Congress returns to legislative business this week following a week long Columbus Day recess. With numerous outstanding issues for Congress to consider before adjourning for the year (possibly by Thanksgiving, but December remains a distinct possibility), the small and family owned business community must continue to be vigilant for any misguided efforts to raise payroll taxes on S Corps and other small businesses.

The first priority of the tax writing committees continues to be legislation to encourage the physical restoration of the areas hit by Hurricane Katrina. Both the Senate Finance Committee and the House Ways and Means Committee are expected to take up hurricane legislation this month.

Growing restlessness among conservative Republicans and Democrats to offset Hurricane Katrina recovery costs - either through increased spending cuts or foregone tax relief - raises the possibility that part or all of this hurricane relief will be paid for through spending cuts and tax increases in other parts of the budget.

It also spells difficulty for the $70 billion tax relief reconciliation bill. After Congress delayed the deadlines once, the House pushed back their deadline further to October 28th, just three weeks prior to the Thanksgiving recess and the date congressional leadership had hoped to finish the session Just how much of the $70 billion in tax relief will survive in the post-Katrina session remains to be seen, but Congresses more emphatic emphasis on deficit reduction once again increases the pressure the tax writers will feel to include revenue offsets, like the JCT’s payroll tax increase on S Corps.

Tax Reform Panel Unlikely to Scrap Tax Code

We are continuing to monitor the progress of the President’s Advisory Panel on Federal Tax Reform recommendations have numerous potential repercussions on S corporations.

First, the tax panel’s mandate to recommend “budget neutral” reforms will force them to fully offset any revenue reduction - like their decision to support eliminating the Alternative Minimum Tax - included in their recommendations. Much of last week’s meeting was spent discussing different ways in which the panel could limit the mortgage interest deduction, cap the amount of employee-health care expenses employers may deduct, and change the manner in which charitable contributions are treated.

Given the sensitivity of these possible changes, the S Corp community needs to be on its toes in case the Panel chooses to take on other sensitive topics as well, including recommendations to overhaul and reorganize the corporate tax structure.

The panel is scheduled to meet on October 18th for what should be its last public meeting before issuing its final recommendations to Treasury Secretary Snow by the November 1st deadline. Other significant tax issues likely to be addressed by the panel include: an expansion of savings incentives, increasing the taxpayer base eligible for charitable deductions, allowing businesses full expensing of equipment purchases, reducing the individual tax on interest income while limiting the corporation interest deduction, moving toward a territorial tax system, and extending the 2001 and 2003 Bush tax cuts. That’s lots of moving parts to keep track of, and the panel’s final report should provide the tax community with lots to talk about. Stay tuned.

Built-In Gains Tax Relief

On a positive S Corp note, legislation has been introduced to provide relief to those S Corps that converted from C corporation status in the past decade. Senator Gordon Smith (R-OR) has introduced a bill to reduce from 10 to7 the number of years a converted S Corp is subject to the built-in gains tax and is working to include this relief in the Finance Committee’s Hurricane Katrina tax bill.

At the October 6th Senate Finance Committee hearing to consider tax initiatives and incentives for businesses in the Gulf Coast region, Senator Smith made the following case for built-in gains relief:

“I’d like to highlight, S. 965, which will provide relief to small business that are S corporations to ensure that now, more than ever, they continue to be the driving force of our economy. Currently, small businesses that changed their tax status (from C corp to S corp) cannot sell off assets for ten years without being double taxed (a regular tax plus a built-in gains tax). The double tax leads companies to hold unproductive assets much longer than they otherwise would just so they do not have this double tax. This directly affects their cash flow by locking up their assets.

It is estimated that there are 400,000 small businesses across the country that are stymied by this double tax. Taking away this double tax is not just important for those small businesses in the Gulf Coast region that want to rebuild. Businesses across the country may be looking to site facilities in that area. My proposal would make it easier for these companies to sell off unproductive assets and use that cash to rebuild, newly build, and create jobs in an economically devastated region. We need to help small businesses restart their engines and that is exactly what my proposal would do.”

A number of S Corps saw significant losses to their businesses after Hurricanes Katrina and Rita. These companies in particular have made their case to Senator Smith, Senator Lincoln and other S Corps allies that built-in gains relief is especially valuable to them now, as they identify ways to reallocate assets and rebuild.