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Washington Wire
Thursday, June 25, 2009
S-Corp Modernization Bill Introduced in the House
Good news! Last week, S-CORP Champion Congressman Ron Kind (D-WI) introduced the “S Corporation Modernization Act of 2009.” Joining Congressman Kind in sponsoring the legislation were fellow Ways & Means Committee Members Wally Herger (R-CA), Allyson Schwartz (D-PA) and Dave Reichert (R-WA).
The legislation is the companion bill to legislation (S.996) introduced in the Senate earlier this year, and represents the priorities of the S Corporation Association for the 111th Congress, including a provision to make permanent the built-in gains reform enacted as part of the larger economic stimulus package adopted earlier this year.
In a statement accompanying the legislation, Congressman Kind noted, “This bill is a commonsense tax code change that will have huge returns in terms of growth and investment for S corporations. Especially in this tough economic time, my goal is to look out for the small and family-owned businesses which drive our economy. This bill speaks to that, reducing a penalty on S corporations, and thus encouraging them to reinvest the savings into growing their business and creating jobs.”
“At a time when small, family and closely-held businesses are struggling to survive, it is encouraging to see that these Members of Congress are dedicated to ensuring the long term viability of S corporations,” said S-CORP Chairman Dick Roderick. “S-CORP would like to congratulate our champions on the timely introduction of this legislation, and express our gratitude for their commitment to the nearly 4.5 million S corporations across the country.”
With legislation now introduced in both the House and Senate, your S-CORP team will be working hard to garner additional support for the legislation. Reforming the rules governing S corporations will allow countless S corporations to reinvest in their businesses and create jobs – something the economy desperately needs at this moment.
S-CORP wishes to thank Representatives Kind, Herger, Schwartz and Reichert for their commitment to closely-held businesses and looks forward to working with these advocates to move this legislation forward this Congress.
How to Pay for Health Care
Chairman Max Baucus today announced he now has a plan to cover the cost of reforming health care. Past options to cover the cost put forward by the President, the Senate Finance Committee, and the House Ways and Means Committee include:
- A value-added tax
- A rate increase on upper-income families
- A rate increase on Medicare payroll taxes
- Capping employer-provided health insurance benefits
- Capping itemized deductions
- A sin tax on alcohol and soda
None of these options is particularly attractive and, given the challenge of raising this much money, our expectation was that the overall scope of the House and Senate reforms would get smaller as the debate moves into July.
It appears that whittling down process is underway. According to his comments, the Finance Chairman now has in mind a $1 trillion expansion of health insurance coverage (down from previous drafts) to be paid for through an even split of spending cuts and tax increases, including a slimmed down version of capping the employer-provided health care exclusion.
“We are much closer on the scores for a health care reform package than we were at this point last week. We have options the Congressional Budget Office tells us would cost under $1 trillion and are fully paid for,” said Baucus. “Based on these developments, I’m even more confident in our ability to move forward. And as I’ve said before, we will not put out a mark until we are sure we have it right. I’ll continue to work with Senator Grassley and Senators on both sides of [the] aisle to turn these options into a package that can pass the Senate and become law this year.”
The reforms themselves seek to widen health insurance coverage by expanding Medicare and Medicaid while creating a new health insurance exchange for employers and families. The exchange would include both private insurance options as well as some sort of public alternative, and there would be carrots to encourage small employers and low-income families to participate as well as sticks for those who don’t.
The overall cost of these proposals is in the $100 to $200 billion range and would be added on to the $750 billion the federal government already spends on health care programs annually.
But even if Senator Baucus succeeds in offsetting half that cost through spending cuts elsewhere, there is simply no way to efficiently raise $50 billion a year by focusing on individuals making more than $250,000. To raise that kind of money, you need to reach down to the middle class, which is why options like capping the employer-provided health care exclusion are now part of the discussion.
For S corporations, the concern is that the new taxes (whatever form they take) are going to come on top of likely tax increases on income, capital gains and dividends, and estates. These taxes are already scheduled to go up, and with Congress operating at a deficit several times larger than average, they are unlikely to get pared back before they take effect in 2011. Congress simply can’t afford it. Whether Congress (and taxpayers) can afford an expensive expansion of health coverage too is certain to be part of the debate.
Obama LIFO Proposal and S Corps
Speaking of tax increases, the S Corporation Association has been fighting LIFO repeal ever since the issue first emerged as part of a 2006 bill to protect consumers from rising energy prices.
