The S Corporation Association submitted comments today to Ways and Means Committee Members Rep. Charles Boustany (R-LA) and Rep. Richard Neal (D-MA), sponsors of the draft “Innovation Promotion Act of 2015.”

As you’ll recall, the two members released a “discussion draft” of their innovation box idea back in July and asked stakeholders to weigh in.  The box itself offers US firms a lower tax rate on some income derived from the use of patents, inventions, formulas, etc.  Our friends at the Tax Foundation identified three motivating factors in the introduction of the box:

  • The U.S. tax code has become increasingly uncompetitive;
  • Lawmakers are concerned that under the BEPS project, U.S. companies will be pressured to move related R&D to foreign countries to satisfy new foreign tax laws; and
  • Lawmakers want to encourage the creation of more research and development and the related jobs in the United States by providing a lower rate on its income.

Regarding our comments, you can read the whole letter here, but the two essential points are 1) the best means of encouraging innovation is to reduce tax rates on all business activity and 2) a more targeted effort to reduce rates on “innovative” activity should be drafted as broadly as possible, including applying it to S corporations and other pass through businesses.  As we noted previously, the innovation box draft currently applies to C corporations only.

A cornerstone of tax reform is to apply rules and rates evenly, so that investment and hiring decisions aren’t unnecessarily distorted.  An innovation box, by definition, targets a more narrow set of activities than across-the-board marginal rate cuts, but it doesn’t need to pick and choose among business types too.  Innovation takes place within C corps, S corps, and other pass through entities alike, so all these business should be included in the box.


Tax Extenders on Fall Agenda

Congress returns to a full legislative plate for September and beyond, including the following deadlines for action:

  • Iran nuclear deal (September 17th)
  • Government funding (September 30th)
  • Internet Tax Freedom Act (October 1st)
  • October 29th (Highway authorization)
  • December (Debt Limit)
  • Tax Extenders (December or January)

Add in the controversy over Planned Parenthood’s funding and it’s difficult to see how Congress manages to wade through all these deadlines unscathed.  Should be an interesting few months.

On the tax policy front, Congress needs to extend the so-called “extenders” before tax season officially begins next year.  As readers know, this batch of 50-plus tax provisions (including business-friendly provisions like the R&E tax credit, the shorter built-in gains (BIG) recognition period, higher limits on small business expensing, etc.) officially expired at the end of last year, but everyone in DC expects Congress to act this fall to extend them, both for the current year and for 2016.  There should also be an aggressive effort to make some of the provisions, including BIG relief, permanent.

We’ve commented previously on the adverse impact this on-again, off-again approach to tax policy has on businesses and their investment decisions.  As Jody Fledderman of Batesville Tool and Die testified earlier this year, the temporary expiration of these tax provisions has the effect of draining resources from his company, resources he can’t get back even when Congress retroactively extends the provisions.

This dynamic is one reason over 2000 businesses and trade groups wrote to Congress calling on them to act on extenders quickly.  As the letter, led by the National Association of Manufacturers, states:

Failure to extend these provisions is a tax increase. It will inject instability and uncertainty into the economy and weaken confidence in the employment marketplace. Acting promptly on this matter will provide important predictability necessary for economic growth.

The expired provisions should be renewed as soon as possible this year. We urge all members of Congress to work together to extend seamlessly on a multiyear basis, and where possible enhance or make permanent, these important tax provisions.

So Congress’ plate is full, but early action on extenders would be greatly appreciated by the business community.  It would instill a higher degree of certainty while representing an important step towards the reformed tax code everybody would like to see.


Pass Throughs and Bracket Creep

Add “bracket creep” to the list of tax challenges specific to pass through businesses.  According to the Congressional Budget Office, individual tax collections are expected to rise sharply over the next decade, in part due to wages rising faster than inflation.  As the TaxVox Blog noted:

The expected rise in individual income taxes is largely due to a phenomenon known as real bracket creep. Income tax rates are mostly indexed for inflation so nominal increases in income don’t boost effective rates. But when incomes rise faster than the rate of inflation, as CBO projects in a growing economy, that income is pushed into higher tax brackets. As a result, CBO figures individual income taxes will rise by 0.6 percent of Gross Domestic Product by 2025.

An increase of 0.6 percent of GDP doesn’t sound like much, but it works out to more than $150 billion in additional annual tax collections by the end of the decade.

Missing from the CBO report is any commentary on the impact bracket creep has on Main Street businesses.  While the vast majority of C corporation income is already taxed at the top corporate rate of 35 percent and is therefore immune to bracket creep if it occurs at all — does business income rise faster than inflation? – a sizable amount of pass through income is taxed at rates below the top 39.6 percent top rate.  Combined with the fact that pass through income is added on top of wage and salary income and it means that many S corporation shareholders will have their business income subject to higher effective tax rates over time.

So “bracket creep” joins the Alternative Minimum Tax, foreign tax credit treatment, and other tax policies and interactions that present particular challenges to the pass through business community.