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.

S-Corp Submits Comments

July 17, 2017 by · Leave a Comment 

The S Corporation Association submitted the following comments to the Senate Finance Committee today as part of the Committee’s request for input:

The United States is unique among developed countries in the emphasis it places on pass-through business structures – S corporations, partnerships (including limited liability companies), and sole proprietorships.  Pass-through businesses make up 95 percent of all U.S. businesses, they employ the majority of private sector workers, and they contribute the majority of business income to our GDP.

This reliance on pass-through businesses is not an accident or a byproduct of other priorities.  Rather, it was done purposefully by successive Congresses seeking to strengthen the role of private businesses in the American economy.  These deliberate actions date back to the creation of the S corporation structure in 1958 and they have worked to the benefit of the businesses themselves, the people they employ, and the communities they serve.  America has more jobs, higher wages, and a more diverse economy because of the strength of its pass-through business sector.

It is critical for Congress to understand this history as it seeks to tackle tax reform in the coming months.

One reason the pass-through business structure has been so successful is that it is, fundamentally, the correct way to tax business income.  If Congress were in a position to start from scratch, the pass-through treatment of business income, particularly how S corporations are taxed, would be the starting point.  As Eric Toder of the Tax Policy Center testified before the Senate Finance Committee:

I would.. note that the ideal way to tax business income is the way we tax S corporations.  We would like to attribute the income to the owners and the only reason we have a corporate tax is for large and frequently traded companies – very hard to do that and identify the owners who would pay the tax.  So where you can do that, we should do that, and that is the right treatment. 

For publicly-owned companies with thousands of shareholders, pass-through treatment is simply not feasible.  But for everyone else, allowing closely-held businesses to pay their taxes using the pass-through structure would be an improvement in tax administration and tax simplicity while helping to make U.S. business more competitive globally.  

Starting with the premise that S corporation taxation is the correct way to tax business income, we encourage the Senate Finance Committee to consider the following broad principles supported by 120 national business trade associations (see attached) as it considers how to best reform the tax code and tax business income:

  1. Tax reform needs to be comprehensive.  Most workers in the United States are employed at pass-through businesses that pay taxes at the individual rates, not the corporate rates.  To ensure that we avoid harming a large segment of American employers, tax reform needs to include both the individual and the corporate portions of the tax codes.  

  2. Congress needs to reduce the tax rates paid by individuals and corporations to similar, low levels. Excessive marginal rates discourage investment and hiring, while splitting business income and taxing it at significantly different rates encourages planning to circumvent the higher rates, ultimately resulting in wasted resources and lower growth.  To ensure that tax reform results in a more simple and competitive tax code, Congress needs to keep top tax rates low, and it needs to keep them at similar levels.  

  3. Congress should continue to reduce the incidence of double-taxing business income.  A 2011 study on tax reform by Ernst & Young made clear that the predominance of pass-through businesses in the United States, and the single layer of tax they face, results in higher levels of investment and employment in the U.S.  A key goal of tax reform should be to continue this progress towards taxing all business income only once.  

Read the entire submission here.

Business Community Rallies Behind 3.8% NIIT Repeal

July 11, 2017 by · Leave a Comment 

The Business Committee came out in force today in opposition to the Obamacare 3.8 percent Net Investment Income Tax (NIIT) and, more to the point, in support of repealing this harmful tax as part of the on-going health care reform effort.

More than forty national trade groups joined the S Corporation Association in writing to Senate Majority Leader McConnell supporting NIIT repeal as a priority in health care reform. Since the beginning of the year, repeal of this tax had been a core part of Republican efforts to roll back the Affordable Care Act (ACA).  But in recent weeks a number of senators have argued to keep the tax in place even as health care reform moves forward.  As the Associated Press reported prior to the July 4th break:

Top Senate Republicans may try preserving a tax boost on high earners enacted by President Barack Obama in a bid to woo party moderates and rescue their sputtering push to repeal his health care overhaul.  The break from dogma by a party that has long reviled tax boosts — and most things achieved by Obama — underscores Senate Majority Leader Mitch McConnell’s feverish effort to yank one of his and President Donald Trump’s foremost priorities from the brink of defeat.  The money from the tax boost would instead be used to bolster proposed health care subsidies for lower-income people.

That’s a really bad idea – not only would it keep the harmful NIIT in place, it would also bake the NIIT’s revenues into the budget baseline for tax reform, making it even more difficult to reduce rates on pass through businesses to competitive levels.  The entire business community has rallied around the idea of treating Main Street businesses fairly in tax reform.  Failing to repeal the NIIT as part of health care reform threatens that goal.  As the letter states:

The NII tax was enacted as part of the ACA and sold as both a “tax on the rich” and as a means of shoring up the Medicare trust fund.  The tax has no connection to Medicare, however, and its burden falls on many middle class families and Main Street businesses.  The surtax imposes an additional 3.8 percentage points of tax on investment income, including capital gains, dividends, interest, as well as certain S corporation and partnership income, for families making as little as $200,000 a year.  Furthermore, because the ACA failed to index the NII tax to inflation, millions of additional taxpayers will be subjected to this tax in the future due to “bracket creep.” 

S corporations in particular are affected by the NIIT.  The tax targets passive ownership – read “savers” — so S corporation shareholders who don’t work at the business would have to pay the tax.  But S corporations are only allowed a single class of stock, which in practice means that all distributions have to be pro rata to the ownership interest.  The result is that S corporations with passive shareholders must increase their tax distributions for all their ownership, increasing the distributions and draining capital from the company.

The bottom line for the NIIT is that it’s a tax on the majority of taxable savings in the United States – savings we need to provide the capital for the future.  As S-Corp wrote when the tax was first announced:

Finally, while the tax has been described as applying to the “unearned” income of only a few taxpayers, it is actually a direct tax on the majority of taxable savings in this country.  In 2007, households with incomes exceeding $200,000 accounted for 47 percent of all interest income, 60 percent of all dividends, and 84 percent of all capital gains reported on tax returns.     

The $200,000 threshold is not indexed for inflation, so these numbers have only gotten worse since 2010.  The result is the tax is a significant drag on employment and wages.  According to the Tax Foundation:

Repeal would raise employment by 133,000. The economy would be 0.7 percent larger, and wages about 0.6 percent larger. The income gains would be spread over all income levels. After-tax incomes in the bottom 80% of the income distribution would be about 0.65% higher than with the tax in place. They would share in the gains.

So the NIIT was enacted without debate or any public review, it raises the cost of capital throughout the U.S., it taxes middle class families and Main Street businesses, and it reduces jobs and wages.  It needs to go, and it needs to go as part of health care reform.

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