under the CTA were just released today with a delayed effective date of 2024.

S-Corp initiated this effort after the ENABLERS Act was snuck onto the National Defense Authorization Act in the House. If that process sounds familiar, it’s how the initial Corporate Transparency Act was adopted two years ago. They hid it on the NDAA and the business community was unable get the security-minded staff and members of the defense committees to pay attention.

Today’s letter is an effort to make certain the same process gambit doesn’t result in yet another assault on the privacy of Main Street businesses.  As with the CTA before it, today’s letter points out that the ENABLERS Act would do little to combat illicit activity and instead targets a broad swath of law-abiding business owners, charity executives, and foundation trustees with new and intrusive reporting requirements. How broad a swath?

While the bill’s stated goal is to increase reporting by “professional service providers who serve as key gatekeepers to the U.S. financial system,” its broad language would cover the owners, board members, and senior executives of most businesses and charities. Anyone engaged in an entity’s formation, acquisition, or disposal would be covered, as would owners and employees engaged in nearly every financial activity of the business, including money management, payment processing, wire transfers, or buying and selling currencies.  

The ENABLERS Act appears to lack the energy and bipartisan support of its predecessor, but it’s still just one conference and two votes away from enactment, so the business community needs to remain vigilant all the way through the end of the year.  We’ll be taking today’s letter up to key Senate offices to educate them on the history of this issue and how these bills are being used to target private businesses and their owners.

A full copy of the letter can be accessed by clicking here.

For additional background on the ENABLERS Act, please click here.

Tax Gap Claims Come Up Short, Again

September 20, 2022|

We’ve been skeptical of grandiose promises to close the so-called tax gap for years (here, here, here).  Part of that skepticism stems from the blatant self-interest of those making the estimates – we could raise billions, trillions, quadrillions if only you gave us more money! (Perhaps the CRS or JCT could be in charge of making these estimates in the future?)

Last week’s piece from The Hill is a perfect example.  Under the breathless headline, “Lucrative IRS program targeting wealthy tax cheats is withering from a lack of funds,” the article reveals many things, none of which are consistent with the headline.

First, far from lucrative, the program’s returns stink.  Here’s The Hill:

The Finance Committee report found that since 2007, the whistleblower program has brought in almost $6.5 billion while paying out just over $1 billion in rewards.

Despite those soaring returns, the number of investigations opened by the IRS as a result of the program has fallen from 43 in 2014 to just six in 2020, according to the report. 

Revenues from the program have also been falling, down to $245 million collected from noncompliant taxpayers in 2021 from $1.4 billion in 2018.

Six-and-a-half billion in 15 years?  Oooh.  Cuing Dr. Evil.  Seriously, that’s less than $500 million a year, or enough to fund the federal government for about an hour.

Second, notice the cherry-picked statistics?  We are told collections in 2021 were only one-sixth of those in 2018.  But 2018 was a banner year for the program and an obvious outlier.  When you compare 2021 collections to the program’s average (again, around $500 million annually), the reduction is much more in line with normal variations.  Moreover, the budget cuts to the IRS began a decade ago – shouldn’t the reduced funding have depressed 2018 collections, too?

Third, where’s the meat?  This program encourages Americans to snitch on their neighbors, colleagues, and employers with really substantial rewards and all they can gin up is a few billion over 15 years? What happened to all those billionaire tax cheats the IRS has promised?

As we’ve noted in the past, the reality of the tax gap is much more complicated than the Marvel Comic version being peddled by the IRS and its supporters.  First, much of the gap is from taxpayers who are broke and unable to pay anything, let alone a large tax debt. Second, much of the debt is owed by lower-income Americans and would require lots of enforcement to collect relatively small amounts.

And third, a not insubstantial amount is the result of disputes between the IRS and taxpayers. In those cases, they count the amounts in dispute as part of the tax gap, even when the taxpayer prevails.  Let that sink in for a second: in cases where the IRS is wrong, they still add that amount to the tax gap estimates.

All of which is why former Finance Committee staffer Dean Zerbe’s comment should have been the story’s headline:

I don’t think people realize how much the IRS kind of shoots blanks, meaning that they audit folks and it just kind of comes up to zero or next to a zero. The whistleblower program is much better at really targeting the bad actors,” he said.

The program itself is designed to go after the big-dollar folks. The way that the law is structured, it kicks in for major corporations, for wealthy individuals and very wealthy individuals,” he added.    

How are those comments consistent with the rest of The Hill’s story, or the recent tax gap narrative?  If most IRS audits turn up little or nothing, how will more audits produce the windfall promised by the Inflation Reduction Act?

And if the whistleblower program is so much better at targeting the cheats than random audits, why does it produce relatively miniscule amounts of revenue? Either it’s not that great of a program, or the tax cheats aren’t really that rich or prevalent.

None of this makes any sense and it all points to the ultimate futility of all that new IRS funding.  The US tax code relies on Americans paying their taxes in good faith and, with some exceptions, it works very well.  Our compliance rate is among the highest in the world, after all.

But good faith works in both directions.  It requires a tax code that’s fair and understandable, and an enforcement agency that helps taxpayers comply with the rules – rather than targeting them as tax cheats.

