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Washington Wire2018-12-11T13:53:32+00:00

S-Corp Member Survey 2019

July 30th, 2019|

S-Corp sent its members a new survey this Spring.  The goal was to follow up the survey we did just after tax reform was enacted to see how things had evolved.  Now that our members had a year to digest the new rules, where did they stand?  Here are the key takeaways –

  1. Seven out of ten say their taxes went down or stayed about the same;
  2. Four out of five say making permanent the 20-percent 199A deduction is a priority; and
  3. Seven out of ten plan to remain S corporations in the near future.

That’s not bad, considering where we started.

The first question we asked this year was how our members fared under tax reform.  Did their taxes go up, down, or sideways.   About half the respondents reported that their tax burden declined while 17 percent said their taxes remained about the same.   Just one out of ten reported a tax hike.

Eight out of ten reported that making the 199A deduction permanent is a priority.  As our EY study shows, tax reform achieved rough parity for pass-throughs with the lower, 21-percent corporate rate, but only if the companies get the full 20-percent 199A deduction, and only if it stays in the Code.  Based on these responses, making the 199A deduction permanent will continue to be the top legislative priority for the Association.

Are S corporations switching following tax reform?  Harvard economists Robert Barro and Jason Furman estimate one-fifth of pass-through income will migrate to C corporation world in response to tax reform.  That seems about right to us — S-Corp has already seen a number of members convert in 2018 and a few more are considering making a change this year.  Responses to our survey fit that pattern, with seven out of ten S corporations staying put, while less than one-in-ten are considering switching.

On the other hand, two out of ten report not being sure if they are going to convert.  That closely matches the two out of ten who aren’t sure if their taxes went up or down.  Treasury is still working through some of the rules they need to calculate their taxes – particularly on international and for calculating the interest deduction cap – so this remaining uncertainty might stem from that.  (We’re going in to see Treasury this week on a GILTI issue that could mean the difference between tax cuts and tax hikes for affected business.)  For those companies, the jury is still out.

As to why a company might covert, the most cited reason is to access the new 21-percent rate.  Inability to access the 199A deduction, complexity of the new deduction, and the loss of SALT all weighed in about equally as the second most important factor.  The loss of the SALT deduction will fall more heavily on companies operating in high tax states, so we expect to see state-by-state differences in the response to that new policy.

Finally, respondents made clear that complexity continues to be an issue.  Two-thirds reported their taxes are more complex while less than one-out-of-ten reported less.  The remaining one-fourth reported it was about the same.  Tax reform simplified filing for many families, but for most S corporations, filing got more complex, not less.

The S-Corp survey was sent to companies organized as S corporations, with the survey respondents tending towards the larger size.  Four out of five companies had revenues above $10 million and more than half had 50 or more employees.  While the findings are by no means scientific, they do provide a useful window into how larger S corporations are doing under tax reform.

For the majority of respondents, the outlook is generally positive – their taxes went down or stayed the same.  But that outcome depends entirely on making the 199A deduction permanent, and it did come at the cost of more complexity.  Meanwhile, a significant minority are still working through the numbers, are not sure if their taxes went down or up, and are not even sure if they will remain S corporations next year.  For those companies, the benefits of tax reform remain to be determined.

The Myth of Corporate Decline

July 26th, 2019|

The visual economist issued another great chart last month, this time showing the largest public companies by market cap.

Our first reaction is, wait, Microsoft is number one?  When did that happen?  All the focus on FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) and stodgy old Microsoft is bigger?  Go figure.

Our second reaction is “Gee Grandmother, what big market caps you have.”  These companies are huge!  And that’s not limited to the ten companies illustrated here.  Measured against GDP, the market cap of all public companies in the US has tripled since 1986.

The irony is that this growth came at a time when we were warned repeatedly that the corporate sector was shrinking and it’s all the fault of the 1986 tax reform act and those pesky pass-through businesses.  Here’s a representative example from the Tax Foundation from 2015:

The U.S. loses about 60,000 corporations per year and has lost about 1 million corporations since the Tax Reform Act of 1986.

Over time, more businesses have structured themselves as “pass-through” entities. This allows profits to be passed through to owners and taxed at individual tax rates that are often lower than the corporate tax rate and eliminates double taxation for shareholders.

