Good news! Last week, S-Corp champions and Ways & Means Committee members Dave Reichert (R-WA) and Ron Kind (D-WI) introduced the latest version of the S Corporation Modernization Act of 2013. Designated H.R. 892, the bill seeks to improve the rules governing S corporations by making permanent the five years BIG holding period, allowing non-resident aliens to invest in S corporations through an ESBT, and reducing the sting of the “sting tax”, among other provisions.
Specifically, H.R. 892 would make needed changes to keep S corporations competitive and ensuring continued success of America’s predominant private business model by:
- Increasing the ability of S corporations to access much-needed capital;
- Modernizing the rules that apply to firms that have selected S corporation status; and
- Easing and expanding S corporations’ ability to make charitable donations.
Said Congressman Reichert of the bill in a press release—which also cites our 2011 Ernst & Young study—issued on Thursday:
This tax relief proposal that would make it easier for S corporations to access capital, compete, and hire new workers by modernizing outdated rules that currently stifle their growth. A 2011 independent study revealed tax law dealing with S corporations affects 31 million Americans as S corporations employ one out of four workers in the U.S. private sector.
“S corporations and similar businesses are responsible for more than half of the jobs in Washington State and across America,” Rep. Reichert said. “As our economy continues to struggle to regain sound footing, I’m proud to introduce bipartisan legislation to help these proven job creators access the capital needed to grow, compete, and get Americans back to work. Working with the Ways and Means Committee toward comprehensive tax reform, I am committed to supporting these small businesses by advocating for pro-growth tax policies.”
The Reichert-Kind legislation presents a realistic set of reforms that would improve the ability of 4.5 million S corporations to access much-needed capital and increase their hiring capabilities. These reforms would improve the ability of S corporations to respond to the current business environment and remove impediments that prevent them from competing on a level playing field at home in the United States.
The bill is consistent with legislation introduced in the past, and we’re confident several of these provisions will be seriously considered this Congress. Thank you Mr. Reichert and Mr. Kind!
It’s been an active week for supporters of an extension of built-in gains (BIG) tax relief.
First, Sens. Olympia Snowe (R-ME) and Mary Landrieu (D-LA) worked to find another way to highlight an extension of built-in gains relief, culminating in a package of small business tax and other provisions that got 57 votes on the floor today.
Together with Sens. Ben Cardin (D-MD) and Pat Roberts (R-KS), our Senate allies have continued to press the need to extend this important access to capital provision for small and closely-held businesses, and we appreciate their efforts.
Second, Reps. Jim Gerlach (R-PA) and Ron Kind (D-WI) introduced a bill last night to permanently extend several important small business provisions that have expired, including BIG relief. In addition to permanently extending the five year holding period for built-in gains assets, the bill, H.R. 6102, would also extend on a permanent basis the:
- 100 percent exclusion of gain on certain small business stock.
- 5-year carryback of general business credits of eligible small businesses
- Alternative minimum tax rules for general business credits of eligible small businesses
- Increased expensing limitations and treatment of certain real property as section 179 property made permanent
- Special rule for long-term contract accounting made permanent
- Increase of amount allowed as a deduction for start-up expenditures made permanent
- Allowance of deduction for health insurance in computing self-employment taxes made permanent
Third, we’ve added some cosponsors to the S Corporation Modernization Act, H.R. 1478, introduced by Reps. Dave Reichert (R-WA) and Ron Kind (D-WI) which also includes a permanent extension of the five year holding period. Rep. Richie Neal (D-MA) and Pete Sessions (R-TX) have been added to the cosponsor list, and we are thankful!
Three cheers for our BIG supporters in the House and Senate! Now, let’s keep our fingers crossed for some action on important provisions like BIG in the near future!
S Corp in the News
Just 173 days until we reach the Fiscal Cliff, and the volume of the debate has picked up sharply.
The S Corporation Association was featured on NPR’s “Marketplace” Wednesday. The story, authored by Mitchell Hartman, focused on the national debate over tax rates and their impact on jobs, and provided S-Corp with a good opportunity to highlight our new Ernst & Young numbers on how many S corporations are harmed by the higher rates.
Mitchell Hartman: I started with a group called the S Corporation Association. They represent business owners who pass their business’s income through a corporation, partnership or sole proprietorship. Then they file a personal income tax return. These are the people whose taxes might go up.