Over the years, we’ve made the case that LIFO is a perfectly legitimate inventory accounting method that can provide the IRS with a more accurate picture of a firm’s income, especially in an environment where prices are rising. (Has anybody looked at long-term Treasuries recently?)
And over the past three years, Ways and Means, Finance, the Joint Committee on Taxation, FASB, and the SEC have all taken positions that, to one degree or another, would undermine the ability of firms to use LIFO in the future.
The most recent shot in the LIFO wars was included in President Obama’s FY 2010 budget. The Obama proposal would repeal LIFO for tax purposes effective in 2012. This change would adversely affect LIFO firms in two respects. First, firms would no longer be able to use LIFO moving forward, likely resulting in higher reported income and higher taxes.
Second, firms would need to pay taxes on their so-called LIFO reserves -- an accounting entry that doesn’t reflect real wealth or income. As we’ve observed, for firms that have been on LIFO for any significant period of time, their LIFO reserves are going to be substantial. The Obama proposal recognizes this double hit by allowing LIFO firms to pay tax on their reserves over an eight year period.
Firms will still be hit with a double tax increase for the privilege of switching to FIFO, but at least the second tax will be spread out over eight years. Of course, they’ll also be paying for health care reform and shouldering the 2011 tax increase and paying down record federal deficit…
Washington Wire
Tuesday, June 02, 2009
Value-Added Tax Coming to America?
Two weeks ago, the Senate Finance Committee released its summary of options to pay for health care reform. As expected, the list was long and could be divided up any number of ways. One item missing from the list, however, is a source of revenue folks are talking about for health care reform and other spending priorities too -- a value added tax (VAT).
The Finance Committee summary followed the release of papers on improving health care delivery and expanding coverage. The key to all three papers is that, while they give the reader a sense of where the Committee is headed, the exact plan remains shaded by options and generalities. So are the costs.
Exactly how much will health care reform cost? Some advocates -- including the Obama Administration’s top economists -- argue that a properly structured plan would save the taxpayer money, but that’s mere rhetoric. Expanding health care coverage to more Americans will cost money. Lots of it.
That’s why President Obama’s budget set aside $326 billion in tax increases to help pay for health care reform, but that may not be enough. Most observers believe the ultimate price tag will be several times higher while many of President Obama’s proposed pay-fors are simply non-starters with Congress. Enter the latest idea of a pay-for -- the value-added tax. The Washington Post reported last week:
With budget deficits soaring and President Obama pushing a trillion-dollar plus expansion of health coverage, Some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax… A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama's policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.
The story points out that, in addition to several well-placed congressional advocates, there are a few folks within the Obama Administration who support a VAT, such as Office of Management and Budget health advisor Ezekiel Emanuel (who also happens to be White House Chief of Staff Rahm Emanuel’s brother).
While this proposal is clearly far from becoming a reality, it is indicative of just how hungry Washington is for money these days that perhaps the most feared of all taxes -- the VAT -- is being floated as a possible revenue source.
How Progressive is Progressive?
The American economy is remarkably dynamic, with a large percentage of folks moving from one income group to another every couple years. This movement is often the product of life-cycle earnings, where workers earn little when they start out and then slowly increase their incomes until they reach their peak earnings years of around 40 to 65.
So what happens when you climb that economic ladder and reach those peak earning years? You’ll find a really high tax burden waiting for you. According the latest numbers from the Congressional Budget Office, the top twenty percent of income earners paid 70 percent of all Federal taxes in 2006. This percent has increased over the years and, contrary to popular (or should we say populist) perceptions, actually increased following the Bush tax cuts.
Your S-CORP team has often speculated that businesses follow the same pattern as workers, starting with little or no income and increasing their size and profitability as they mature (if they survive, of course). Recent work by the Kaufman Foundation gives us a better picture of which companies are a significant source of job creation. It turns out that, if you group businesses by age, the only net job creators are start-ups and firms 26 years and older. Every other age category is a net job loser.
It stands to reason that mature job-creating businesses are highly profitable too. If they are structured as S corporations, then their income is subject to the effective tax rates illustrated above. Something to think about as the unemployment rates approaches 10 percent.
Canada Runs Surpluses
Most references to Canada these days focus on the pros and cons of their universal health insurance system. Our friends at CATO have noticed something else about our neighbor to the north. While the U.S. is busy operating with the largest deficit in history, Canada is planning for a surplus.
