The House is scheduled to take up a Paygo bill — short for b”pay-as-you-go” — this week that makes room for an estate tax fix. Paygo was established back in 1990 as a means of controlling the Federal deficit. Under Paygo, any increase in the deficit, either by a reduction in revenues or an increase in mandatory spending, must either be fully offset or it will be added to the Paygo scorecard and possibly trigger an across-the-board spending cut (called sequestration) at the end of the fiscal year.

Of interest to S-CORP readers, the bill to be considered by the House (H.R. 2920) specifically exempts four policies from the Paygo rules:


  • Adopting the doctor payment fix proposed to Medicare;
  • Extending the higher exemption levels under the Alternative Minimum Tax;
  • Extending select tax cuts from the 2001 and 2003 tax bills; and
  • Extending the 2009 estate tax rules to 2010 and beyond.



In other words, Congress is seeking to ensure it pays for any tax cuts or spending increases, except for the four policies listed above.B As the Congressional Budget Office reported, “In effect, that rule would allow the Congress to enact legislation that would increase deficits by an amount in the vicinity of $3 trillion over the 2010-2019 period without triggering a sequestration.”

The theory behind the exemption is to allow Congress room to continue “current policy” in each of these areas.B The $1000 child tax credit, for example, expires at the end of 2010.B Extending the credit would reduce revenues by $243 billion over ten years.B H.R. 2920 shields this cost and the cost of other similar policies from Paygo.

What does this signal for estate taxes?B The policy exempted in H.R. 2920 is an extension of estate tax rules for 2009.B As the bill outlines:

(B) with respect to the estate and gift tax, assume that the tax rates, nominal exemption amounts, and related parameters in effect for tax year 2009 remain in effect thereafter without change;

The exempted policy is consistent with the Obama Administration’s budget proposal and was scored by the JCT to reduce revenues by $243 billion over ten years. What doesn’t get exempted is any further reduction in the estate tax beyond the 2009 rules.

For example, Members have been working on a compromise that would lower the estate tax rate to 35 percent and increase the exemption to $5 million per spouse. That’s certainly better than the 2009 levels of 45 percent and $3.5 million but, under H.R. 2920, the increased revenue reduction from the compromise would need to be offset with tax increases elsewhere.

Where would Congress find offsets to a potential estate tax compromise? Both the Obama Administration and Congressman Pomeroy (D-ND) have proposed targeting family businesses for higher taxes by inflating the value of their estates. Exactly how much revenue this would raise is unclear, but family businesses need to be on alert.

A package that lowers rates below 2009 levels while inflating the tax base has the potential to raise, not lower, estate taxes on family-owned enterprises and may be no compromise at all.

Do Small Businesses Really Create All Those Jobs?

A recent paper by Alan Viard at the American Enterprise Institute raises two fundamental questions: Are smaller firms responsible for creating a majority of new jobs in our economy and is there a bias towards smaller firms in the tax code? With small businesses at the epicenter of the debate on reforming our health care system, clearing the record on these questions is critical.

The “small businesses do not really create all those jobs” argument has been around for a long time. However, it is usually raised by folks with a history of supporting Big Government and Big Business. Thus, having someone with Alan’s background on the other side is a new twist.

Regardless of who asks the question, however, the answer is the same. Yes, small businesses really do create all those jobs.B Hereb�s what the Small Business Administration’s (SBA) Office of Advocacy writes:

Since the mid-1990s, small businesses have created 60 to 80 percent of the net new jobs. In the most recent year with data (2005), employer firms with fewer than 500 employees created 979,102 net new jobs, or 78.9 percent. Meanwhile, large firms with 500 or more employees added 262,326 net new jobs or 21.1 percent.

Critics argue that this analysis suffers from several flaws, including how to best classify firms using longitudinal data.B For example, if a firm begins at 450 employees and grows to 550, the SBA says that’s 100 jobs created by small business. But if the same firm shrinks from 550 to 450 employees the next year, it’s a loss of 100 jobs for big business. Classifying the firm based on its initial size biases the results in favor of smaller firms.

But seriously, how many firms “cross the threshold” each year? There simply are not that many firms with more than 500 employees.B Adjusting for these instances may move some numbers around, but the basic tenet remains intact — businesses employing fewer folks create most of the new jobs and policymakers should pay attention.

A study from the Bureau of Labor Statistics adjusting for these statistical challenges found that firms with fewer than 500 employees created about 80 percent of net new jobs. Enough said.

The question of whether the tax code is biased towards small businesses is more difficult. The tax code, after all is incredibly complex and it does include numerous provisions — like Section 179 — targeted to help smaller enterprises. How do you tally up all the variables?

S-CORP readers may remember Dr. Viard from the LIFO debate. Alan pointed out that, if LIFO accounting is an undeserved tax windfall, why is the effective tax burden under LIFO similar to that tax burden shouldered by other forms of capital investment? How could it be a windfall if the tax burden is the same?

The same approach may work here as well. If the tax code is too small business friendly, then the effective tax burden on S corporations, partnerships, and sole proprietorships should be lower than for other taxpayers. But a study commissioned by the Small Business Administration found that the effective tax burden for small businesses (including small C corporations) in 2004 was 19.8 percent, or 3.5 points above the average for all taxpayers that year.B S corporations, by the way, faced the highest effective rate of 26.9 percent.

Moreover, limiting the analysis to income and payroll taxes does small business a disservice. Home Depot doesn’t worry about the estate tax, the family-owned lumber yard down the street does. And studies show that the burden of federal regulations falls more heavily on smaller firms than larger ones.

Finally, we believe Alan’s argument misses a broader point. Your S-CORP team is not comprised of legal theorists, but we do recall that government grants corporations the same legal status as individuals in order to encourage their creation and economic growth. Corporations can enter into contracts and appear in court. Perhaps most importantly, the owners of corporations are shielded from liability.

The S corporation was created, in part, to counter the advantage the corporate structure gives to larger firms. The idea behind the S corporation was to allow smaller firms to thrive by extending some of the essentials of the corporate structure without the onerous tax rules.But S corporation rules also limit their ability to grow and raise capital. They limit the number and type of shareholder and they limit how the firm can be structured.B How do these rules enter into the question of bias in the tax code?

The bottom line is that the effective tax rate on small businesses is higher than the rate for taxpayers in general. Given that reality, itb�s difficult to see how small businesses are somehow advantaged. If Congress wants to help larger businesses by cutting the corporate rate, web�re all for it.B But donb�t forget who creates most of the jobs out there. It’s small business, and during economic downturns, the role they play is more important than ever.