Today is the deadline for the so-called “clean slate” process in the Senate, and while S corporations and other pass-through business entities are (properly so) not tax expenditures, we thought it was important that the priorities of this community be made clear to tax writers as they begin drafting their reform plans over August.
With that in mind, today more than 70 (!) national business trade associations, including the American Farm Bureau, the National Federation of Independent Business, the National Restaurant Association, and the S Corporation Association, signed a letter reiterating the three tax reform priorities of the pass-through community:
First, tax reform needs to be comprehensive. Most private sector workers are employed at pass-through businesses that pay taxes at the individual rates, not the corporate rates. To ensure that we avoid harming a large segment of American employers, tax reform needs to be comprehensive and include both the individual and the corporate tax codes
Second, Congress needs to keep the tax rates paid by individuals and corporations at similar, low levels. The resolution of the fiscal cliff resulted in individuals and pass-through businesses paying, for the first time in a decade, a significantly higher top marginal tax rate than C corporations. Splitting business income and taxing it at different rates penalizes pass through businesses and encourages planning to circumvent the higher rates, ultimately resulting in wasted resources and lower growth. To ensure that tax reform results in a simpler, fairer and competitive tax code, Congress needs to keep top tax rates low, and it needs to keep them at similar levels.
Third, Congress should continue to reduce the incidence of double taxing business income. A recent study by Ernst & Young made clear that the predominance of pass-through businesses in the United States, and the single layer of tax they face, results in higher levels of investment and employment. This prevalence of pass-through taxation is the result of purposeful and explicit reforms enacted by Congress over the past half-century. A key goal of tax reform should be to continue this progress to tax business income only once.
In addition, S-CORP has sent in its own statement of priorities to the Senate Finance Committee, making clear that any reform of the tax code should recognize and promote the interests of America’s pass-through community. As the statement begins:
The United States is unique among developed countries in the emphasis it places on pass-through business structures - S corporations, partnerships (including Limited Liability Companies), and sole proprietorships. Pass-through businesses make up 95 percent of all U.S. businesses, they employ the majority of private sector workers, and they contribute the majority of business income to our GDP.
This reliance on pass-through businesses is not an accident or a byproduct of other priorities. Rather, it was done purposefully by successive Congresses seeking to strengthen the role of private businesses in the American economy. These deliberate actions date back to the creation of the S corporation structure in 1958 and they have worked to the benefit of the businesses themselves, the people they employ, and the communities they serve. America has more jobs, higher wages, and a more diverse economy because of the strength of its pass-through business sector.
It is critical for Congress to understand this history as it seeks to tackle tax reform in the coming months.
You can read the entire statement here.
Tax Reform Outlook
With the close of the “clean slate” process, it’s a good time to step back and assess the future of tax reform and how it fits into the broader fiscal debates coming this fall. For a while now, we’ve been focused on the remarkable number of fiscal issues converging this fall, including:
- Debt Limit (October/Novermber)
- Start of the Fiscal Year (October 1)
- Roll Out of Obamacare (October 1)
- Second Round of Sequestration
- Farm Bill Expires
Add into this mix the possibility of tax reform. Chairman Baucus announced this week that the Senate Finance Committee will begin marking up a comprehensive tax reform bill this fall, after Congress returns from its August recess. This puts him on a similar timeline as Chairman Camp, who has said that he wants a tax bill voted out of his Ways and Means Committee by year’s end, which suggests the following timetable for both bodies:
- August: Craft draft reform package
- September: Make draft public and open to comments
- October/November/December: Markup in Ways and Means and Finance Committee
So the timetables look similar. So do the basic parameters. Both Chairmen have promised comprehensive reform that includes individuals, pass-through businesses (yea!), and corporations within a general approach of lowering marginal rates and broadening the tax base.
That said, several significant differences remain that could derail the process, including the basic problem that there’s no agreement on the revenue target: is tax reform going to be revenue neutral or should reform raise money?
There also is considerable distance between the approach embraced by Baucus - lower rates, broader base – and the views of key members of his party, including President Obama and Majority Leader Reid: higher rates with more revenues coming from wealthy taxpayers and successful businesses.
Those differences would appear to sound the death knell for tax reform, except for all those other fiscal items coming due this fall. How does Congress come together to raise the debt limit? How does it resolve differences on spending, the Farm bill, and sequestration? Will the roll out of Obamacare be successful, or such a disaster that the President is eager to change the subject?
All these variables suggest no one knows what will happen this fall. It could be a piffle, it could be a grand bargain, or anything in between. What we do know is that there will be two tax reform drafts just sitting there, waiting for an opportunity to be considered by the House and the Senate. And we have two motivated Chairmen, eager to finish this process and produce some legislation.
Coalition for Fair Effective Tax Rates
Earlier this week, a group of more than a hundred business trade associations, including the S Corporation Association, announced a new business coalition focused on making sure that tax reform results in a fairer distribution of tax burdens.
Today, two of the leaders in the coalition – the National Federation of Independent Business and the Retail Leaders Association - penned an op-ed that highlights the current unfairness of the burden the tax code imposes of different industries:
Another argument for reform is the sometimes large disparity in effective tax rates among industries in the U.S. For example, the retail industry, the second largest private-sector employer in the U.S., is taxed at an effective tax rate that is significantly higher than other industries. Some retailers, even the largest of them, tend to have effective tax rates in the 30s. This contrasts sharply with other industries whose effective tax rates are often in the teens or lower.
This critique applies to business types too. A report sponsored by the Small Business Administration back in 2009 found that S corporations pay the highest effective tax rates of any business type. With the higher marginal rates in effect for 2013, we expect the unequal tax burden shouldered by S corporations is higher today than before. We’ll have an update on that report soon, and we’ll make sure it is a key part of the policymaking discussion moving forward.