There are 25 million of them, says executive director Brian Reardon.
Brian Reardon: Of those 25 million, 2.1 make more than the $250,000 threshold.
Mitchell Hartman: The other 23 million? They don’t make enough to get dinged under the president’s proposal. Let’s ignore them.
But not all the business owners who make $250,000 actually pay the top rate. A lot of them pay the alternative minimum tax. So the real number whose taxes might go up? Just under a million.
Still, they’re important, says Reardon. Their businesses make most of the profits and employ half of all American workers. But would they slow down their hiring if they had to pay more in taxes?
Our take-away from this story is how much education we still need to do on the impact higher taxes, and particularly higher tax rates, have on the decisions employers make. And, by the way, those 1.2 million AMT-paying business owners aren’t out of the woods thanks to the new healthcare law and the impending 3.8 percent investment income tax hike.
There remains a consistent theme in certain circles of, “Oh, don’t worry. It’s only a small percentage of taxpayers that could get hit.” Well, that small percentage of taxpayers is generating more than 50 percent of pass-through business income. Does America need that much of its economy to be hit with higher taxes? You can guess what our answer is.
We would rather incent them to keep investing and creating more jobs – not less.
New Tax Foundation Numbers
A new report by the Tax Foundation gets it right. Here are the operative paragraphs:
It is often assumed that a tax increase on high-income individuals will have little impact on business activity because only 2 or 3 percent of taxpayers with business income are taxed at the highest rates. While this statistic is true, the more economically meaningful statistic is how much overall business income will be taxed at the highest rates. For example, Treasury data for 2007 indicates that 50 percent of all pass-through income is earned by taxpayers subject to the top two tax brackets of 33 percent and 35 percent.
As Table 1 indicates, the vast majority (66 percent) of pass-through business income was reported by taxpayers earning more than $250,000. Millionaire tax returns earned 36 percent of this private business income while taxpayers earning between $250,000 and $1 million earned 30 percent. Meanwhile, taxpayers with incomes below $100,000 earned 13 percent of all private business income.
These numbers are consistent with the estimates Ernst & Young produced for us earlier this week and make clear the threat raising top rates poses for pass-through business owners in general, and S corporation shareholders in particular – not to mention the broader economy.
Building on the oral testimony of Congressman Dave Reichert (R-WA) at the member’s hearing on tax extenders held by the Ways and Means Revenues subcommittee, Congressman Ron Kind (D-WI) also weighed in to support extending built-in gains relief this year.
An original author of the S Corporation Modernization Act, Kind, in his written comments to the subcommittee writes:
A provision of chief importance is the provision reducing the holding period for Built-In Gains from 10 years to five years for those small businesses known as S corporations. This provision allows our business community to create jobs in the United States. Unlike public companies, these closely –held businesses have little or no access to the public capital markets, and must be able to access their own capital in a timely manner in order to grow their businesses, create jobs, and remain competitive. The S Corporation Modernization Act (HR 1478) that I co-authored with Dave Reichert (R-WA) extends the five-year holding period, and ensures that S-corporations will continue to spur job growth.
Unless Congress extends the five-year holding period, it will revert back to 10-years, and S corporations will be forced to wait an entire decade to access their own capital without penalty.
Meanwhile, the business community has come out in strong support of legislation extending important small business tax provisions, including a shorter Built-In Gains (BIG) holding period. The bill, S. 2050, the Small Business Tax Extenders Act of 2012, is sponsored by Senators Olympia Snowe (R-ME) and Mary Landrieu (D-LA) and features a permanent extension of the 5-year BIG holding period. As stated in the letter:
The bill grants much needed relief to S corporations, by increasing their ability to access capital. It does so by reducing the built-in gains holding period for S corporations. When businesses convert from a C corporation to an S corporation, they have been required to hold their appreciated assets for up to a decade or else face a punitive level of double taxation.
The letter was signed by the U.S. Chamber of Commerce, the National Federation of Independent Businesses (NFIB), the S Corporation Association and 23 other business groups. Main Street businesses know that these days growing our businesses is about access to capital – that’s what this bill is all about, and that’s why the business community applauds the leadership of Senators Snowe and Landrieu.
