Innovative Pass Thrus

Last month’s release of the “innovation box” proposal by Ways and Means Committee Members Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA) started us thinking, “Exactly how much innovating do S corporations do?”

In our own membership we have lots of innovative companies with robust R&E operations, but is that a representative sample, or an outlier?  Moreover, when you think of today’s most innovative companies – the real so-called “disrupters” – almost all of them began small and grew largely based on the quality of their ideas.  Apple is the most notable example these days but certainly not the only one.

So is there good data out there that captures this dynamic and gives us an accurate assessment of how much innovation is being conducted in the pass through space?  Not really.

Available data regarding usage of the Research and Experimentation tax credit (R&E credit) is dated and, in many instances, groups the usage of all pass through businesses together.  Furthermore, this data may not present an accurate assessment of pass through innovation because of a variety factors, including the well-recognized compliance burden of claiming the R&E credit, the availability of other cost recovery mechanisms and the impact of the alternative minimum tax (AMT).

While we may struggle to quantify the amount of research, we’re confident that there is more innovation in the pass through community than the numbers suggest.  The good news is that Congress knows this, too. This year, Rep. Kevin Brady (R-TX) sponsored the “American Research and Competitiveness Act of 2015” (H.R. 880), which passed the House in February.  Aside from increasing the alternative simplified credit (ASC) from 14 percent to 20 percent, the bill would also allow the R&E credit to act as an offset to the AMT for businesses with less than $50 million in receipts.

We are not crazy about the $50 million threshold – why should Apple get full access to the R&E credit but not a mid-sized S corp? – but the general acknowledgement that today’s complex code produces undesirable outcomes for innovative businesses is healthy, and we plan to work with Mr. Brady’s office to make sure this provision, without the threshold, becomes law.

We are also going to make certain that pass through businesses are treated fairly under any international provisions considered by the Ways and Means Committee this fall, including their innovation box draft.  More comments to follow on that front.


IRS Minority Discount Rule Pending

We have mentioned in previous Wires that the Treasury Department is considering new regulations to limit or scrap some minority discounts for valuations of family-owned businesses. The first rumors of this came back in May. It’s looking like Treasury is planning to announce the new rules within the next month. This is a big deal and there’s an increasing amount of noise on exactly what Treasury has in mind.  This press release from Blank Rome LLP lays out the timeline for Treasury’s actions:

Recently, it has been reported that Treasury official Cathy Hughes said (without specifically addressing the Section 2704 Regulation project) that various Treasury initiatives are likely to be delivered prior to the September meeting of the American Bar Association’s Tax Section (which is September 17-19, 2015). It is therefore possible and perhaps likely that proposed regulations under Section 2704 could be issued before the end of the summer.

It is not clear at this time whether such regulations, when issued, will be prospective or retroactive (for example, to the date or the day after the date the proposed regulations are published in the Federal Register). The scope of these regulations and what safe harbors may be included are also areas of uncertainty. Some have suggested that minority discounts will be disallowed or restricted, although the legislative history indicates otherwise. Even so, discounts for lack of liquidity and lack of marketability will likely be impacted and could be significantly reduced.

Once these rules are proposed, we’ll be working with other business groups to make certain policymakers on the Hill are aware of their adverse impact on family businesses.  Discounts for minority ownership stakes are well established both in the economic and the tax world, and the IRS has lost on this front many times in the past.  Looks like history may be repeating itself here.