Who knew Canada was running surpluses these days? How did they do it?
First, they cut spending at the Federal level from more than half of their national income to less than 40 percent. That, in turn, produced budget surpluses that were used to pay down their national debt.
Second, they cut taxes rather than raise them. Whereas Canada’s tax burden used to dwarf ours, in the next couple years Canadians will face individual and business tax rates that are no higher, and in many cases lower, than the rates we pay.
What’s the lesson here for S corporations? While Congress and the new Administration search the tax code for new revenues to offset new spending and reduce the deficit, the experience of Canada and others demonstrates that deficit reduction begins with spending restraint -- not tax increases.
Washington Wire
Thursday, May 07, 2009
S Corp Modernization Introduced in the Senate!
Good news for S corporations! S-CORP allies Senator Blanche Lincoln (D-AR) and Orrin Hatch (R-UT) today introduced the “S Corporation Modernization Act of 2009.” This legislation is similar to bills offered in previous Congresses and includes many of our Association’s priorities for the year. In a statement accompanying the bill, Senator Lincoln noted:
“A strong economic recovery will depend on the health and strength of our small business sector,” Lincoln said. “Over four million of our small businesses across the nation are organized as S corporations, including more than 40,000 in Arkansas, and at least 60 percent of the new jobs created over the last decade have come from small businesses. Congress has not updated many of the rules governing S corporations, and as a result many privately-held businesses are not ideally positioned to deal with the current downturn in the economy. We must modify our outdated rules so that these businesses that are starved for capital have the means to expand and create jobs.”
The bill is designed to update and simplify S corporation rules -- some that date back 50 years -- to make it easier for these small and closely-held businesses to raise capital and compete in a difficult economy. The “S Corporation Modernization Act” would:
• Enhance the ability of S corporations to attract and raise capital;
• Make it easier for family-owned S corporations to stay in the family; and
• Encourage additional charitable giving by S corporations and the trusts that hold them.
The whole S-Corp team thanks Senators Lincoln and Hatch for continuing their support of America’s small and closely-held businesses and we look forward to working with them to get these important reforms enacted into law this Congress!
More S Corps than Ever!
Just in time for our advocacy of the S Corporation Modernization Act, our friends at Statistics of Income have published their taxpayer Data Book for 2008 and guess what?
For 2008, there were nearly 4.4 million S corporations, an increase of more than 300,000 firms from 2007 and 1.7 million more than just 10 years ago.
Now if the SOI folks would only update their more in-depth “S Corporation Returns” study, we could dive into these numbers and get a better sense of the source of this growth. The most recent study is from 2003, and newer analysis is long overdue.
Obama Administration’s Tax Hikes
This week President Obama released the details of his proposals to raise taxes on multinational corporations. The two main components of the plan are new limits on deferral and the foreign tax credit and additional enforcement tools targeted at overseas “tax havens.”
Reaction on Capitol Hill was somewhat underwhelming. Senate Finance Committee Chairman Max Baucus (D-MT) referred to the proposals as “controversial,” and noted, “We'll look at it. I don't know how much is going to be enacted this year.” Despite this less than glowing review, we do expect some form of the President’s proposal to move through the Congress this year -- their need for new revenues is just that strong.
What about S corporations? These proposals do not directly affect S corporations, but they are a worrisome indicator of the Obama Administration’s overall approach to business taxation. This Administration is looking to the business community to raise the tax revenues.
During his press conference yesterday, Obama decried the “broken tax system, written by well-connected lobbyists on behalf of well-heeled interests and individuals. It's a tax code full of corporate loopholes that makes it perfectly legal for companies to avoid paying their fair share.”
But businesses don’t pay taxes -- people do -- and the burden of raising taxes on corporations will fall primarily on the workers of those companies. Capital can and does move from one country to the next. For workers, it is just a little more difficult. It’s more difficult for S corporations too.
Washington Wire
Tuesday, April 28, 2009
The Washington Post Discovers Small Employers
The Washington Post this week reported on an issue that shouldn’t come as a surprise for S-CORP readers: President Obama’s tax plans could hurt many of America’s small businesses. Small business owners who report their business profits on their personal income returns (like most small business owners do) are suddenly finding themselves classified as the “richest” Americans, and thereby subject to Obama’s tax increases. The Post explains:
Across the nation, many business owners are watching anxiously as the President undertakes expensive initiatives to overhaul health care and expand educational opportunities, while also reining in runaway budget deficits. Already, Obama has proposed an extra $1.3 trillion in taxes for business and high earners over the next decade. They include new limits on the ability of corporations to automatically defer U.S. taxes on income earned overseas, repeal of a form of inventory accounting that tends to reduce business taxes, and a mandate that investment partnerships pay the regular income tax rate instead of the lower capital gains rate.