As always, we appreciate Congressman Kind and Congressman Reichert’s steady support for the critical Built-In Gain provision, as well as the willingness of Senators Landrieu and Snowe to feature the BIG holding period in their small business extender bill. These are the pieces that set the stage for tax conversations on the immediate horizon, so their contributions are invaluable!
In advance of next week’s vote to raise taxes on S corporations by $9 billion, a group of 38 business associations wrote Senate leadership strongly opposing the provision. Signed by S-Corp, the US Chamber, NFIB and other leading groups, the letter details the numerous flaws in the provision. As reported in The Hill:
A coalition of business groups is pushing back against a Democratic proposal to pay for lower student loan rates with tax revenue. The U.S. Chamber of Commerce, along with roughly three dozen other groups, said…the plan “could increase the payroll tax burden on business owners who are already fully complying with the law. For those businesses, this provision represents a tax increase rather than a clarification of existing tax burdens,” the groups wrote in a letter to Senate leaders…
Under current law, S corporations pay taxes through the individual code. Democrats say that some business owners are underpaying their payroll taxes by counting certain income as company profits that have “passed through” to the owner…The Democrats say their proposal, which is scheduled for a vote next week, would end that practice for those making more than $250,000 per year…But Republicans have said that the Democratic efforts would undercut entitlement programs because the payroll tax helps fund Social Security and Medicare.
And this in the National Journal:
In a letter to Senate Majority Leader Harry Reid, D-Nev., and Minority Leader Mitch McConnell, R-Ky., the business groups said they opposed legislation supported by Democrats that would cover the $6 billion cost of keeping interest rates on federal student loans from doubling by subjecting S Corporations to payroll taxes.
They said the bill would make tax collection “less enforceable than current law and will do little to increase compliance.”
The Senate plans to take up the student-loan legislation, with the S Corporation pay-for, next week. … Increasing taxes on S Corporations has long been viewed as a potential revenue raiser, but the offset is unlikely to survive at this time.
As the Journal indicates, they are scheduled to vote on Tuesday on cloture to close out debate on a motion to proceed to the bill. It takes 60 votes to close debate in the Senate, and we expect they are well short of that level of support for raising taxes on closely-held businesses. The underlying student loan issue is popular, however, so assuming this version fails, we expect a scramble by both House and Senate leadership to identify a $6 billion offset that can clear the Senate. Let’s hope the new version doesn’t target Main Street.
Senators Come Up BIG!
On the positive front, four S-Corp champions in the Senate — Senators Cardin (D-MD), Snowe (R-ME), Roberts (R-KS), and Landrieu (D-LA) — wrote to the Finance Committee Chairman this week in support of extending the shorter, five-year built in gains provision.
As Washington Wire readers know, this shorter holding period expired at the end of last year along with all the other so-called tax extenders and it’s been a priority for us to see it renewed. This letter in the Senate builds on the testimony last week in the House by Congressman Reichert (R-WA) and sends the signal that BIG relief enjoys strong support in both bodies.
According to the letter:
S corporations are the cornerstone of the business community. Such corporations are located in every state, participate in a broad range of industries, and employ one out of every four private-sector workers. For many of these Main Street businesses, access to capital is a primary challenge that inhibits their ability to invest, expand, and create jobs. Much like bonus depreciation, the shorter, five-year holding period serves as a powerful incentive for these closely-held businesses to increase their investment efforts.
Could not have said it better ourselves. Thanks to all the Senators who signed the letter. We’ll be working to build on that support this spring and summer.
Three cheers for Sen. Olympia Snowe (R-ME) and Sen. Mary Landrieu (D-LA) for fighting to move extensions of expired tax provisions benefiting Main Street businesses! Senators Snowe and Landrieu introduced the Small Business Tax Extenders Act of 2012 (S. 2050) this week to extend through 2012 those tax provisions benefiting Main Street businesses that were allowed to expire last year – including, an S-CORP priority, built-in gains (BIG) relief. Other provisions include extensions of the:
- Temporary 100 percent exclusion of gains on certain small business stock;
- 5-year carryback of general business credits of eligible small businesses;
- AMT rules for general business credits of eligible small businesses;
- Increased Section 179 expensing limitations and treatment of certain real property;
- Special rule for long-term contract accounting;
- Increased amount allowed as a deduction for start-up expenditures; and,
- Allowance of the deduction for health insurance in computing self-employment taxes.