More than 60 percent of U.S. business profits are now taxed under the individual income tax code rather than the corporate tax code, which explains why the U.S. collects a relatively small amount of tax revenue from corporations despite having the developed world’s highest corporate tax rate.

Outside of taxation, the traditional corporate form often provides the most efficient business structure for large-scale projects and investments. Excessive corporate taxation and the subsequent decline of the corporate sector artificially limits this important aspect of the economy.

The U.S. should do what the rest of the developed world has done: reduce the corporate tax rate, integrate the corporate and shareholder taxes to avoid double taxation, and limit corporate taxation to profits earned domestically.

Just for the record, in 2015 the top rate on pass-through businesses was higher than the top rate for C corporations, but we digress — If the 1986 tax reform spelled the demise of C corporations, how come the smart money continues to pour into them?

The simple fact is the “decline of the corporate sector” narrative was a myth no matter how you measure it.  Corporate tax receipts were 1.4 percent of GDP prior the 1986 tax reform; they were 1.5 percent of GDP prior to the 2017 tax reform.  Corporate taxes paid as a percent of total government receipts were 8.2 percent in 1986; they were 9.0 percent in 2017.

So the C verses S dichotomy painted by the Tax Foundation and others is the wrong way to frame the debate over how to best tax businesses.  What’s the right way?  Here are some thoughts:

  • The real balancing act is not between pass-through businesses and C corporations, but between public companies and private ones. The decline in C corporation numbers is dominated by private companies either moving into the pass-through space or being gobbled up by public companies.  It’s true the number of public companies listed on the US exchanges shrunk by half over the last two decades, but it’s only a few thousand companies and the overall growth of the remaining market cap indicates that what we’re seeing is consolidation, not decline.


  • The dramatic increase tax exempt shareholders is likely responsible for some of this growth. In the 1960s, four out of five C corporation shareholders was fully taxable.  Today, it’s just one out of four.   This growth in tax exempt or advantaged investment increased the pool of capital available to public companies over the past fifty years even as it sharply reduced their effective tax rates.


  • The rise of tax exempt shareholders has also given public companies a significant advantage over private C corporations. Unlike public companies, private companies are largely limited to rewarding their shareholders by paying dividends, and those dividends are usually – and in the case of S corporations, always – paid to shareholders who actually pay taxes.  The double tax lies more heavily on private companies.


  • Tax reform will push more business income into the double tax. Barro-Furman estimate 19 percent of pass-through income will migrate into the lower, 21-percent corporate rate.  Wharton estimates its 18 percent.  Some of this shift may come from conversions of existing companies, but much of it will be in the form of increased consolidation, either through acquisitions (Berkshire Hathaway) or by public companies taking market share from existing private businesses (Amazon).  Bottom line: More business income will be subject to the harmful, distortive double tax in coming years.

The common perception that the 1986 tax reform favored pass-through businesses ignores just how tax-disadvantaged pass-through businesses were prior to 1986.  The top tax rate imposed on pass-through income was 70 percent prior to the Reagan revolution.  The top rate on C corporations was 46 percent.  As result, nearly all business income prior to 1986 was reported by C corporations, not pass-throughs.

But pass-through taxation is the correct way to tax business income!  The tax code should tax all business income once, when it is earned, and at reasonable rates.  S corporations for everybody is our mantra.  Re-read the policy prescriptions of the Tax Foundation paper:

The U.S. should do what the rest of the developed world has done: reduce the corporate tax rate, integrate the corporate and shareholder taxes to avoid double taxation, and limit corporate taxation to profits earned domestically.

We agree – double taxation is the wrong way to tax business income, and eliminating it should be the focus of tax policy moving forward, not promoting myths about corporate-tax-base erosion.

S-Corp Mod Introduced in Senate!

July 18th, 2019|

Senators John Thune (R-SD) and Ben Cardin (D-MD) today introduced S. 2156, the 2019 version of the S Corporation Modernization Act.  The new Modernization Act focuses on leveling the rules between S corporations and other business forms while increasing the opportunity for S corporations to raise capital.  Among other items, the bill would:

  • Provide meaningful relief from the so-called “Sting Tax” passive income rules;
  • Expand the ability of IRAs to invest in S corporation banks; and
  • Level the tax-treatment of asset sales with sales of S corporation stock.