The Washington Post is catching up to what S-CORP and its friends have been pointing out for a while now -- if your goal is to reinvigorate the economy, placing additional burdens upon the very business that can help pull us out of this crisis is the wrong way to go. The example used by the Post -- Gail Johnson of Richmond, Virginia -- should give S corporation shareholders pause:
Johnson declined to say whether she voted for Obama. But she said she ignored his tax plans until her husband, who handles real estate and construction for the schools, mentioned it one day. "I've since talked to my accountant," she said. "And, oh, my gosh!"
In a typical year, Johnson's federal tax bill would be about $120,000. But starting in 2011, the higher marginal rates would add about $13,000 a year, Hurst said. Capping the value of itemized deductions at 28 percent would add another $10,000, for a total increase of $23,000.
And Johnson's tax bill stands to grow dramatically if Obama were to revive a plan to apply Social Security tax to income over $250,000 instead of capping it at the current $106,800. Because Johnson is an employee and an employer, she would have to pay both portions of the tax, Hurst said, tacking another $30,000 onto her bill.
That’s a potential $50,000 tax increase for a small employer whose family earns about $500,000 a year, including the income from her business. It’s hard to see how increasing her federal tax bill (this does not include state and local taxes) from around $120,000 to $170,000 would not harm Gail’s plans to invest in her business and hire additional employees.
Budget Plan Finished
On that note, perhaps the most frustrating aspect of the tax increases outlined above is that they simply will not be enough. Federal deficits are going sky-high and higher taxes on the middle-class are all but inevitable. House and Senate negotiators this week put the final touches on the budget outline for next year. For S corporations, three major items stand out: total deficit estimates, the estate tax and the inclusion of reconciliation instructions for health care.
The Congressional Budget Office estimates that the Obama budget, if enacted, would result in deficits of $1.8 trillion, $1.4 trillion, $1 trillion, $658 billion, $672 billion, and $749 billion over the next five years. That’s a cumulative of $4.4 trillion over five years, or $1.7 trillion more than if we simply did nothing over the next five years and maintained current law.
The U.S. government has never run deficits of that magnitude and exactly how the debt will be financed is an open question. To put these five-year numbers in perspective, over eight years of President Bush -- who is rightly criticized for not paying more attention to holding down spending -- debt held by the public increased by $2.4 trillion. The budget offered up by conferees this week has deficit estimates that are smaller than the Obama budget, but not enough to address the question of who is going to finance all that debt.
Regarding the estate tax, the budget agreement calls for maintaining the 2009 rates and exemption levels of 45% and $3.5 million per spouse. While the Senate’s original budget allowed for higher exemption levels and a lower rate, the House ultimately prevailed and stuck with freezing the 2009 rules.
On the reform front, the resolution will include “reconciliation instructions” for health care reform. As S-CORP readers know, reconciliation is valuable to the majority in the Senate because it allows for controversial items to pass the Senate with a simple majority rather than the usual 60 votes.
There are limitations, however, because bills brought to the Senate floor under reconciliation may not increase the deficit outside of the budget window, which means whatever they enact under this budget would have to be sunset after five years.
S corporation shareholders know how these sunsets work -- we have been dealing with the uncertainty of the estate tax repeal sunset for a decade now. How effective could broad-based health care reform be if it goes away in just five years?
Moreover, reconciliation bills may not include provisions with no or little impact on revenues and spending. The core provision in most health reform plans is to create a health insurance “exchange” similar to the Connector up in Massachusetts. This may or may not be a good idea, but it doesn’t have a significant impact on either revenues or spending and would likely fall outside of reconciliation. For a full review of these issues, we recommend reading the analysis of S-Corp ally Keith Hennessey.
Bottom line: Attempting to reconcile health care reform could cost the majority more than it’s worth, especially with Senator Specter now aligning himself with the Democratic Caucus.
Washington Wire
Tuesday, April 21, 2009
Middle-Class Tax Increases on the Horizon
Last Wednesday’s The Hill included a comprehensive overview of the exploding spending and deficit picture and calls into question President Obama’s ability to live up to his long-held promise not to raise middle class taxes. It’s worth a look.