We appreciate Senators Snowe and Landrieu for recognizing the importance of protecting Main Street businesses and in particular for supporting BIG relief. Senator Snowe’s floor statement gives a great explanation of the importance of this relief measure:
Additionally, the Small Business Jobs Act of 2010 provided for a temporary reduction in the recognition period for S corporation built-in gains tax. When businesses convert from a C corporation to an S corporation, they have been required to hold their appreciated assets for a full decade or face a punitive level of double taxation. In such instances, first the built-in gain corporate tax rate of 35 percent is applied and then all other applicable federal, state and local shareholder tax rates are applied, often totaling near 60 percent in most states, including Maine. In effect, the built-in gain tax locks-up businesses’ own capital and forces them to look elsewhere–a particular challenge for S corporations since closely-held businesses have limited access to the public markets and therefore fewer options for raising needed capital.
Recent law changes temporarily shortened this holding period to 7 years, but that is still too long. By infusing capital–that is, releasing their own capital–this provision in the Small Business Jobs Act, reducing the holding period from 7 years to 5 years, enabled companies that have long been S corporations to redeploy this capital to invest in and grow their businesses. Extending this provision also underscores how vital access to capital is for small businesses, while preserving the original policy intent of the holding period and making it more reflective of the shorter business planning cycles of the 21st century.
We couldn’t agree more, and will continue to work with them and our other congressional allies to advocate for immediate relief.
So the question remains, when is Congress going to deal with the tax extenders that have expired? Will it be during the payroll tax conference? There doesn’t appear to be a clear path on that train quite yet – but the entire business community is with us trying. Or will the issue be saved for broader tax reform? Let’s hope not, as we don’t see real action on comprehensive tax reform coming prior to the end of 2012. As Caroline Harris from the U.S. Chamber testified before the Senate Finance Committee hearing entitled “Extenders and Tax Reform: Seeking Long-Term Solutions” –
The Chamber believes that this Committee and Congress need to act immediately to prevent the negative impact on jobs and the fragile economy that is likely to result from inaction on these annual extenders…
…The Chamber applauds this Committee’s continuing work towards comprehensive fundamental tax reform. However, we believe that the extension of these annual extender provisions cannot be delayed until work on comprehensive tax reform is complete. Taxpayers need stable and predictable rules they can rely upon while that important process is completed.
“Buffett Rule” Bill Introduced
Legislation to enact the so-called “Buffett Rule” has been introduced in the United States Senate. The bill, entitled the “The Paying a Fair Share Act” was introduced by Senators Sheldon Whitehouse (D-RI), Tom Harkin (D-IA), Bernie Sanders (I-VT) and others. According to the authors:
Whitehouse’s legislation would apply only to taxpayers with income over $1 million – including capital gains and dividends. Taxpayers earning over $2 million would be subject to a 30% minimum federal tax rate. The tax would be phased in for incomes between $1 million and $2 million, with those taxpayers paying a portion of the extra tax required to get them to a 30% effective tax rate. The bill also includes language to preserve the incentive for charitable giving.
The Wall Street Journal has a few more details:
The legislation introduced Wednesday by Sen. Sheldon Whitehouse (D., R.I.) would ensure that anyone earning more than $2 million in income each year, including from capital gains, would pay a minimum 30% federal tax rate, Mr. Whitehouse said on the Senate floor Wednesday morning. Wealthy taxpayers who face a tax rate above 30% would still pay the higher rate.
The “fair share tax” would be gradually phased in for those earning between $1 million and $2 million in annual income. They would pay a portion of the extra tax needed to get them to the 30% rate, the lawmaker said.
“This way, we make sure that no taxpayer is ever in a situation where earning an additional dollar of income will increase his or her taxes by more than that dollar,” Mr. Whitehouse said in his remarks prepared for the Senate floor. The new tax would not affect anyone making less than $1 million.
We have several complaints with this effort. First, as we’ve pointed out before, the Warren Buffett’s of the world don’t pay a lower effective tax than their secretaries. Congressional Budget Office estimates make clear that the existing tax code is strongly progressive, with wealthy taxpayers paying significantly higher levels of tax – both in absolute terms and as a percentage of their overall income – than middle-class and low-income Americans.
