Last week, the S Corporation Association joined a group of nearly 50 small business organizations to support estate tax legislation (H.R. 3905) to make permanent rates and exclusion levels more favorable than those in place in 2009. In a letter to family business allies on the Ways and Means Committee, the Family Business Estate Tax Coalition stated: 

The cost of the estate tax falls heavily on family businesses and farms. The cost comes not only from paying the tax itself, but also from estate tax planning costs. Resources diverted from businesses to pay for estate tax planning would be better invested in business operations and expansion.

The goal of the FBETC continues to be repeal of the estate tax, but this legislation will provide much needed additional relief above the current law. The higher exemption level and reduced rate will lessen the burden of the estate tax and provide family businesses and farms with more capital to reinvest in their business.

As S-CORP readers know, there are three key questions to any estate tax solution — what is the rate, what is the exclusion, and what is the base? Earlier this month, your S-CORP team was joined by fifteen other business groups to make sure Congress doesn’t increase the estate tax base for family owned businesses. This legislation would lock in the other two and help set the stage for continued estate tax relief in the future.

Taxes Are Going Up

The consensus in Washington is that taxes are going up. Just how high is debatable, but higher tax rates appear to be baked in whatever policy cake we are eventually served. So what does the Obama Administration think about higher rates? Obama economist Austan Goolsbee was on CNBC the other day and has this exchange on health care reform after CNBC Squawk Box host Joe Kernen pointed out marginal rates in his home state of New Jersey would soon approach 60 percent:

Goolsbee: We need health care reform so that small business can thrive. You know very well in every small business survey the unaffordability of health care is the thing that small business says is the number one barrier to their growth.

Kernen: But is there a marginal rate were you would say this is a disincentive for small businesses. Is there somewhere where you’re willing, where the administration is willing to draw the line?

Goolsbee: I don’t like high marginal rates, Joe, I agree with you. But to say the marginal rate is going to be 60 percent is totally nuts.

But Joe is right. Marginal rates are going much higher than what they were under Clinton if the House health care reform is adopted. Here’s a rough summary of tax rates in 2011 if the House health care bill is adopted:

Rates in 2011*
Top Rate 39.6
Health Reform Surtax 5.4
Medicare 2.9
State Average 6
Pease 1.2
Total 55.1
Dr. Goolsbee took pains to point out that state taxes are deductible at the federal level. Fair enough. That would reduce the average state rate from around 6 percent to maybe 4 percent and the total effective rates to around 53 percent.  But Pease reduces the value of that deduction, and the surtax applies to “modified” AGI thus it actually has a bigger impact that a regular rate increase. In other words, worrying that the top effective marginal rate may approach 60 percent in high tax states is not so nuts after all. Go Joe.

(S-CORP ally Bob Carroll at the Tax Foundation issued a nice paper last summer summarizing these concerns and pointing out that high marginal rates are an extremely inefficient means of raising tax revenue.)

The good news is that it is still just 50/50 that the House surtax will survive in health care reform and make it to the President’s desk. The bad news is that won’t matter much, since the fiscal pressures facing Congress are almost unprecedented. As former CBO Director Doug Holtz-Eakin testified before the Senate Budget Committee earlier this week:

Any attempt to keep taxes at their post-war norm of 18 percent of GDP will generate an unmanageable federal debt spiral. In contrast, a strategy of ratcheting up taxes to match the federal spending appetite would be self-defeating and result in a crushing blow to economic growth.

In other words, we’re stuck between the proverbial rock and the hard place. Federal spending levels far exceed their post-war averages and unless taxes are raised to match them, the resulting deficits will be enormous. On the other hand, raising taxes by the necessary amount will, at best, retard economic growth and job creation for years to come.

And what is team Obama doing about this? Downplaying valid concerns about higher marginal rates and supporting legislation that will add more than $1 trillion to our spending obligations over the next ten years.

Update on Healthcare Reform in the Senate

Senate Majority Leader Harry Reid (D-NV) is still working to combine the two health care packages passed by the Senate Finance Committee and the Health, Education, Pensions and Labor Committee.  Word is the cost of the plan may be going up. He also is reportedly looking at raising the threshold for the “high cost” plan from $21,000 to $25,000, resulting in lower tax collections from the excise tax. As a result, the Majority Leader is apparently looking into a new way to help pay for the cost of the package by applying Medicare taxes to non-wage income earned by couples making over $250,000. As Bloomberg News reports:

Reid’s proposal would apply Medicare taxes to non-wage income earned from capital gains, dividends, interest, royalties and partnerships for U.S. couples earning more than $250,000, the aides said. He’s also considering an alternative that would simply increase the 1.45 percent Medicare tax on salaries of couples who earn more than $250,000, one of the aides said.

The Wall Street Journal this morning has a bit more on the item, suggesting the proposal could include raising the HI tax to 1.75 percent for individuals starting at $200,000 and couples starting at $250,000.

This new pay-for is an attempt to scale back the previously proposed tax on so-called “Cadillac” health plans. So what does this mean for S corps? More pressure on rates, higher taxes on business income, and less capital to invest and hire new workers. And these hikes would take place during the worst economy since at least 1980 and maybe before. What are they thinking?