Submit your email below to subscribe to the Washington Wire:
This morning, more than 90 trade associations representing millions of individually- and family-owned businesses sounded the alarm on the proposed changes to grantor trust and valuation rules in the Build Back Better Act (H.R. 5376) and called on lawmakers to reject these provisions.
The letter builds on a prior S-Corp letter sent last week, focusing on the adverse impact these proposed changes would have on family businesses nationwide. Regarding Grantor trusts, the letter reads:
The changes related to the taxation of grantor trusts would eliminate the usefulness of the grantor trust for normal and legitimate business (non-tax) purposes, such as facilitating the transfer of business ownership between generations and protecting assets from liability or creditor claims of a trust beneficiary.
Worse, these new rules would unfairly punish taxpayers who relied on decades-old laws and Internal Revenue Service guidance to establish estate plans to transfer family businesses to future generations, threatening the viability of thousands of family businesses across the country. In some cases, these plans have been in place for decades, and it is simply unfair for Congress to step in and retroactively change them now, just when they are to be called upon to help with the transfer of a family business from one generation to the next.
On changes to the valuation rules, the letter focuses on the impact those changes would have on family businesses:
In a similar vein, the changes related to the valuation of interests in entities holding so-called “passive assets” (including real estate) are unnecessarily overbroad. They undermine the settled principle that property is valued for transfer tax purposes at its “fair market value” by imposing tax based on a value greater than fair market value when non-controlling or non-marketable interests are transferred.
The changes broadly apply to all interests in any entity holding “passive assets,” whether or not the interest owner can actually access a proportionate share of those assets, whether or not the amount paid by the interest owner to acquire the interest was significantly less than a proportionate share of the assets of the entity, and whether or not the transferor or transferee have any control over the entity. As such, the changes unfairly impose transfer taxes on “phantom assets” and “phantom value” that an owner of the interest often has no ability to access. If enacted as drafted, family farms, ranches, and operating businesses across the country would be harmed.
Proponents of the House bill claim they would ensure billionaires “pay their fair share.” In reality, family-owned businesses of all sizes would bear the brunt of these tax hikes, threatening their ability to stay family-owned. That’s bad for these businesses, and bad for America.
Like a vampire, the Wyden “mark-to-market” (or M2M) proposal rose from the dead over the weekend in what appeared to be a Hail Mary effort to replace large portions of the House tax hike plan at the last minute. Those parts were objected to by Senator Sinema, leaving negotiators with a large hole both in their revenue and their rhetoric. Enter M2M. Then Senator Manchin and Chairman Neal spoke up in opposition to the idea. Exit M2M.
Before we get to the outlook, it’s important to focus first on just how bad an idea M2M is. As we noted when Wyden rolled out his plan back in 2019, it would introduce a whole new concept of income and taxation into the Tax Code, a concept that has been considered and rejected many times in the past, and for good reason:
Taxing gains before they are realized, particularly with private companies, creates both valuation and liquidity issues — how do you determine the value of the asset and how do you ensure the taxpayer has the means to pay the tax?
To address all these issues, the Wyden plan takes up 107 pages of legislative text. That’s a lot of text to tax 700 billionaires and it illustrates the complexity of what otherwise sounds simple in concept. The Wyden proposal attempts to address these concerns by treating publicly-traded assets differently than private ones. Gains on public assets with liquid markets and transparent pricing would be taxed annually while gains on private assets would be taxed when there is a sale (or death), with a special formula used to calculate the tax. The goal of the formula is to balance out the treatment of public and private assets – the longer the private asset is held, the higher the tax.
Treating different assets differently creates its own challenges, however. Even with a formula-based tax, it is likely investors will prefer private investments with deferred taxation over public ones with immediate taxation. How do you prevent gaming between the asset categories? What is the impact of the new tax on asset prices? If the tax applies to existing gains, does it force a fire-sale of public stocks? Is it constitutional?