Second, if enacted, this new legislation would impose a third tax code (and calculation) on individual taxpayers. We already have two codes, the regular income tax and the Alternative Minimum Tax. Now we would have three:
- Regular Income Tax
- Alternative Minimum Tax
- Fair Share Tax
Third, the author takes pains to point out that no taxpayer will face marginal rates of more than 100 percent on additional earnings, but exactly how high would the effective marginal rates reach as a taxpayer’s income rises above $1 million? The dead weight economic loss imposed by a tax increases by the square of the rate hike, so the potential cost to the economy is significant.
Nor is it clear the Fair Share tax would successfully target the rich. The AMT was created four decades ago to ensure that the same taxpayers targeted by the Fair Share tax pay at least a “minimum” amount of tax. Over the years, however, the tax has morphed into a burden on middle- and upper-middle income taxpayers. Actual millionaires are less likely to pay the AMT than a middle-class family with three children living in a high tax state. What’s the guarantee that the Fair Share bill will not make the same progression into the middle class?
Finally, you’ll notice the bill contains an exemption for charitable donations. Think of it as the “Buffett Loophole” to the “Buffett Rule” since one of the more glaring ironies of the whole debate is that Warren Buffett has aggressively planned his estate to avoid paying any tax on most of his accumulated wealth. According to press accounts, he’s given most of his money away to foundations run by his children and Bill Gates. This new “Buffett Tax” won’t touch those transfers.
So we now have legislation to fix a problem that doesn’t exist in order to impose a new tax on a billionaire who’s already figured out how to avoid paying it. In the meantime, real taxpayers with real companies and real employees who aren’t in a position to hide all their wealth inside a foundation will be stuck paying the bill. Not helpful.
Happy New Year! As we’re preparing for the new Congress and the new challenges it brings, we would like to once again thank you for your continued support of the S Corporation Association and to emphasize the important work we do in defense of the S-Corp community.
Perhaps the best that can be said about 2010 is that it showed consistent improvement. The year started with a horrible economy and policy clouds on the horizon. And though some of those policies were enacted—the new 3.8 percent tax on S corporation income, for example—many were defeated and the year ended in a much better place than it began.
Tax hikes were avoided, the rules governing S corporations were improved, and policymakers are better educated about the critical role that flow-through businesses play in creating jobs and economic growth. And through it all, the S Corporation Association was right in the middle, representing our members and protecting the community from policies that would harm our ability to invest and grow.
Key among these victories was the defeat of the $11 billion payroll tax hike on the incomes of certain S corporation shareholders. This policy passed the House earlier in the year and came within one vote of passing the Senate, too. Check out past Washington Wires for the full story, but the short version is the S Corporation Association rallied the business community and our friends and allies in the Senate and—led by Senators Olympia Snowe of Maine and Mike Enzi of Wyoming—was able to ensure that the provision was not included in the final bill. In the process, we helped save S corporation shareholders from higher taxes and higher compliance costs, and ultimately sent a message to the Hill that S corporations, as one of our members eloquently put it, were not to be treated like the government’s private ATM machine.
In addition, the Association successfully championed legislation temporarily reducing the built-in gains holding period from ten years down to five years. This provision has been a multi-year undertaking for us and it builds upon our previous success in lowering the holding period down to seven years in 2010. As a result, thousands of S corporations are free to sell underutilized assets in 2011 and put that money back to work. In an economy starved for capital, what makes better sense than allowing firms to access their own capital?
And finally, S corporations and all flow-through businesses got an early Christmas present when Congress passed a two-year extension of the lower tax rates—including the top marginal tax rates and the 15 percent rate on capital gains—this December. While we advocated for a permanent extension, two years is still one year longer than we hoped for, and it sets the stage for some serious tax policy work between now and the Federal elections in 2012.
Looking forward, our plate is full: extending the five-year built-in gains holding period into 2012 and beyond, fighting efforts to increase S corporation payroll taxes, advocating the repeal of the new 3.8 percent tax, and educating policymakers on the role of Main Street businesses in job creation will be no small task, but not one we’re about to shy away from.
One new issue emerging from the headlines is the push for corporate tax reform this year (see below). We are all in favor of improving the tax code for corporations– as long as it doesn’t hurt the five million or so employers who are not structured as C corporations. That, of course, is the challenge.
Another goal for this year is to pass the full array of reforms included in our S Corporation Modernization Act. This legislation includes several priority items, including allowing S corporations access foreign capital and expanded benefits for S corps that engage in charitable activities.