As the Senators noted at the introduction:

“While I believe we’ve made a great deal of progress toward strengthening the tax code for families and businesses, I think there is always more that Congress can and should do to help further modernize it, the boundaries of which are constantly being tested by innovation and entrepreneurship,” said Thune. “S corporations are located in nearly every single city and town across America, particularly in those throughout rural America, which is why it’s important for our tax code to keep up with these businesses and the communities in which they operate.”  

“S Corporations, which employ more than 600,000 Maryland workers, are critical to the well-being of the Maryland economy and support thousands of middle class families,” said Cardin. “I’m pleased to work with Senator Thune on this bipartisan legislation that will spur investment in S Corporations so they can better attract capital, innovate, invest in their communities and create jobs.”

Over the years, numerous provisions from the Modernization Act have been enacted into law, including provisions to permit overseas investment in S corporations and increased charitable deductions that were included in the Tax Cuts and Jobs Act of 2017.

S Corporation Association President Brian Reardon thanked the Senate sponsors for their longtime support of the S corporation community.  “We are fortunate to have strong leadership in the Senate on S corporation issues” Reardon noted.  “Senators Thune and Cardin have demonstrated unwavering support for Main Street businesses, and we look forward to working with them to seeing these provisions enacted into law this Congress.”

S-Corp is working with sponsors in the House to see a companion bill introduced soon.

Joe Biden’s S-Corp

July 11th, 2019|

What is it about Presidential candidates and S corporations?  First John Edwards made the practice of abusing the S corporation structure infamous back in 2004.  Then we learned Newt Gingrich did the same thing when he ran in 2012.  And now Joe Biden.  At some point, these candidates are going to realize that saving 3.8 percent on your taxes isn’t worth the political pain it will cost you.  (Hat tip to Bernie Sanders and former President Obama.)

For those not up to speed, the former Vice President and his wife released their tax returns this week.  Focusing on his 2017 return, they show that the Biden’s had adjusted gross income of just over $11 million and paid $3.7 million.  That’s a 34 percent effective rate and well above what most Americans think is fair.

They also show most of their income came from Biden’s writing and speeches, but instead of simply having his clients make the check out to “Joe Biden”, they set up two S corporations and ran the income through those.  He then paid himself a small salary and claimed the rest as business profits.  As a result, he was able to avoid about $380,000 of payroll taxes.

The Wall Street Journal wrote about the issue yesterday, and had very nice summary of the law and the challenge the IRS has in enforcing it:

Under current law, S-corporation owners can legally avoid paying the 3.8% tax on their profits as long as they pay themselves “reasonable compensation” that is subject to regular payroll taxes. S corporations are a commonly used form for closely held businesses in which the profits flow through to the owners’ individual tax returns and are taxed there instead of at the business level.

The difficulty is in defining reasonable compensation, and the IRS has had mixed success in challenging business owners on the issue…

For businesses that generate money from capital investments or from a large workforce, less of the profits stem from the owner’s work, and thus reasonable compensation can be lower. For businesses whose profits are largely attributable to the owner’s work, the case for reasonable compensation that is far below profits is harder to make.

As S-Corp reader know from previous posts, we don’t support the misuse of the S corporation structure to avoid payroll taxes, and believe the IRS needs to be more active going after those that engage in this practice.  If the reasonable compensation standard means anything, it should preclude a one-man shop whose occupation is writing and giving speeches from claiming a salary that’s less than 2 percent of revenues.  As the Journal quoted accountant Tony Nitti, “This is pretty cut and dried. If you’re speaking or writing a book, it’s all attributable to your efforts.”

Going back to their overall tax burden, one question we have is what difference, if any, tax reform would make.  Would the Biden’s tax burden go up or down?

The first thing is that the Biden’s don’t take the 199A deduction on their 2018 returns.  As Peter J. Reilly with Forbes notes:

It is interesting to note that Biden did not take a 199A deduction in 2018.  Presumably, they determined that the businesses were of the sort that don’t qualify.  I could see that on the speaking fees but earnings on the book should qualify.   Of course, some of the salary would have to be allocable to the writing business in order for that to work.

We believe the last point is that the guardrail limiting the deduction to 50 percent of W-2s would effectively reduce any available 199A deduction, since they set their salaries so low.  It’s one of the more interesting side-effects of tax reform – the less salary an S corporation shareholder pays themselves to avoid payroll taxes, the more they limit their 199A deduction.