For the past half-year, your S-CORP team has focused on President Obama’s long-stated goal to pay for health care reform and his other spending priorities by raising taxes on American families making more than $250,000 per year, all while cutting taxes for middle-class families.
With the Federal deficit approaching $2 trillion this year, however, just how does one expand government, reduce the deficit, and cut taxes for a large swath of taxpayers – all financed by less than five percent of the population? As The Hill reports, skepticism that the Administration can pull it off is on the rise:
“President Obama’s proposed changes to the tax code, combined with exploding entitlement costs, will lead to ever-growing debt, according to independent estimates. The big question for Obama and his economic team will be whether he can meet the rising costs with increased tax revenue only from small slices of the electorate…Many economists, including some who voted for Obama, do not believe that he can indefinitely avoid imposing tax increases much further down the income scale — on the middle class.”
It is becoming increasingly obvious that taxes on the middle class – not just the “wealthiest” – will need to go up to pay for the Obama Administration’s ambitious goals. Exactly what sort of taxes? Len Burman at the Tax Policy Center thinks a value-added tax is inevitable. Just like France. Great.
CBPP to States -- Tax Your Way to Prosperity
If higher taxes at the Federal level weren’t enough, the folks over at the Center for Budget and Policy Priorities (CBPP) have a novel recommendation for states hurt by the current recession -- balance your books by taxing job creators!
In a report entitled “Reforming the Tax Treatment of S-Corporations and Limited Liability Companies Can Help States Finance Public Services,” the CBPP provides a blueprint for and encourages states to "consider imposing meaningful levies on S-Corps and LLCs as a source of additional revenue to help close the major budget gaps many of them are facing.” Sure, gaps like those created by the extra unemployment checks for folks laid-off when their over-taxed business closes.
Enough said.
Private Enterprise and Job Creation
On a more positive note, our friends at the Kauffman Foundation have taken the new Business Dynamics Statistics series at the Census Bureau and crunched the numbers a bit.
What they have found is presented in a series of short papers that does a great job of demonstrating the critical importance of start-up businesses to job creation. Key findings include:
- More than 100 percent of all net new jobs in any particular year can be attributed to start-up businesses. Or put another way, absent new business creation every year, employment in the United States would shrink.
- Remaining net job growth comes from firms more than a quarter century old. Their job creation levels are low compared to younger firms, but unlike younger firms, surviving older firms create more jobs than are lost when older firms close.
- States differ substantially on the portion of employment attributed to younger companies (less than 3 years old). In the West and Southeast, it’s up to 12 percent, while in the Midwest and Northeast, it’s about 6 percent.
How does this add to our understanding of job creation and job creators? The important role of start-ups and entrepreneurs has been examined for hundreds of years, but who knew that older, more mature firms were a source of net job creation? Findings like this put the whole estate tax debate and the importance of transferring businesses from one generation to the next into a whole new light.
Your S-CORP team is often amazed at the gulf between the rhetoric over jobs and the actions of some policymakers. Everybody talks about the importance of jobs and job creators, but the policies supported by some folks make you wonder just how deep their understanding and commitment goes.
The work at the Kauffman Foundation gives us critical insight into the job creation process. We hope policymakers -- especially those engaged in estate tax discussions -- will pay attention.
Washington Wire
Wednesday, April 08, 2009
Budget Process and Reconciliation
Both the House and the Senate completed their respective budget resolutions last week. The plan now is for the two bodies to get together to resolve any differences and produce a single budget in the form of a conference report. We expect most of those discussions to take place over the next couple of weeks.
One of the key questions for budget conferees is whether or not they will include reconciliation instructions for health care reform and climate change. As S-CORP readers know, the virtue of reconciliation is that it lowers the bar to pass something in the Senate from a 60 vote supermajority to just a basic majority (in this case, half of those present and voting plus Vice President Biden).
As has been noted, currently the Senate budget does not include reconciliation instructions at all while the House included them for health care and education only. This lack of instructions does not mean the Senate leadership had decided to forego reconciliation. Instead, most observers believe they were intent on pursuing a conference strategy whereby the House reconciliation instructions would be expanded to also include the Senate.
By adding the instructions at the last moment in conference, Senate leadership avoids an ugly floor battle on all of these issues. Instead, senators would be given one vote -- up or down -- on the conference report as a whole without the ability to make any changes.
