Foreshadowing things to come, the House on Thursday adopted legislation to increase Veterans education benfits by raising marginal tax rates on individuals – including S corporation shareholders – making $500,000 a year or more. As Congress Daily reported:

“The House, as one portion of a three-part war funding supplemental spending package, approved a provision that would pay for a four-year college degree at any public university for veterans of the wars in Iraq and Afghanistan for at least three years. To pay for the increase — $52 billion over 10 years — the House Thursday voted to impose a 0.47 percent tax on individuals with a gross income of more than $500,000 and couples with income more than $1 million.”

This tax-and-spend approach is unlikely to be adopted by the Senate, and the President has issued a veto threat based on his opposition to the tax increase:

“In addition, amendment number three to the bill would impose a tax increase on individuals and owners of small businesses, totaling more than $50 billion over ten years. A tax increase would be harmful to jobs and economic growth, and the President has been clear that tax increases are unacceptable. If the bill presented to the President contains a tax increase, he will veto it.”

Nonetheless, the S Corporation Association expects that efforts like this will be the norm in coming years rather than the exception. Increasing education benefits for Veterans is a worthy cause, but there are an infinite number of worthy causes, and a limited number of taxpayers. Raising marginal tax rates on small businesses is bad tax policy that deserves to be defeated.

House Extender Package Likely Veto Target

The common perception is that lame duck Presidents have little or no role in on-going policy debates, but reality is slightly different.

President Clinton late in his tenure effectively used his veto pen to either kill legislation outright or negotiate significant changes. This President is doing the same. By our count, more than half of the Statements of Administration Policy issued this year contain veto threats (21 out of 36).

We expect another veto threat when the House takes up the tax extender package next week. The bill would extend for one year a number of tax provisions that either expired at the end of 2007 or will expire at the end of 2008. As outlined in BNA and other publications, the bill would also include two revenues raisers affecting the level of US taxes paid on income earned overseas.

Both the White House and the Senate oppose offsetting the extender package in general and do not like these offset in particular, so the long-term tax picture for extenders and AMT remains as unclear as ever.

Tax Reform Hearing in Senate Finance

The Senate Finance Committee held another in a series of hearings on reforming the tax code. As we have indicated in the past, these hearings and those planned in the House Ways and Means Committee are being held to prepare for the major tax reform expected next year.

What caught your S Corp team’s attention was the uniformity of opinion from the witnesses. All four witnesses argued that rates should be flattened and the base broadened. All four argued for lower taxes on capital income. And all four pointed out that taxes applied to businesses are really paid by individuals.

S Corp readers know the expectation for the next Congress is for higher rates on families and businesses. If Congress does nothing, taxes are going up. If Congress acts, taxes are likely to go up. Given that baseline, it was interesting to hear a panel of witnesses uniformly testify against the direction Congress appears ready to go. Maybe we need to rethink our expectations.

Speaking of baselines, S Corp readers know we have a problem with the baseline accounting Congress uses to score expiring tax provisions. Dr. Foster from the Heritage Foundation included a critique of the current rules:

“The issue arises, of course, because the 2001 and 2003 tax cuts are slated to expire at the end of 2010. This leads some to suggest that extending any or all of the tax provisions, provisions that will then have been in the law for eight or 10 years, is somehow a tax cut. Respectfully to those who make this argument, this is utter nonsense Washington style. Extending current law, or better yet, making it permanent, prevents a tax hike.”

Amen to that.