Both the House and the Senate completed their respective budget resolutions last week. The plan now is for the two bodies to get together to resolve any differences and produce a single budget in the form of a conference report. We expect most of those discussions to take place over the next couple of weeks.
One of the key questions for budget conferees is whether or not they will include reconciliation instructions for health care reform and climate change. As S-CORP readers know, the virtue of reconciliation is that it lowers the bar to pass something in the Senate from a 60 vote supermajority to just a basic majority (in this case, half of those present and voting plus Vice President Biden).
As has been noted, currently the Senate budget does not include reconciliation instructions at all while the House included them for health care and education only. This lack of instructions does not mean the Senate leadership had decided to forego reconciliation. Instead, most observers believe they were intent on pursuing a conference strategy whereby the House reconciliation instructions would be expanded to also include the Senate.
By adding the instructions at the last moment in conference, Senate leadership avoids an ugly floor battle on all of these issues. Instead, senators would be given one vote — up or down — on the conference report as a whole without the ability to make any changes.
Floor action last week, however, threw a big monkey wrench into that plan, at least as far as climate change is concerned. On Wednesday, the Senate voted 67-31 to support Senator Mike Johanns’ (R-NE) amendment. The amendment reads:
Section 202 is amended by inserting at the end the following: “(c) The Chairman of the Senate Committee on the Budget shall not revise the allocations in this resolution if the legislation provided for in subsections (a) or (b) is reported from any committee pursuant to section 310 of the Congressional Budget Act of 1974.”
In effect, the Johanns’ amendment is a statement that the Senate should not use reconciliation for climate change legislation. While the provision itself could easily be dropped in conference and reconciliation instructions added in its place, that change would still face the 67 senators who by all appearances are opposed to using this process to consider cap and trade, at least this year.
All the more reason for S-CORP readers to expect health care reform, rather than climate change, to be the first major reform item considered by Congress this year.
Estate Tax Votes
Lots of Senate activity on the estate tax front as well. The underlying budget resolution produced by the Budget Committee assumes Congress would extend 2009 estate tax rules for 2010 and beyond.
That means the top tax rate on estates would hold at 45 percent and the exclusion would be $3.5 million per spouse. That’s a definite improvement over where we started in 2001, with a top rate of 55 percent and an exclusion of $1 million per spouse, but its step back from the one-year repeal currently scheduled to take effect in 2010.
To make the pending compromise a little better, S-CORP ally Senator Blanche Lincoln (D-AR) offered an amendment to allow the Finance Committee to consider a deficit-neutral alternative with a 35 percent top rate and a $5 million per spouse exclusion. The S Corporation Association joined a long list of business groups in support of the effort. That amendment was adopted by the Senate, 51-48 with all Republicans and 10 Democrats voting in support, including Finance Chairman Max Baucus.
What followed then was a classic “what just happened?” moment when the Senate also adopted, 56-43, an amendment by Senator Dick Durbin (D-IL) to create a point of order against any additional estate tax relief (beyond the underlying resolution) that doesn’t include an equal amount of tax relief for families making less than $100,000.
It is possible to support both middle-class tax relief and estate tax relief, so exactly what the implications the Durbin amendment has for future estate tax legislation is unclear. For the moment, we’ll focus on the positive, which is that a majority of the United States Senate is now on record supporting an estate tax deal that is better than the 2009 rules. Given the current leadership in Congress, that may be as good as we’re going to do.
SBA on Effective Tax Rates
Anybody involved in tax policy for a reasonable period of time will pick up on the prejudice of some policymakers and folks at the IRS that S corporations tend to under-pay their taxes. Over the years, the S corporation has been described by some as “tax avoidance schemes” and worse.
Given that background, the findings from a new report commissioned by our friends at the Small Business Administration (SBA) might surprise you. Of the four core business types — C corporation, S corporation, Partnership, and Sole Proprietorship — which one pays the highest effective tax rate?
S corporations! By a lot.
The research, conducted by Quantria Strategies for the SBA, looked at a broad sample of firms with under $10 million in gross receipts and found that S corporations pay a significantly higher effective tax rate than C corporations, partnerships, or sole proprietorships.
Average Effective Federal Income
Tax Rates by Legal Form of Organization, 2004
Entity Type Rate (%)
Sole Proprietorship 13.3
Small Partnership 23.6
Small S Corporation 26.9
Small C Corporation 17.5
All Small Business 19.8
Source: Quantria Strategies LLC
To be fair, the effective tax rate for C corporations does not include taxes paid by shareholders on dividends and capital gains. As the researchers note:
… the effective tax rate analysis does not capture the taxes paid by C corporation owners on dividends and capital gains. This will tend to understate somewhat the total effective tax rate of small businesses organized as C corporations, but this bias will tend to be small, particularly because of the fairly low rates of tax currently applicable to individual dividends and capital gains.
So even with the shareholder level tax included, the research suggests that S corporations may shoulder the highest effective rate of any business type.
What’s the source of the higher tax burden? After all, the tax treatment of S corporations at the federal level is mirrored on the tax treatment of partnerships. One possibility is that S corporations may tend to be older, more mature companies that were organized before the emergence of the Limited Liability Company.
Whatever the underlying reason, if your operating premise is that S corporations have a significantly lower tax burden than comparable businesses structured as partnerships or C corporations, you might want to think again.
Jobs and Trade
Our friends at the Kaufman Foundation have a great site devoted to entrepreneurship called growthology that’s worth a look. The site is heavy on the high-tech side of growth, but it’s a great window into how the internet and entrepreneurship are combining to form an incredibly potent partnership.
What caught our eye this month was a new survey of economic bloggers on the best sources of job creation in the economy. “Economic Growth” was number one — no news there — while free trade was well down the list. Your S-CORP team finds that strangely disturbing. If anybody should understand the critical importance of open borders to continued economic growth, it’s economists who use the internet to circulate their writing. What is the internet, after all, but one big open border of products and ideas? Maybe it was just how the questions were worded, but this tepid response on the importance of free trade is one more reason to fear for the future of global commerce.