The President’Fs fiscal year 2009 budget was released this morning together with the “Blue Book“ describing his proposed tax policies. Here are a couple thoughts as Congress begins the process of putting together its tax and spending bills for the coming year.

First, the whole process of the President’s budget has a strong element of unfairness to it. For the past three decades, every President has put together a comprehensive annual budget and sent it up to the Hill. And every February, whoever runs the Congress immediately labels it DOA, or “Dead on Arrival.”

The unfairness is that Congress mandates that the President put together a budget each year;it’s required under the 1974 Budget Act. So Congress demands the President produce a budget and then promptly ignores it for the rest of the legislative session. Such is the life of the staff over at the Office of Budget and Management.

This routine is too bad for S corporations –  this particular budget is decidedly pro-small business. It calls for extending tax relief, including the lower rates and estate tax repeal. It asks Congress to increase the Section 179 small business expensing limits. And it would extend the relief from the Alternative Minimum Tax that many S corporation shareholders pay for another year.

On the other hand, the new budget reveals a couple more macro trends that will be hard for Congress to ignore. First, the deficit picture has gotten decidedly bleaker. In recent years, the deficit peaked in 2004 at $412 billion dollars and declined in each of the succeeding years, falling to $162 billion in 2007. The weakening economy and lower corporate tax collections are expected to reverse that positive trend in 2008, resulting in a predicted $410 billion deficit.

Second, the cost of making the President’s tax relief permanent is growing. According to the budget, simply extending the lower tax rates on wages and investment will reduce revenues by over $1.3 trillion. Extending all the tax relief, including the repeal of the estate tax, would reduce revenues by nearly $2.2 trillion over the 10-year budget window.

For S corporations, neither is particularly good news. The rate relief is very much in the interest of our members, since all 3.8 million S corporations pay their taxes according to the individual, rather than corporate, tax rate schedules. As the cost of extending the lower rates rises, the likelihood that they expire or are pared back increases as well.

Second, rising deficits mean more focus on the so-called “tax gap” and those policies that promise to close it. Where is the Administration and Congress going to look? Of the $36 billion of proposals to “Improve Tax Compliance” in the President’s budget, nearly all are directed at individuals, small businesses, and independent contractors.

So, once again, the challenge for S corporations in 2008 will be to preserve our victories over the past decade and seek to improve the rules under which we operate, all while fighting off unfair tax increases put forward under the guise of closing the “tax gap.”

Stimulus Package and Other Tax Priorities The Senate will hold a series of votes on the stimulus package on Wednesday. While the ultimate outcome of those votes is unclear, we do expect the House and the Senate to agree to a stimulus package in short order, in the next week or so, and send something to the President that he will be willing to sign. The core components of a likely deal remain the same-checks to families, increased but temporary write-offs for businesses, and loosened restrictions for qualifying mortgages.

Once that bill is completed, congressional tax writers will need to turn their focus to a list of”must-do” items that will look eerily familiar to those of us who followed last year’s tortured process – tax extenders (including those like the R&E tax credit that expired last year), another AMT patch, and new and existing renewable energy tax provisions.

For the AMT and regular extenders, the outlook is as clear as mud. The same challenges that faced Congress last year remain. First, should Congress offset the revenue impact of extending these tax provisions and, second, if they do choose to offset them, where will the tax writers come up with $100 billion or so in tax increases that the House, the Senate, and the President (considering his State of the Union threat to veto all tax increases) can all agree to? Given the stalemate that confronted this question last year, another lame duck session to resolve this issue is looking increasingly likely.

On the energy front, the decision by the Senate Finance Committee to include the non-farm renewable energy tax provisions in the stimulus package indicates that they intend to include the farm-related tax provisions on the farm bill. These provisions – including the ethanol and biodiesel tax incentives – are being used as leverage to get the complicated agriculture bill out of conference and on to the President’s desk.

The challenge with that bill, as with so many legislative items, is the desire by congressional leadership to offset the cost of increasing farm payments by raising taxes. The current farm program’s authorization expires March 15th, so some sort of resolution to this issue will have to be attempted in the next six weeks. Otherwise, expect another short-term extension of existing farm programs.