That’s just the beginning. Below are some links to analysis of M2M that raise these and many other concerns:
The plan would also impact way more than 700 billionaires, as once again Congress is targeting trusts and estates. The headline says $1 billion in assets and $100 million in income, but the text released last night has significantly lower thresholds for trusts and estates – $100 million in assets and $10 million in income. As some of the affected trusts have multiple beneficiaries, even those thresholds don’t define the total affected population. A business owner with income well below $10 million could still get pulled into this “billionaires” tax.
As you can imagine, S-Corp and the Main Street Employers coalition were planning to raise holy hell about this in the coming days. Now, with the opposition of Manchin and Neal, it appears we can focus our energy elsewhere.
In recent months, every Monday your S-Corp team wakes up thinking, “Wow, they just might get this thing done this week” but by Wednesday we have moved on to “There’s simply no way.” Today is Wednesday and there is no way Democratic leaders will be able to cobble together a bill from all the remaining moving parts in the next couple days.
As one Democratic representative joked last night, “We are just missing two things: What exactly is going to be in the bill and how we’re going to pay for it. Other than that, we are good to go.” That’s not to say we haven’t seen movement. They do seem to be closing in on an overall spending number and some specific items appear to be either in or out. The “In” items include:
- A 15-percent Book Tax for Corporations
- SALT Relief
- A Tax on Stock Repurchases
- Changes to IRAs
- NIIT Expansion to S Corporation and Partnership Profits
- Increased IRS Funding
- Individual, Corporate and Capital Gains Rate Increases
- A Cap on 199A Deductions
- Bank Account Reporting
- Loss Limitation Rules
- Grantor Trusts, Discounts, Unified Exemption
- 3-Percent Surtax
To state the obvious, none of these lists are set in stone, particularly with the M2M proposal off the table. Tax writers may need to revisit some of the discarded revenue raisers.
Meanwhile, the Corporate Minimum Tax in particular should come with a big asterisk attached. As with the M2M, it sounds simple in concept but is really complicated in practice. Finally, weekend reports on a SALT compromise suggest they will suspend the cap for two years on the front end and then tack on a couple extra years on the back end. Sounds about right.
If negotiators do miss this week’s deadline, then expect these negotiations to be kicked into December along with all the other unfinished business before Congress, including the infrastructure package, the debt limit and funding the federal government. Some say there’s a chance to see movement in November, but absent some sort of backstop forcing the two sides together, it’s hard to see how any significant concessions would be made in the coming weeks.
Which means folks should prepare for a giant train wreck, “fiscal cliff”- like scenario just before Christmas. We could be wrong, but that seems to be where things are headed.
The proposed changes to grantor trusts included in the Build Back Better Act (H.R. 5376) are a serious threat to Main Street employers nationwide. The authors claim these changes would ensure billionaires “pay their fair share,” but in reality they would fall most heavily on family-owned businesses, making it all but impossible for some of them to survive from one generation to the next.
To highlight this threat, S-Corp sent a letter today to the House’s top tax writers detailing the history of grantor trusts, the flaws in the proposals in H.R. 5376, and the harm they would inflict on Main Street. As the letter states:
…It is important to point out that the grantor trust rules were created by Congress and have been in place for more than fifty years. The practices described above are in full compliance with the rules and, in fact, have been blessed by the courts and by Congress multiple times. Moreover, these tools would need to exist with or without an estate tax. Trusts are used to facilitate the transfer of ownership of a business and to give younger generations a stake in the business while also protecting the business’ assets from creditor claims, claims of a spouse in divorce, etc. There are many non-tax reasons why trusts are necessary.
Given this background, it is one thing for Congress to change these rules looking forward. It is entirely different, and wrong, to retroactively apply the changes to grantor trusts created in the past. Considering the length of time some of these plans have been in place, Congress should take great pains to ensure that established grantor trusts that have relied on rules in place for decades are not upended now, just before they are called upon to preserve a family business.
The proposed changes to existing grantor trust rules will unfairly punish family businesses at a very difficult time, driving many of them into forced liquidations or sales, while stacking the deck in favor of the large, multinational corporations who have thrived throughout the pandemic. From the letter:
These changes are a private company challenge only. Public corporations like Amazon and Apple are effectively immune from the estate tax and have no use for grantor trusts. While some small portion of their owners may pay the tax, the company itself is largely unaffected. Public companies don’t engage in estate tax planning, they don’t have to pay for life insurance or to otherwise set aside resources to pay the eventual tax, they have access to massive pools of capital that also don’t pay the estate tax (or any tax for that matter), and they don’t have to reorganize their ownership to ensure a smooth transition of leadership and control.