To champion this bill and our other priorities, we are fortunate that our House team remains intact, with Representatives Dave Reichert (R-WA) and Ron Kind (D-WI) ready to reintroduce our modernization bill early in the 112th. Meanwhile, in the Senate, we are thrilled that our long-time S corporation supporter Orrin Hatch (R-UT) has taken over as Ranking Member on the Senate Finance Committee, and together with Senator Snowe, we are thankful that they will continue to champion our efforts.
Another S-CORP priority this coming year will be to preserve the IC-DISC and its benefits to small and closely-held exporters. Many of you have not heard of the IC-DISC, but if you export, then you know how critical the DISC is to ensuring competitiveness in those foreign markets. Despite being in law since 1984, the DISC has its critics and detractors, but nevertheless, the S Corporation Association will lead an inspired defense in 2011.
Those are the S Corporation Association goals for the 112th Congress. As always, we look forward to working with you in 2011 to defend the greatest vehicle for private enterprise ever invented — the S corporation.
Corporate Tax Reform Front and Center
We are hearing increasing noise that corporate tax reform may see an early push here in the 112th Congress:
- Treasury Secretary Tim Geithner met with the CFOs of 20 major U.S. companies on Friday, discussing rates and the possibility of reform;
- The House Ways and Means Committee will hold its first hearing of the year on tax reform and tax complexity on Thursday, January 20th; and
- President Obama is being encouraged to highlight tax reform in his January 25th State of the Union Address.
For S Corporations, partnerships, and sole proprietorships, the challenges of tax reform were best highlighted by the 2007 bill H.R. 3970 — termed the “Mother of all Tax Bills” by its sponsor Representative Charlie Rangel (D-NY). That legislation would have broadened the tax base for corporations while reducing the top tax rate they pay from 35 to 30.5 percent.
What many did not realize is that the base broadening would have also affected partnerships and S corporations while their rates were scheduled to go up as well! As a result, the Rangel “Mother” bill would have resulted in a dramatic tax burden increase on smaller, privately-held businesses.
The effects of the recent report from the President’s National Commission on Fiscal Responsibility are less clear. Although the Commission called for cutting both corporate and individual rates—a welcomed proposal— it appears that, overall, the report also proposes to shift the tax burden from public companies to individuals and smaller businesses.
As you can imagine, this negative outcome for S corporations has caught our attention, and we are working with other business groups around town to make certain policymakers understand the implications of any reform proposals out there.
Tax reform is great in theory, but if it is used as a cover to raising the overall tax burden, or to shift the tax burden from one sector to another, then policymakers need to be made aware.
In a capital-starved economy, what makes more sense than allowing firms access to their own capital? For one year beginning in 2011, hundreds of thousands of S corporations around the country will be able to do just that, thanks to the efforts of the S Corporation Association and its allies in Congress, particularly Senators Grassley, Lincoln, Hatch, and Snowe and Representatives Kind and Reichert.
On September 27th, President Obama signed into law the Small Business Lending Fund Act of 2010 (HR 5297). Among other business friendly provisions, the bill includes one of the S Corporation Association’s tax priorities, a reduction in the built-in gains holding period. The provision is for 2011 only, but it allows firms that converted as few as five years ago to sell appreciated assets without paying the punitive built-in gains tax.
This success builds on last year’s reduction in the holding period to seven years, and we hope it signals a move towards permanently reducing the holding period below the old ten-year requirement. Ten years is a long time, and in a world where capital is dear, it only makes sense for firms planning new investments to begin by accessing their own capital.
Latest on Tax Outlook
House Speaker Nancy Pelosi (D-CA) has lost control of the tax debate headed into the November elections. Last week, 31 House Democrats signed a letter supporting extending all the individual tax rates, including the top two rates. Then, 47 Democrats wrote Speaker Pelosi calling for keeping dividend and capital gains rates at their current 15 percent. As The Hill reports:
Forty-seven House Democrats have signed a letter calling on Speaker Nancy Pelosi (D-Calif.) to extend the current tax rate on capital gains and dividends. “By keeping dividends and capital gains tax rates linked and low for everyone, we can help the private sector create jobs and allow seniors and middle-class households to save and invest more,” the letter states. Under current law, beginning next year capital gains will be taxed at 20 percent while dividends will be taxed at ordinary income rates that go as high as 39.6 percent.
