While everyone else is predicting the presidential primaries, we thought we’d take a look at the forecast for tax policy in Congress this year.
The usual refrain for a presidential election year is that all the real policy issues are pushed aside in favor of posturing for the election and the following session of Congress.
While we expect to see lots of posturing, there are two reasons why some real tax work might get done this year, namely, the deteriorating economy and the expiration of the R&E tax credit and other tax extenders.
Nearly all of the Presidential candidates have put forward a stimulus plan to address the credit crunch and slowing job creation. Elected officials in Washington will not be far behind.
Expect the President to announce a substantial ($100-150 billion) economic growth package as part of his State of the Union address on January 28th. The package should include some business investment incentives like bonus depreciation or expensing, plus family relief in the form of checks sent as a pre-fund of temporary rate relief. The Administration has already put forward its plan to help those families wrapped up in the subprime crisis.
Congress will respond in-kind. Congressional leadership has called on the President to join them in crafting a bipartisan plan. This stimulus “summit” may or may not take place, but the policy focus for the Hill should remain the same — a three-prong package combining business tax relief, family tax relief and housing incentives. The family tax relief will likely be both larger and more targeted than what the President announces, with funds funneled through low-income assistance programs like LIHEAP. Business relief may be more conditional, such as lower rates for repatriating profits from overseas.
Either way, absent an unexpected turnaround in the economic numbers, Congress will take up stimulus legislation in the next month or two.
The expiration of tax extenders at the end of 2007 is the second reason why we expect substantive action on taxes this year. Popular extenders like the R&E tax credit and the deduction for state and local taxes expired as of December 31, 2007 and are no longer available to businesses and families.
Perhaps more importantly, the Alternative Minimum Tax (AMT) is also a factor. The higher exemption under the Alternative Minimum Tax was extended just before Christmas, but that was only for 2007. The exemption will revert back to its lower level for 2008, threatening 20 million or so families with higher taxes when they file next year.
Congressional leadership is going to be reluctant to allow their members, including dozens of at-risk freshmen in the House, to go into contested elections having failed to extend the R&E tax credit or to protect their constituents from the growth of the AMT. For that reason, there should be a strong push to move a tax package that combines AMT, extenders, and stimulus prior to summer.
What about the offset issue? Last year, action was delayed, and ultimately truncated by the challenge of offsetting the revenue impact of extending the AMT patch and other tax extenders. While Congress compromised in the end by passing the AMT patch without offsets, the same challenge is present this year. Extending the AMT and other expiring tax provisions — even for just one year — will reduce projected revenues by $100 billion or more. Coming up with that level of offsets is going to be just as hard in 2008 as it was in 2007.
That’s where the stimulus package can help. In 2007, extending the R&E tax credit without offsets was seen as irresponsible by the congressional leadership. In 2008, it will likely be viewed as an economic stimulus and therefore, should not require revenue offsets.
What’s in it for S Corporations? As always, we need to worry about the offsets. The S Corp payroll tax proposal will almost certainly be part of the discussion, as will IC-DISC, LIFO, and other tax items used by S corporations.
Finally, the S corporation community now has its own tax extender. The expanded charitable deduction for donations of S corporation shares expired at the end of 2007 along with the rest of the tax extender group, so the S Corporation Association will be working with our allies to get these provisions restored before April, 2008.
S Corporations and Charitable Donations
Speaking of charitable donations, the rules governing the donation of appreciated assets to charities are complicated. What’s not complicated is that those rules discriminate against the donation of assets, including shares, of an S corporation.
In general, gifts of appreciated property produce a deduction equal to the property’s fair market value. Contrary to the general rule, however, gifts of S corporation stock do not always produce a deduction equal to the stock’s fair market value.
For example, Joe’s Auto Body makes a $100,000 gift to the Boys and Girls Club, which produced a deduction of $100,000. Joe, however, can only claim this deduction to the extent of his basis in Joe’s Auto Body.
If Joe’s basis in Joe’s Auto Body stock is $50,000, his income tax deduction is limited to this amount even though he might otherwise be entitled to deduct $100,000.
As a result, when Joe files his personal income tax return, he will only be able to claim a $50,000 deduction. The excess $50,000 deduction carries forward. If Joe acquires additional basis in the future, then he may claim an additional deduction.
Unfairness #1: If Joe’s Auto Body were a C corporation, Joe would be able to deduct the full value of his donation. Congress addressed this unfairness as part of the 2006 Pension Reform Bill, but as noted above, this fix expired at the end of 2007.
What happens when a charity owns S corporation stock? In that case, the S corporation stock is discriminated against as well.
Say Joe donated $100,000 worth of shares in Joe’s Auto Body to the Boys and Girls Club. If Joe’s Auto Body pays dividends of 10 percent, then the Boys and Girls Club would earn $10,000 a year on the income from those shares. Since this income comes from shares of an S corporation, the charity must pay the Unrelated Business Income Tax (UBIT).
Unfairness #2: If Joe’s Auto Body were a C corporation, no UBIT would apply to the income from his donated shares.
Moreover, if the Boys and Girls Club decides to sell its shares of Joe’s Auto Body, rather than retain them and pay the UBIT on the income, then a capital gains tax would apply on any gains from the sale.
Say the Boys and Girls Club holds the stock for three years, paying the UBIT on the income from the shares during that time. If the Boys and Girls Club sells the shares in year 3 for $200,000, a capital gains tax would apply on the $100,000 gain ($200,000 from the sale less the $100,000 basis).
Unfairness #3: If Joe’s Auto Body were a C corporation, no tax would apply on the gain from the sale of the donated shares.
As these three examples make clear, the tax code currently discriminates against S corporations when they make charitable contributions. Congress should act to eliminate this discrimination, and enable America’s charitable community to access this important and growing source of funds.