Floor action last week, however, threw a big monkey wrench into that plan, at least as far as climate change is concerned. On Wednesday, the Senate voted 67-31 to support Senator Mike Johanns’ (R-NE) amendment. The amendment reads:
Section 202 is amended by inserting at the end the following: ``(c) The Chairman of the Senate Committee on the Budget shall not revise the allocations in this resolution if the legislation provided for in subsections (a) or (b) is reported from any committee pursuant to section 310 of the Congressional Budget Act of 1974.''
In effect, the Johanns’ amendment is a statement that the Senate should not use reconciliation for climate change legislation. While the provision itself could easily be dropped in conference and reconciliation instructions added in its place, that change would still face the 67 senators who by all appearances are opposed to using this process to consider cap and trade, at least this year.
All the more reason for S-CORP readers to expect health care reform – rather than climate change – to be the first major reform item considered by Congress this year.
Estate Tax Votes
Lots of Senate activity on the estate tax front as well. The underlying budget resolution produced by the Budget Committee assumes Congress would extend 2009 estate tax rules for 2010 and beyond.
That means the top tax rate on estates would hold at 45 percent and the exclusion would be $3.5 million per spouse. That’s a definite improvement over where we started in 2001, with a top rate of 55 percent and an exclusion of $1 million per spouse, but its step back from the one-year repeal currently scheduled to take effect in 2010.
To make the pending compromise a little better, S-CORP ally Senator Blanche Lincoln (D-AR) offered an amendment to allow the Finance Committee to consider a deficit-neutral alternative with a 35 percent top rate and a $5 million per spouse exclusion. The S Corporation Association joined a long list of business groups in support of the effort. That amendment was adopted by the Senate, 51-48 with all Republicans and 10 Democrats voting in support, including Finance Chairman Max Baucus.
What followed then was a classic “what just happened?” moment when the Senate also adopted, 56-43, an amendment by Senator Dick Durbin (D-IL) to create a point of order against any additional estate tax relief (beyond the underlying resolution) that doesn’t include an equal amount of tax relief for families making less than $100,000.
It is possible to support both middle-class tax relief and estate tax relief, so exactly what the implications the Durbin amendment has for future estate tax legislation is unclear. For the moment, we’ll focus on the positive, which is that a majority of the United States Senate is now on record supporting an estate tax deal that is better than the 2009 rules. Given the current leadership in Congress, that may be as good as we’re going to do.
SBA on Effective Tax Rates
Anybody involved in tax policy for a reasonable period of time will pick up on the prejudice of some policymakers and folks at the IRS that S corporations tend to under-pay their taxes. Over the years, the S corporation has been described by some as “tax avoidance schemes” and worse.
Given that background, the findings from a new report commissioned by our friends at the Small Business Administration (SBA) might surprise you. Of the four core business types -- C corporation, S corporation, Partnership, and Sole Proprietorship -- which one pays the highest effective tax rate?
S corporations! By a lot.
The research, conducted by Quantria Strategies for the SBA, looked at a broad sample of firms with under $10 million in gross receipts and found that S corporations pay a significantly higher effective tax rate than C corporations, partnerships, or sole proprietorships.
Average Effective Federal Income
Tax Rates by Legal Form of Organization, 2004
Entity Type Rate (%)
Sole Proprietorship 13.3
Small Partnership 23.6
Small S Corporation 26.9
Small C Corporation 17.5
All Small Business 19.8
Source: Quantria Strategies LLC
To be fair, the effective tax rate for C corporations does not include taxes paid by shareholders on dividends and capital gains. As the researchers note:
… the effective tax rate analysis does not capture the taxes paid by C corporation owners on dividends and capital gains. This will tend to understate somewhat the total effective tax rate of small businesses organized as C corporations, but this bias will tend to be small, particularly because of the fairly low rates of tax currently applicable to individual dividends and capital gains.
So even with the shareholder level tax included, the research suggests that S corporations may shoulder the highest effective rate of any business type.
What’s the source of the higher tax burden? After all, the tax treatment of S corporations at the federal level is mirrored on the tax treatment of partnerships. One possibility is that S corporations may tend to be older, more mature companies that were organized before the emergence of the Limited Liability Company.
Whatever the underlying reason, if your operating premise is that S corporations have a significantly lower tax burden than comparable businesses structured as partnerships or C corporations, you might want to think again.
