The Super Committee announced today that it will not produce any recommendations for Congress to act on next month. The markets are reacting badly, which surprises us. They should have seen this coming. Maybe they were hoping for some sort of signal that Congress can function and is prepared to deal with our ongoing fiscal crisis, but every signal we received for the past two months suggested the Committee was going to fall short.

Now that they have missed the mark, the question becomes, “What’s next?”

For the remainder of 2011, Congress needs to act on the tax provisions set to expire this year. That includes a broad package of tax items, including the larger AMT exemption, the R&E tax credit, and important to the S Corporation Association – the shorter 5-year built-in gains holding period. Also in play is the ongoing payroll tax holiday, the expiration of extended UI benefits, and the so-called “Doc Fix” to postpone pending cuts in Medicare reimbursements.

For next year and beyond, the looming issue confronting S-Corp is the expiration of the current tax rates coupled with the imposition of the new 3.8 percent investment tax, both of which will take place starting January 1, 2013. The net effect will be to raise the top marginal rate on S corporation shareholders from 35 percent to nearly 45 percent.

This sharp tax hike facing S corporations is not the only “policy cliff” confronting folks on January 1, 2013. Also on the list is year one of the cumulative $1.2 trillion in spending cuts (sequestration) that were triggered now that the Super Committee has failed (including significant cuts to defense spending) as well as the need for Congress to raise the debt ceiling again.

All of which suggests Congress is going to have to do something big on the tax and spending front by early 2013, if not before. What would this package look like? There’s a short list of provisions almost certain to form the core, including:

  • Debt ceiling increase together with another package of spending cuts;
  • Extension of the expiring middle-class tax relief (lower rates, marriage penalty relief, refundable child credit, etc); and
  • Extension of the AMT patch.

Beyond this core list, other possible (or likely) provisions could include an extension of upper income tax rates or some sort of broader tax reform, plus new spending cuts in exchange for reducing the pending defense cuts.

In response to this outlook, our goal is two-fold. First, work with our allies to get the provisions that expire this year, including the 5-year BIG holding period, extended into 2012 and beyond.

And second, organize the pass-through business community to make certain that Congress deals with the 2013 “rate cliff” in a timely and thoughtful manner. Congress is going to need to act, and the sooner we can educate policymakers on why, the better off we’ll be.