As our Washington Wire readers know, S-CORP released a ground-breaking study on Tuesday by Bob Carroll and Gerald Prante from Ernst & Young. The study quantifies the economic footprint of flow-through businesses for jobs and investment as well measures the impact of corporate-only, revenue neutral tax reform would have on them. Employing more than half of the private workforce (69 million jobs), the study finds that flow-through businesses are essential to the U.S. economy. S corporations specifically employ one out of four private sector workers (31 million jobs).

The study also finds that the existence of flow-through businesses results in higher levels of capital investment and employment than if all firms were structured as C corporations. And, that a corporate-only, revenue-neutral approach to tax reform (broadening the base by eliminating business tax expenditures) would slap an 8 percent tax hike ($27 billion per year) on these flow-through job creators. This hit is on top of the additional tax hike waiting for these same businesses in 2013 if the current individual tax rates are not extended.

The study has received some great attention with policy makers:

Ways and Means Chairman Dave Camp (R-MI) stated:  “Today’s report serves as a strong reminder that any conversation about comprehensive tax reform must consider the needs of businesses of all sizes and structures. As we develop tax reform policies, we must be mindful of the increasingly prominent role of pass-through businesses and be mindful of how to address their needs in the context of comprehensive reform.”

Select Revenue Measures Subcommittee Chairman Pat Tiberi (R-OH) stated: “This report reinforces Dr. Carroll’s testimony before the Select Revenue Measures Subcommittee on March 3 by making a strong case that Congress must include the business structures most commonly used by small businesses in comprehensive tax reform. Dr. Carroll’s report warns that reforming corporate taxes in a vacuum could result in higher tax burdens for many small businesses; instead our goal should be to write a tax code that makes all businesses more competitive.”

The study has gotten good attention in the press as well:

Small Businesses Balk at “Piggy Bank” – Role in Tax Code Rewrite - Bloomberg Government, Rich Miller, April 13, 2011: “Small companies such as Arc Abrasives Inc. in Troy, Ohio may end up as a roadblock to President Barack Obama’s drive to revamp the corporate tax code. Obama has likely focused attention on a corporate overhaul because the administration thinks it would be easier to accomplish than rewriting the entire U.S. tax code. That may have been a miscalculation.

Tax Overhaul: For Small Companies as Well as Big Ones? - Wall Street Journal, Washington Wire Blog, John D. McKinnon, April 12, 2011: “A new paper underscores the political difficulty of overhauling tax rules for big businesses without doing the same for small ones.”

Study: Corporate-only tax reform could hurt small businesses – The Hill, On the Money Blog, Bernie Becker, April 12, 2011:  “Small businesses could be hurt if a tax reform push revamps the corporate code separately from the individual one, according to a paper released Tuesday.”

Study Warns of Tax Reform Impact on Flow-Through Businesses - Accounting Today, Michael Cohn, April 12, 2011: “A new study from Ernst & Young examines the impact on flow-through businesses of the tax reform proposals, and cautions against lowering corporate tax rates at the expense of S Corporations.” Quoting the study, “corporate tax reform that lowers the corporate tax rate and pays for this change by eliminating some or all business tax expenditures would raise the taxes paid by businesses organized using the flow-through form.”

Curtailing Tax Deductions For Business: Smart Move Or Not - Daily News Pulse, Adriana Barnes, April 14, 2011: “The problem with a corporate-first approach, the Ernst & Young study reports, is that many so-called flow-through entities, businesses that pay taxes through the individual code, use tax expenditures, like one for accelerated depreciation, that could be on the chopping block to pay for a reduction in the corporate tax code. The paper added that some small businesses could also see their tax bill rise at the end of next year, when the Bush tax cuts are currently scheduled to expire.”

As before, our plan is to take this report and use it to educate policymakers on the importance of pass-through firms to jobs and investment. Congress is facing a daunting series of challenges this year with a poor economy and worse job market as a background, and any reform considered by Congress should be sure to include the 95 percent of businesses not organized as C corporations.

S Corporation Modernization Introduced in the House

On the heels of our study release, Reps. Dave Reichert (R-WA) and Ron Kind (D-WI) introduced H.R. 1478, the S Corporation Modernization Act of 2011 on Tuesday.

The Reichert-Kind legislation is a critical measure to modernizing the outdated rules that apply to S corporations, and would make it easier for them to raise capital, invest in new buildings and equipment, and hire new workers. Among other items, the bill would permanently reduce the built-in gains holding period to five years allowing access to S corporations’ own locked-up capital, allow non-resident aliens to invest in S corporations through small business trusts, reduce the negative impact of the so-called sting tax, and encourage charitable giving by S corporations by simplifying related rules.