Jobs and Trade
Our friends at the Kaufman Foundation have a great site devoted to entrepreneurship called growthology that’s worth a look. The site is heavy on the high-tech side of growth, but it’s a great window into how the internet and entrepreneurship are combining to form an incredibly potent partnership.
What caught our eye this month was a new survey of economic bloggers on the best sources of job creation in the economy. “Economic Growth” was number one -- no news there -- while free trade was well down the list. Your S-CORP team finds that strangely disturbing.
If anybody should understand the critical importance of open borders to continued economic growth, it’s economists who use the internet to circulate their writing. What is the internet, after all, but one big open border of products and ideas? Maybe it was just how the questions were worded, but this tepid response on the importance of free trade is one more reason to fear for the future of global commerce.
Washington Wire
Wednesday, March 25, 2009
Congressional Budget Takes Form
Lots of budget related news in recent days with implications for small business taxpayers. First, the Congressional Budget Office weighed in last week with its analysis of the Obama budget outline and estimated that the Administration’s proposals, if enacted intact, would double the overall deficit over the next ten years.
The numbers are truly staggering and should scare any reasonable person who plans to be a taxpayer over the next several decades. Starting with a deficit of around $1.8 trillion this year -- easily the highest annual deficit since we were defeating Hitler -- the ten year total is nearly $10 trillion dollars!
 Obviously, deficits of this magnitude will have the effect of restraining efforts to increase Federal spending while placing additional pressure on Congress to raise tax burdens. That’s challenge number one for S corporation owners.
Next, both the House and Senate Budget Committees will take up their respective budget resolutions today, with the goal of getting a final budget in place before Congress breaks for the Easter recess in a few weeks.
For those who have bothered to look, the actual text of a budget resolution is disappointing. It’s primarily a list of budget functions and related spending numbers, most of which have little or nothing to do with the real process of establishing tax and spending policy.
The real meat in any budget is the total amount of discretionary spending allowed (the Appropriations Committee gets to divide it up from there), the overall ceilings on spending and floors on revenue, any reserve funds designed to protect specific initiatives from Budget Act points of order, and finally, and perhaps most importantly, any reconciliation instructions.
Reconciliation allows permanent changes in tax and mandatory spending to be enacted with a simple majority in the Senate, and usually signals what is really important to the leadership in Congress.
This year, the Senate chose not to include any reconciliation instructions while the House included them for health care reform. Cap and trade only got a reserve fund (see below for more on cap and trade), which reinforces the growing perception around town that of the three big reforms on the table -- health care, climate change, and tax reform -- the Administration and Congress have decided to make health care reform their priority for this year.
Small Business Roundtable
Last week, your S-CORP team spent a morning with House Small Business Committee Chair Nydia Velazquez, several other members of the Committee, and a large percentage of the small business organizations around town.
The point of the meeting was for Committee members to hear directly from small business groups on the issues important to them. Frequently mentioned topics included estate tax reform, expensing, LIFO repeal, depreciation and expensing, and several deductions that are important when businesses have little or no income. Only two groups, your S Corporation team and the National Association of Manufacturers, raised the issue of individual tax rates and how they impact job creators.
Another S-CORP ally -- Bill Rys from the National Federation of Independent Business -- did a great job of making the same case on MSNBC the other day:
Chairwoman Velazquez has been extremely proactive in making the small business perspective part of the debate in the House, especially when it comes to tax issues. Legislation she introduced last Congress included a number of small business friendly provisions, including full repeal of the non-resident alien restriction for S corporations (a priority of the S Corp Association).
With so many tax items on the table for this year and next, we expect to see many of the topics raised last week explored by the Committee in future hearings and really appreciate the willingness of Chairwoman Velazquez to reach out and listen to the concerns of the small business community.
Climate Change Coming
There’s the old line that everybody talks about the weather but nobody ever seems to do anything about it. Apparently, our friends over at the EPA don’t understand that it’s supposed to be a joke.
Last week, they sent the White House recommendations to make an endangerment finding for greenhouse emissions under the Clean Air Act. This finding is in response to the Supreme Court decision in Massachusetts vs. EPA.
If the White House signs off on the EPA’s recommendation -- and all indications are it will within the next couple months -- then that agency will have the ability to regulate an enormous percentage of economic activity taking place in the United States. If whatever you are doing has the potential to emit greenhouse gases into the atmosphere, then the EPA may have something to say about it.
We usually try to stick to tax policy here at the S Corp Association, but this issue is simply too big to ignore. Plus, the solutions being considered in Congress -- primarily carbon cap and trade -- are market based and would have the effect of placing a tax levy on carbon emissions.
