The Senate began debate on the bloated tax extender package today. The House passed its version 215-204 shortly before leaving for the Memorial Day recess on May 28th.
That vote was supposed to take place earlier in May, leaving time for the Senate to take action, but opposition to the tax hikes and higher deficits called for in the bill delayed consideration until the Leadership was able to cobble together the votes. As a result, the Senate had already left town and is just now taking up the bill today.
Regarding the schedule, Senator Reid faces a tight window to get the bill done: he needs every Democrat plus at least one Republican to move this, but Senator Lincoln (D-AR) is back in Arkansas for today’s run-off tomorrow and won’t be available until tomorrow.
Meanwhile, there are no votes on Friday or next Monday and debate on Senator Murkowski’s Resolution of Disapproval (climate change) is set to consume much of Thursday.
That basically leaves Wednesday as the only day this week where Senator Reid might have the votes to move the process along, and it’s apparent from the news today that he’s not there yet. Senator Snowe (R-ME), a long-time S-CORP champion, indicated as much to CongressDaily:
Snowe said on Monday she was still waiting to see details. But she said the combination of deficit spending and tax increases, such as a new 15 percent payroll tax on small services-providers organized as “subchapter S” corporations, were giving her pause. “Pretty far from it at this point,” Snowe said, when asked about her comfort level with the bill, adding that it was unlikely to pass this week.
On the policy side, the delay in the House has been a boon for good tax policy, since the longer this payroll tax provision is out there, the worse it appears. Swapping a “reasonable compensation” standard for a “principal asset” test is not an improvement to the Tax Code. Exactly how is the IRS supposed to enforce an annual valuation of the “skill and reputation” of a firm’s three key employees?
Tom Nichols, a long-time S corporation attorney and head of the ABA’s Tax Section on S Corporations penned a letter to Congress making this point and many others. Meanwhile, the blogs of tax practitioners across the country are beginning to weigh in, raising numerous concerns that should have been dealt with through the normal legislative process — except there wasn’t one. The blog Tax Prof has links to a long list of critical commentators. As one observed:
But even assuming that you should hit service providers with self-employment tax on all of their K-1 income, you should do so in a way that is fair, understandable to taxpayers, and enforceable by the IRS. The S corporation provision in H.R. 4213 is none of these.
The Senate being the Senate, we expect this issue to be debated into the next week at least, and we plan to use that time to educate policymakers and improve the bill. There are taxpayers out there that use the S corporation to block payroll taxes they otherwise owe, and we support going after them, either through increased use of the reasonable compensation standard by the IRS or though a well-thought and well-targeted statutory provision. The provision before the Senate right now doesn’t meet that test.
Reasonable Compensation Standard in Action
Speaking of the reasonable compensation standard, the following post showed up in BNA this morning–as it makes clear, the IRS can and does go after payroll tax scofflaws using the reasonable compensation standard:
The U.S. District Court for the Southern District of Iowa May 27 held that David E. Watson P.C. must pay employment taxes on all remuneration for employment. David Watson incorporated an accounting firm as an Iowa professional corporation and chose to be taxed as an S corporation. Watson authorized himself a salary of $24,000 a year and he paid federal employment taxes on that amount. In addition to his salary, Watson received more than $200,000 in what he claimed were dividend payments. The Internal Revenue Service determined the dividend distributions should be recharacterized as wages, subject to employment taxes. (David E. Watson PC v. United States)
A fair reading of the House-passed bill is that the new, untested principal asset test for S corporations would be much more difficult for the IRS to enforce than the existing standard being used here. It would also be more costly for firms, as they would be required to value all their assets every year to determine if they are subject to the new tax. In order to enforce this new rule, the IRS would need to do the same.
The bill is now before the Senate, which has a reputation for debate and deliberation. We are hoping they expend a little deliberation on this provision. It could use it.