“S corporations and other similar businesses are responsible for more than half of the jobs in Washington State and across America,” said Rep. Reichert. “As our economy struggles to get back on sound footing, I’m proud that this bipartisan legislation will help these proven job creators access the capital needed to grow, compete, and help get more and more Americans back to work. I remain committed to supporting these bedrocks of our economy by advocating for pro-growth tax policies from my position on the Ways and Means Committee.”

“This bill is a commonsense update to the tax code that will give S corporations the ability to grow and prosper especially in this tough economic environment,” said Rep. Kind. “It is critical that we ease the tax burden on our small and family owned businesses who are driving our economic growth. Under this legislation, S corporations will be better able to access credit, invest in their business, and create the good paying jobs that we need.”

Thank you Mr. Reichert and Mr. Kind!

Hill Spotlight on Job Creation

The Ways and Means Committee held another tax reform hearing yesterday - this time focused on the current burdens that the Tax Code causes individuals and families and how they demonstrate the need for comprehensive tax reform. So it was mostly about the complexities of savings incentives, the Alternative Minimum Tax, and phase-outs and income limits for various deductions and credits. Nonetheless, the issue of how reform efforts could impact pass-through job creators was raised several times. Some highlights:

Congressman Pat Tiberi (R-OH) cited our Ernst & Young report that the majority of job-creators in this country are flow-through businesses and highlighted this startling comment from the Financial Planning Association’s witness:

Today’s hearing brought into focus the need to go beyond President Obama’s desire for corporate tax reform, and work toward comprehensive tax reform. Our current system is too complex and too burdensome for families and workers. We heard a witness, Mark Johannessen, a Certified Financial Planner and Managing Director at Harris SBSB, describe how for the first time ever he’s hearing from everyday folks who want to minimize their potential earnings in order to avoid paying a higher tax rate. When workers and entrepreneurs ask how they can work less to avoid penalties from the government, it is a sure sign of a broken system. As a son of legal immigrants, whose parents came here on a boat from Italy for an opportunity at a better life, not a guarantee, the fact that workers feel like they are no longer rewarded for hard work is truly disheartening. We must make our tax code simpler and fairer.

Alan Viard from the American Enterprise Institute testified that corporate-only reform would “certainly only be a partial solution” to the complexities of the Code. He stated further that the rules governing pass-through entities such as S corporations and partnerships are “needlessly complex.”

Congressman Vern Buchanan (R-FL), a pass-through owner himself, also questioned the panel about the impact of lowering the corporate tax rate without including pass-through entities “as these folks are the job providers.”

Panelist Neil Buchanan from the George Washington University testified that, “business tax reform would need to be thought of as an integrated whole” due to the potential slippage between different business forms. Rep. Buchanan then highlighted the scheduled tax increase on job creators coming in 2013 and the differential between the corporate and individual rate. Panelist Annette Nellen from San Jose State University (representing the American Institute of Certified Public Accountants) noted that, as history would suggest, there would likely be more people choosing to organize as C corporations and therefore subject to double taxation which “really needs to be addressed along with consideration of lowering the rates.” Viard added that a “holistic solution” is needed ideally, whereby different business structures would be “subject to a single level of tax.”

As Ways and Means Chairman Dave Camp (R-MI) said at the beginning of the hearing, we fully expect to see more from the committee on the impediments created for job creators by the tax code in the near term.

The President’s Plan: Another Commission?

In presenting his version of a long-term fiscal correction plan for the country yesterday, President Obama finally seemed to embrace many of the recommendations from his Fiscal Commission, yet called for another bipartisan commission — this time a “Deficit Summit” — to be held in May with the goal of developing a comprehensive plan by June.

In the face of congressional Republicans stating that tax increases are a non-starter, the President called on Congress to “reduce spending in the tax code,” and then immediately renewed his call to end the tax cuts for the “wealthiest Americans”:

In December, I agreed to extend the tax cuts for the wealthiest Americans because it was the only way I could prevent a tax hike on middle-class Americans. But we cannot afford $1 trillion worth of tax cuts for every millionaire and billionaire in our society. And I refuse to renew them again.

He went on to say that the tax code is “loaded up with spending on things like itemized deductions,” and proposed to “limit itemized deductions for the wealthiest 2 percent,” claiming the proposal would raise $320 billion over ten years.

The President then finally called for comprehensive tax reform - after months of pushing corporate-only tax reform. On the individual side however, he called for “fair and simple” tax code that would “build on the Fiscal Commission’s model of reducing tax expenditures so that there is enough savings to both lower rates and lower the deficit.” Since the Fiscal Commission called for lower rates and a broader base, it is unclear where the tax increases Obama proposed earlier in his speech fit into this plan.

We’re glad the President has seen the light on the need for comprehensive tax reform, but it is hard to see how increasing tax rates on a significant portion of job creators would help make our country more competitive.