Given the choice between the EPA regulating carbon under the forty year old Clean Air Act or Congress addressing it through a cap and trade system, many folks will choose cap and trade. For that reason, the failure of the Budget Committee to reconcile instructions for a cap and trade bill this year does not mean the issue will not come up. The EPA’s action last week may ensure that it does.
Washington Wire
Wednesday, March 04, 2009
Small Business and Tax Rates -- The Debate Continues
The advocates over at the Center for Budget and Policy Priorities (CBPP) issued a new study last week demonstrating, once again, how few “real” small businesses would be adversely affected by raising the top two income tax rates back to their old 39.6 and 36 percent levels. As their study states:
“Some critics of the President’s budget charge that his proposals to roll back tax breaks for taxpayers with incomes over $250,000 would harm small businesses. In fact, only 8.9 percent of people with any small business income have incomes of over $250,000 and, thus, would even potentially be affected by these provisions.”
As S-Corp readers know, this is old ground. One side says only a tiny portion of small business owners pay the top two rates. The other side says that small business owners make up a large percentage of those affected. Back and forth, over and again.
Missing from the debate is a sense of scope. For example, there are only six million or so employers in the United States while there are about 30 million businesses. Under the CBPP’s approach, then, a policy to raise taxes on every single employer in America could be dismissed because it “only” affects twenty percent of all businesses. It’s not the number of taxpayers affected that matters, but rather the amount of total economic activity being taxed.
The reality is, as we’ve pointed out before, an enormous amount of business activity is subject to the top two rates. More than half of all business income is taxed at the individual rates (S corporations, partnership, and sole proprietorships), and more than two-thirds of that income is taxed at the top two rates, which means more than one-third of all business income earned in the United States will be subject to higher tax rates under the President’s plan. As the Tax Foundation points out, more than half the new revenues collected from the higher rates would come from business income.
Moreover, those higher rates are going to be applied to a larger tax base. Under proposals put forward by the President and/or the Chairman of the House Ways and Means Committee, the business tax base will be broadened by eliminating or restricting deferral, LIFO accounting, Section 199 deductions, and many other deductions used by business.
Finally, the President’s budget proposes to reinstate the old PEP and Pease rules. These rules phased out the personal exemptions and capped itemized deductions, respectively. Their net impact is to raise the base on which tax rates apply and would increase the number of taxpayers subject to the top two rates, including those who are small business owners.
So the cumulative result of these proposals would be to dramatically raise both the tax rate and tax base for a large percentage of business income earned in the United States. There’s no way to minimize the negative effect of that.
Obama Budget Limits LIFO
Speaking of base broadening, the budget outlined last week by the Obama Administration calls for repealing LIFO. Exactly how he would structure this repeal is unclear -- the only reference to the policy is back in the revenue tables.
According to the revenue score, the proposal would increase tax collections by $61 billion beginning in 2012, or just about half of the projected tax increase from the provision included in the 2007 Rangel “Mother of All Tax Bills” legislation ($105 billion).
The Rangel provision applied to all businesses -- large and small -- using LIFO inventory accounting rules and gave them an eight year period to pay taxes on their accumulated LIFO reserves. (Keep in mind, repealing LIFO is a double whammy for LIFO businesses -- their annual taxes go up moving forward but they are also on the hook to pay back-taxes on their accumulated LIFO reserves.)
Until the Treasury Department issues its “Blue Book” to describe all the tax provisions in the Administration’s budget, we won’t know for sure how the Obama repeal differs from the Rangel repeal. They might have limited the change to publicly-held companies, or eliminated the retroactive tax on LIFO reserves.
At this point, however, such differences are meaningless, since whatever President Obama proposes will have to go through Chairman Rangel’s committee anyway.
The headline here, which should be noted by every LIFO business and their accountants, is that the President of the United States, the Chairman of the Ways and Means Committee, the Securities and Exchange Commission, the Financial Standards Accounting Board, and the Joint Committee on Taxation have all weighed in recently against LIFO in one form or another.
The case against LIFO is a wholly contrived money-grab, but with that lineup against us, you might want to begin making contingency plans.
Washington Wire/News Flash Archive
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S Corp Modernization Bill Introduced in House
S Corp Modernization Bill Introduced in Senate
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S-Corp Executive Director Brian Reardon's Op-Ed Appears in Baltimore Sun
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