With Congress gone, we thought we might dust off the old S-CORP Crystal Ball and make some predictions. By all accounts, the seats in play this cycle are well above the norm and this could go down as an historic election, much like 1974 or 1994.
So what do we expect? We predict that Republicans will control the House next year, while Democrats will retain the majority in the Senate, albeit with just a one or two vote majority. We come to this conclusion after reviewing the following sources:
We recommend each, especially the RCP site. It’s an eye-opener. The RCP has Republicans winning 212 House seats, excluding the results of 44 toss up races. It takes 218 seats to control the House, so Republicans would only need to win 6 out of 44 to get there. No wonder Intrade predicts there’s an 88 percent chance they win the House.
Meanwhile, RCP has Republicans winning 46 seats (up from 41 now) with six seats in the toss up category (no, the Delaware seat is not one of them). Joe Biden is the Vice President and the President of the Senate, so Republicans would need to win five of six toss-up seats in order to control that body. It is possible, but highly unlikely.
So we predict the House flips while the Senate stays. What are the implications for tax policy and S corporations?
Rates: We’ve written extensively about this and our general view remains the same. Of the three possible broad outcomes - 1) nothing happens, 2) an extension of middle-class relief only, and 3) an extension of everything for one year — it’s a close race between nothing and everything, with the middle-class option nowhere to be seen.
For example, we can see how Congress comes back from the election and, despite an unusual number of seats switching parties, the stalemate over this issue continues. Speaker Pelosi will still control the House floor, after all, and the President would still be waiting with his veto pen. To date, they have yet to change their “ middle-class only” position.
What might cause them to change? The size of Republican gains is one possible variable. If they win the bare minimum to claim the House — 40 to 50 — then we expect the Speaker and President to hold firm and nothing to happen. If Republicans win a huge number however — 60 to 70 — then there’s a chance the Speaker may step aside and allow the House to extend everything for one year. The President also may embrace an opportunity to kick this issue into next year.
The other key variable here is the economy. It continues to struggle, and it is hard to believe the President’s economic team would welcome a $230 billion one-year tax hike on families and businesses. We’ve made the case for extending the current top rates. It’s a question of jobs and investment. But what about the threat to the economy if nothing gets extended? The experts we listen to suggest it sharply raises the possibility of a Double-Dip Recession.
That has to be a concern for everybody, which is why we believe a one year extension of everything (rates, dividends, cap gains, credits) is now the slight favorite for the Lame Duck.
Estate Tax: How do you handicap a race that shouldn’t have happened? Congress should have passed something last year. Then it should have acted quickly early this year. People were leaving large estates in limbo as their attorneys waited to learn what the rules would be. Last summer, too, was a good time to provide clarity.
Now, almost a year later, they are still waiting. Ouch.
One explanation for this inaction is that Congress, or at least those folks running things, are happy with the status quo. They might not have the votes to reinstate the old estate tax proactively, but they can get to the same place through inaction. Just wait a couple months and you’ll see.
Another explanation is that no particular fix enjoys sufficient support to pass. They could make permanent 2009 rules. They might embrace the Kyl-Lincoln formula of 35 percent rats and $5 million exemptions. They could allow the old 2000 rules to rise from the dead with their 55 percent top rate and measly $1 million exemption. Or anything in-between. With so many options, no one option appears to have the 60 votes needed to pass the Senate.
So what is our prediction? We don’t have one, or more accurately, we don’t have a strong sense that one option will prevail. Which suggests that nothing happens and the status quo — a return to 55 percent and $1 million — has the best chance for next year. And if you passed away in 2010? Well, you were lucky, estate-tax-wise. You’re probably also not reading this. But we digress.
Meanwhile, careful S-Corp readers will remember we were particularly concerned with valuations. Congressman Earl Pomeroy (D-ND) introduced legislation this Congress that caught the attention of the valuation crowd. Among other things, the bill would disallow minority interest discounts for family-owned businesses. The argument is that related parties always act in concert, so if the broader family controls the business, minority discounts should not apply.
There are numerous problems with this approach– families don’t always act in concert, you can’t have two competing valuation systems, etc. With the [likely] pending flip in the House, and the possibility that Pomeroy loses his seat (he’s down), what are the odds that this issue lives?