And while tax reform lowered the Biden’s top tax rate from 39.6 to 37 percent in 2018, they also lost the ability to deduct the state and local taxes they paid, so it’s kind of a wash.  Their effective tax rate stayed remarkably flat – its 33.9 percent in 2017 and, despite making less than half the income, 33.4 percent in 2018.  It’s even possible that tax reform raised their taxes above what they otherwise would have been.

Finally, notice how the Biden’s didn’t get caught up in the AMT in 2017?  They simply made too much money.  The AMT was designed to make sure millionaires paid a minimum level of tax, but it mostly hit upper-middle class families making between $100,000 and $500,000.  Only a small percentage of taxpayers in the Biden’s income range got caught up in it, one of the reasons the AMT had to go.

So the Edwards-Gingrich-Biden loophole lives on (at least until the IRS begins to use the newly codified “reasonable compensation” standard) and that will be the focus of discussion in the coming weeks, but the headline here should be that wealthy taxpayers continue to pay a lot of taxes.  The Biden’s paid more than one-third of their income to the IRS, and over 40 percent when you include the state and local taxes they paid.  That’s a lot.  But don’t expect to see many stories about that.

Progress on S-Corp SALT Parity Efforts

June 25th, 2019|

The House Select Revenue Subcommittee held a hearing today entitled “How Recent Limitations to the SALT Deduction Harm Communities, Schools, First Responders, and Housing Values.” Missing from the list are Main Street Employers, many of whom lost the ability to deduct the State and local taxes they pay on their business income.

That’s because tax reform subjected deductions on state and local taxes (SALT) paid by pass-through business owners to the same $10,000 cap as taxes paid on wages and property.  Taxes paid by the business entities themselves, like C corporations, remain fully deductible.

Since most states tax pass-through businesses at the owner level, this policy increases Main Street Employer tax rates and puts them at a competitive disadvantage compared to C corporations.  It also puts these businesses at a disadvantage compared to those operating in states that have no income tax, like Texas and Florida.

This is a BIG deal!  The S Corporation Association estimates that 3.6 million (out of 4.8 million S corporations nationally) will lose their SALT deduction this year, the equivalent of paying an extra 2 percentage points of tax on average.  Millions more partnerships face the same tax hike.

In response to this new policy, the S Corporation Association and the Parity for Main Street Employers coalition has been working with states to restore the SALT deduction at the state level by allowing pass-through businesses the option of paying their SALT at the entity level.  To date, four state legislatures have adopted this reform – Connecticut, Wisconsin, Oklahoma, and Louisiana.

One outstanding concern for businesses is how the IRS will respond.  We fully expect Treasury to weigh in on this issue at some point, but it’s unclear what such guidance would entail.  As our legal analysis points out:

The Internal Revenue Service (the “Service”) has consistently held that income and other taxes imposed upon and paid by pass-through entities are simply subtracted in calculating nonseparately computed income at the entity level, and are not separately passed through or incorporated into the various provisions and calculations applicable to itemized deductions at the individual level, such as the standard deduction, alternative minimum tax and the Pease reduction. In discussing the final provisions of the Tax Cuts and Jobs Act, the Conference Committee Report explicitly reiterated and relied upon this principle in describing the scope of new section 164(b)(6) of the Code.

It was widely expected Treasury would make some sort of pronouncement on the pass-through SALT front when they issued final rules to kill the so-called charitable workaround earlier this month, but they did not.  The longer they wait – Connecticut passed their reform over a year ago, after all – the better it looks for restoring pass-through SALT deductions.  A recent article from Law 360 appears to agree:

After digesting it, some tax professionals speculated that not only did it provide protection for C corporations, but it also outlined a way for other business owners, particularly sole proprietors, partners or sole owners of LLCs, to get around the proposed SALT cap rules — an option not available to individuals who don’t own businesses. By ignoring various state entity level tax schemes, the final regulations leave the door open for those business owners to do so.

And indeed, some states have taken steps to allow resident business owners to bypass the SALT deduction cap, and others have considered doing so. States such as Connecticut, Wisconsin, Oklahoma and Louisiana have enacted legislation to allow pass-through entities to elect taxation at the entity level. The federal taxation agencies have thus far turned a blind eye to schemes protecting pass-through entities while lowering the boom on those that might benefit individuals who do not own businesses.

So, continued progress on restoring SALT deductions for pass-through businesses.  Congress may ignore the challenge of pass-through parity, but the states aren’t.

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