With that in mind, we’ll go out on a limb here and predict that more whistleblowers and thousands of new, poorly trained auditors are not going to result in the predicted revenue windfall. It will, however, severely undermine the good faith necessary to make it all work.

Disable the ENABLERS Act

September 7, 2022|

Worried about your privacy?  You should be.  Congress is back and is quietly moving legislation that threatens the privacy and security of millions of business owners, charities, foundations, and investors.

The bill is called the Establishing New Authorities for Business Laundering and Enabling Risks to Security (ENABLERS) Act, and it has already passed the House as a rider on the annual National Defense Authorization Act (NDAA).

In simple terms, the Act would dramatically expand the Corporate Transparency Act’s (CTA) reporting requirements imposed on business owners and their employees. Here’s how Bloomberg describes the policies:

This is where tax professionals come in. The version of the bill that passed the House earlier this year would require “professional service providers who serve as key gatekeepers to the U.S. financial system adopt anti-money laundering procedures that can help detect and prevent the laundering of corrupt and other criminal funds into the United States.”

So, who exactly is a gatekeeper? “Ghostbusters” jokes aside, it’s you and me. Under the current version of the bill, any person—government workers excepted—who provides corporate or legal entity formation services, trust services, third-party payment services, or legal or accounting services involving certain financial activities would qualify.

If that sounds broad and potentially complicated, it is.

The bill would give Treasury up to one year to figure out the specifics, including who exactly would be considered a gatekeeper—and what their responsibilities would entail. Some examples in the bill include identifying and verifying account holders, collecting and reporting information, creating anti-money laundering programs, alerting authorities to suspicious transactions (think SARs, or suspicious activity reports), and establishing due diligence policies and controls.

As broad as Bloomberg makes it appear, the Act’s text is even broader.  The bill doesn’t just target professionals, but instead appears to touch every business or non-profit in America other than those who are already “appropriately regulated” – whatever that means.  Here’s who is covered according to the bill text:

(A) any person involved in—

(i) the formation or registration of a corporation, limited liability company, trust, foundation, limited liability partnership, partnership, or other similar entity;

(ii) the acquisition or disposition of an interest in a corporation, limited liability company, trust, foundation, limited liability partnership, partnership, or other similar entity;

(iii) providing a registered office, address or accommodation, correspondence or administrative address for a corporation, limited liability company, trust, foundation, limited liability partnership, partnership, or other similar entity;

(iv) acting as, or arranging for another person to act as, a nominee shareholder for another person;

(v) the managing, advising, or consulting with respect to money or other assets;

(vi) the processing of payments;

(vii) the provision of cash vault services;

(viii) the wiring of money;

(ix) the exchange of foreign currency, digital currency, or digital assets; or

(x) the sourcing, pooling, organization, or management of capital in association with the formation, operation, or management of, or investment in, a corporation, limited liability company, trust, foundation, limited liability partnership, partnership, or other similar entity;

The pool of covered individuals continues through subsection (D), but you get the idea.  Covered individuals would be required to collect and report beneficial ownership information, report any suspicious transactions, and establish anti-money laundering policies.

In terms of enforcement, covered individuals would be subject to Treasury audits initially, but the Act requires Treasury to make recommendations for additional enforcement activities after a year. By way of example, the related Corporate Transparency Act imposes fines up to $10,000 and jail time up to two years for failing to make the appropriate reports.

The stated purpose of this effort is to help Treasury and law enforcement identify illegal activities taking place within businesses and investments but, as with the CTA, it’s highly unlikely that criminals engaged in such conduct will self-report their crimes.

Instead, the burden will fall on the millions of law-abiding business owners and investors who will be forced to comply with these new reporting requirements.

The irony is that this legislation is being rushed through Congress before the CTA has even taken effect.  Final rules for implementing the CTA are due out this month, and once they are finalized, an estimated five to six million businesses will be required to annually report the personal information of their owners to Treasury.  The ENABLERS Act would expand those reporting requirements to non-profits and larger businesses, while also increasing the total amount of information Treasury collects.

Proponents of this data grab claim the information will remain secure, private, and used solely for law-enforcement purposes, but the recent record suggests otherwise:

  • Thousands of suspicious activity reports (SARs) were purposefully leaked out of FinCEN in 2020 in an obvious attempt to embarrass FinCEN and the reporting banks. The leaker was identified and punished, but by then the information was already public.
  • Hundreds of tax returns of the wealthiest Americans were leaked to ProPublica, again for political purposes. This time, no leaker has been identified or punished.
  • Just last month, an Ivy League professor testified before the Senate Banking Committee that the FinCEN database should be made public to enable political operatives to more easily target the owners of real estate and other businesses.

In other words, while the ENABLERS Act and CTA regulations will be marginally beneficial to law enforcement agencies, at best, the databases they produce can and will be used politically to name and shame the millions of covered business owners, non-profits, the professionals they work with and their employees.

As noted, the ENABLERS Act has passed the House as part of the National Defense Authorization Act and is awaiting consideration in the Senate.  It’s a sneaky way to impose new regulations on businesses, and we expect the business community to strongly oppose this this data grab, much as it opposed the CTA. The question is, will anybody listen when we do?

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