Surprisingly good, unfortunately. Both President Obama and key tax folks on the Hill believe this approach is good tax policy and we expect to see some version of this policy in the President’s budget. Which means we need to keep after this issue, and not let it be described as a “ tax loophole” or “ tax evasion.” Even a Republican Congress will need to find new revenues. Punishing family businesses with higher estate taxes should not be the source.
Payroll Tax: A provision included in the House-passed tax extender package last summer included an $11 billion tax hike of S corporations in the form of higher payroll taxes for some service sector companies.
S-Corp led the charge to oppose this unjustified tax, convincing a bare minimum of forty-one Senators to oppose the package, including S-Corp champ Olympia Snowe (R-ME). It was close, but ultimately Finance Committee Chairman Max Baucus (D-MT) dropped the provision from the broader package.
But what about next year? This issue has been around as long as S corporations (more than fifty years) but it really gained notoriety when former Senator John Edwards used his S corporation to block paying payroll taxes on his law practice. Edwards is gone, but the issue lives on.
With Republicans taking the House, the pen for drafting tax policy will shift from Congressman Sander Levin’s (D-MI) hands to Congressman Dave Camp’s (R-MI). They are both from Michigan, but that’s where any similarity ends. We do not expect a payroll tax hike to emerge from a Camp-led Ways and Means Committee. Using an S corporation to block payroll taxes you legally owe is tax avoidance. It’s against the rules, and the IRS has the tools to go after you. The $11 billion tax hike passed by the House last year was about revenue, not tax enforcement.
The provision could emerge from the Senate and the Administration, however, so we’ll continue to work this issue and educate policymakers on the distinction between a tax loophole and tax avoidance.
So those are our S-CORP Crystal Ball predictions into the future. The predictions are based on a Republican House and Democratic Senate. That seems to be the most likely outcome this November, but things change. If they do, we’ll come back with some new assessments. It’ll give us something to write about while Congress is gone.
President Obama — Tax Cutter?
The New York Times ran a piece the other day entitled, “ From Obama, the Tax Cut Nobody Heard Of.” What they are referring to is the $400 Making Work Pay credit adopted as part of the broader 2009 stimulus package. This credit was available in 2009 and 2010 and had a total price tag of $116 billion.
The point of the story is that the President, contrary to the popular perception, is actually a tax cutter. From our perspective on the front lines of many of these battles, we’re not sure we agree.
First, many of these credits went to families with no tax burden. Of the credit’s $116 billion cost, about $37 billion takes the form of transfer payments from one taxpayer to another and are not properly described as tax relief. For example, a family filing jointly with two kids and making $40,000 typically has no income tax liability and would receive an additional $800 refund under this credit. Not bad, but it’s not tax relief.
Second, the credits were — by design — temporary.The net tax relief from the credits took place in 2009 and 2010. So even if you could describe the President as a tax cutter because of this provision, it only was only temporary. Tellingly, the President’s most recent budget only calls for a one-year extension of the credit. Again, temporary.
Finally, the credit’s net tax relief is fully offset by tax hikes the President either has signed into law or has put forward as part of his two budgets. Unlike his tax cutting accomplishments, this list is long and permanent, and includes the $400 billion-plus tax increase enacted as part of health care reform, including the new 3.8 percent tax on all investment income.
Taken on balance, it is hard to make the case that this President is a tax cutter. He has proposed tax cuts in the past, and signed some of those into law. But he has signed into law or proposed many more tax hikes — including a $700 billion permanent tax hike about to take effect this January — and has made clear in his rhetoric and his budgets that he believes a significantly higher tax burden is both necessary and appropriate.
So what to make of the new effort to label the President a tax cutter? Could it be a trial balloon preceding a shift in his tax policies in the new Congress? We’ll see.
S-Corp Joins Panel on Tax Policy
Looking for a concise review of the tax issues facing private businesses? Look no more!
Last month the Heritage Foundation hosted a forum on b� Pro-Growth Tax Policy for All Americans.b� B S-Corp Executive Director Brian Reardon joined several other tax experts, including the Tax Foundationb�s Scott Hodge, in reviewing the state of tax policy and where itb�s headed in 2011.