Where to start? The August break is nearly over and Congress is scheduled to return after Labor Day with a full agenda that includes finishing (or finishing off) health care reform, wrapping up all the spending bills, increasing the debt ceiling, doing something on the energy front, and adopting a package extending expiring tax provisions, including a possible estate tax compromise.

Earlier this month, Martin Vaughan of the AP had a nice piece outlining the current state of play on the estate tax. While the House is poised to enact a simple extension of 2009 rules into 2010, we don’t expect the Senate to follow suit quickly or easily for the simple reason that it would surrender any leverage Senate Republicans have to negotiate a deal beyond 2011. The only thing bringing Democratic leadership to the table is their wish to avoid next year’s repeal.

For that reason, the staffs of Senate Finance Committee members are using the August break to finalize the outline of a possible compromise, including provisions to reduce the overall cost of the package. The budget resolution allows for an estate tax fix that extends 2009 rules into 2010 and beyond to be adopted without needed offsets. Negotiators in the Senate would like to go beyond the 2009 rules, so they would need offsets for any additional relief.

S-CORP members are worried that the old IRS “family attribution” concept for valuing family business assets at a premium might make an appearance during these talks. The IRS unsuccessfully pushed this idea back in the 70s and 80s and lost repeatedly in court.B They gave up in 1993, but as we all know, no bad idea ever dies in Washington D.C.

Legislation to resurrect the concept has been introduced in the House, the concept is part of the Obama budget this year, and the Treasury Department has been looking into promoting it administratively. All of this activity should be troubling to family businesses.B Our S-CORP team continues to work with friendly members of Congress to educate them on the harmful impact this would have on family businesses across the country.

SOI on S Corporations

After a multi-year year hiatus, the Statistics of Income folks over at the IRS have issued a new update on their S Corporation analysis, this time for 2006. The report is along the same lines as previous efforts, outlining the general size and nature of the S corporation community, but a few items stand out.

First, “Sting Tax” collections — the tax applied to excess passive income — took a big 108 percent jump from 2005 to 2006.B Not sure why, but we’re hoping that the Sting Tax relief enacted in 2007 helps ensure that fewer S corporations get stung by this unreasonable tax.

Second, the Bulletin reminds us that S corporations have been the predominant business form (excluding sole proprietorships), eclipsing C corporations back in 1996 and widening the gap ever since. This chart does a nice job of reflecting the trend.

Bottom Line: S corporations are an important segment of the economy, a key contributor to job creation, and their success is important to economic recovery.

Deficit Implications for Closely-Held Businesses

The Obama Administration released its mid-session budget review last week on the same day the Congressional Budget Office updated its ten-year budget outlook. The headlines for both reports are the dramatic — really dramatic — deficit levels for the next ten years and beyond.

Mid-Session Review Deficits and Debt
2008 2009 2010 2011 2012 2013
Deficits 459 1580 1502 1123 796 775
Debt Held by the Public 5803 7856 9575 10590 11443 12281
Source: Office of Management and Budget

Consider what this means for managing the public debt. Over 2009 and 2010, deficits will exceed $3 trillion. Add to that Treasuryb�s need to roll over maturing existing debt and it means the Treasury will be auctioning around $50 to $75 billion in new bonds, bills and notes every week for 100 weeks in a row. Wow.

For closely-held businesses, our take away is that taxes are going to rise in the next few years. This chart from the CBO is instructive.B Historically, federal revenues have been around 18 percent of national income, while federal spending has been in the 20 percent range. The growth of entitlements in the next decade will take federal spending to 23 percent of national income and beyond. Meanwhile, tax receipts are expected to rise to above 20 percent, largely reflecting the growth of the Alternative Minimum Tax and the expiration of the Bush tax cuts.

So even if Congress allows all the Bush tax cuts to expire — including repealing the lower marginal rates, the $100 child credit, and the marriage penalty relief — the gap between revenues and spending will still grow. To shrink this gap and get deficits under control, Congress will need to raise taxes even further, reducing spending by a large amount, or some combination of the two.

Given that the current health care plans before Congress would expand federal health care spending, not reduce it, we doubt the ability of Congress to effectively reduce spending and expect the policy bias will be towards higher taxes instead.