Meanwhile, every single successful family business or farm in this country struggles with the estate tax. As one of our members observed, the estate tax forces families to buy back a large portion of the business from the federal government every generation. The changes to the treatment of grantor trusts included in H.R. 5376 will make these challenges much more acute, resulting in fewer successful transitions and fewer family businesses.
Taken as a whole, the tax increases included in H.R. 5376 represent a grave threat to millions of Main Street businesses. They would raise taxes on these businesses to unprecedented levels and tilt an already uneven playing field even further in favor of large, publicly-traded corporations. The changes to the grantor trust rules are particularly harmful, as they would hit the affected businesses at a particularly difficult time (the death of their owner) and they would undo years if not decades of careful planning to ensure the company survives the transition.
As the letter notes, if Congress wants to address concerns regarding grantor trusts, it should consider those changes carefully and transparently, and it should do so in a targeted manner that preserves the value of these trusts to families. S-Corp is willing to participate in that process.
Ken Kies is a former head of Congress’ Joint Committee on Taxation and one of Washington’s most respected tax experts. Today he has a succinct and highly persuasive defense of the Section 199A deduction that’s worth the attention of tax writers.
In a letter published in Tax Notes, Kies makes clear that C corporations are already tax advantaged when compared to pass-through businesses, and that paring back 199A would only make the imbalance worse:
Current law should be retained in its entirety. Taking into account all the proposed changes in the pending legislation, passthrough businesses would wind up being taxed more heavily than C corporations, even if current law section 199A is retained in its entirety.
Kies bases this position on the relative rates embraced by the Neal legislation, under which. S corporations would pay 46.4 percent, while C corporations would pay just 26.5 percent.
Kies addresses the double corporate tax too. As we’ve written many times before, the concept of the “double tax” is a relic, as the bulk of corporate earnings today aren’t subject to it. Kies illustrates this point by referencing a 2016 study conducted by the Tax Policy Center:
In the United States it’s common to talk about the double tax on corporate earnings. As a general proposition, it’s not fake news: A corporation pays tax on its earnings and the owners of corporations — that is, the shareholders — generally also pay tax on any remaining earnings that are distributed to them.
Based on the best available data, it’s estimated that no more than 9 percent of annual corporate profits are subject to tax a second time, and no more than 14 percent will eventually be taxed upon later distribution (that is, as taxable pension or retirement account distributions). That means that only around a maximum of 23 percent of U.S. corporate earnings ever face a second layer of taxation.
When an S corporation earns a dollar under the Neal bill, it retains just 54 cents. A public C corporation, on the other hand, can keep 74 cents. Imagine a market where your business is paid 37 percent less than its competitors. How would you compete for jobs, employees, market share? You can’t, is the simple answer.
The logical conclusion of such a tax system is the rapid expansion of Amazon and Apple, all at the expense of Main Street. That’s good news for the billionaires whose wealth is tied up in public securities, but it’s bad news for the communities and workers who rely on private and family-owned companies.
Ken Kies’ message is simple: “Current law section 199A should be retained in its entirety. Doing so will still leave passthroughs more heavily taxed than C corporations, but removing any of the benefits of section 199A will only make the disparity worse.” We could not agree more, and urge lawmakers to reject this poorly conceived bill.
Kevin Kuhlman, a Vice President of Federal Relations at NFIB, walks through the results of the organization’s latest research, and details the extent to which Main Street businesses have been kneecapped by severe revenue losses, labor shortages, supply chain disruptions, and rising prices over the past 18 months. Add in the harm these businesses will suffer under the House tax hike bill and what the new Senate debt limit deal means for the timing of any potential tax hikes, and this is a “must listen” edition of the Talking Taxes in a Truck podcast.
This episode of Talking Taxes in a Truck was recorded on October 7th and runs 20 minutes long.