As a result, a majority of House members now support extending all the current rates, at least temporarily. How is it possible that an issue that’s been 10 years in the making is still unresolved eight weeks before the election? Keith Hennessey has a very good entry on his blog outlining the steps Congress took to get here. As Keith points out:
The sequence of events was:
1. The President picks a big fight on the tax extension and highlights the partisan split;
2. a handful of Senate Democrats signal they’re not onboard; (first warning)
3. the Speaker says “the Senate will go first;” (second warning)
4. the President doubles down on the fight and elevates the conflict by making it the centerpiece of his election-cycle argument;
5. the President’s just-resigned budget director guts the President’s argument in his first New York Times column; (third warning)
6. (same day as #5) the President proposes “new” policies that are ignored by both sides; (confusion reigns)
7. Members return from August recess;
8. 30 House Democrats bail on the President’s position; (final blow)
9. Senate Democrats delay the vote until after the election.
That’s not poor coordination, it’s a total absence of coordination. Going into a highly partisan conflict on the other team’s turf, you either make sure your team is unified first, or when you figure out they’re not, you concede or switch topics quickly. We have seen a strategy and an alliance slowly collapse over a several month period. I don’t understand how the blue team [Democratic] leaders could allow that to happen.
So that’s how we got here. How does the Speaker respond? Last month, we listed the possible outcomes of the rate debate. Congress could:
- Extend all current tax policies (except the estate tax rules) for one or two years;
- Extend just those policies benefiting families making less than $250,000; or
- Do nothing and leave this issue to the next Congress.
The events of the last week have killed option two. There may be a way for the Speaker to move a middle-class-only bill through the House, but we are unable to think of how. There’s talk they may consider the bill under the Suspension Calendar, but suspensions need two-thirds support in order to pass, and the Speaker doesn’t control a simple majority on this issue. Once you lose the majority on an issue in the House, you generally lose.
Option one is becoming increasingly likely, but it would require the Speaker to allow a vote on blocking all the tax hikes when Congress returns in November. She may not control a majority on this issue, but she does control the floor. It would also require an emboldened Republican conference to accept a temporary fix to an issue they probably would like to fight next year.
So while “extending all” is moving up on the options list, we continue to believe the most likely outcome is that this issue will remain unresolved through the end of the year and would be the first order of business for the new Congress.
More on “Big” vs. “Small”
Meanwhile, the debate over how higher rates might impact business continues. On Meet the Press Sunday, Representative Chris Van Hollen (D-MD) made the following point about extending all the tax rates:
They have tried to mask this as an issue with small businesses. Well, it turns out that only 2 percent of small businesses are affected. And when you look at the definition of small businesses, you find that they’re big hedge funds, big Washington lobbying firms, KKR, Pricewaterhouse. Because, under the definition of tax code, anything that’s an S corporation qualifies. So I want Mike to tell us whether he really believes that KKR, whether Pricewaterhouse, whether those are the kind of small businesses that need help? Because that’s the folks that they’re trying to help out.
S-CORP ally and AEI economist Alan Viard warned policymakers about this argument earlier this month. As he wrote in an AEI research piece:
A common argument is that the high-income rate reductions lower taxes on small business. The valid form of this argument, recently explained by Kevin A. Hassett and myself, is that the rate reductions lower marginal tax rates on investment by all firms, including small businesses. Unfortunately, the more common forms of the argument adopt an exclusive focus on small business and obscure the growth implications.
To begin, the argument is often founded on the mistaken premise that small firms are inherently better than large firms, which suggests that the government should interfere with market forces to promote the former over the latter. In a previous Outlook, Amy Roden and I explained that firms of all sizes contribute to national prosperity and demonstrated that small firms do not play a disproportionately large role in job creation. By focusing only on small (more precisely, pass-through) firms, the argument ignores the adverse effect of letting the high-income rate reductions expire on investment by big business. The data cited above suggest that the affected high-income households finance a greater fraction of corporate investment than pass-through investment. The potential tax-rate increase on corporate investment is also larger, at least if the dividend tax cut fully expires.
While in the past we’ve disagreed with Alan on the job creating capabilities of smaller businesses, we agree wholeheartedly with him that allowing the rate debate to devolve into a fight over the size of the businesses affected is simply a distraction. This is a debate about jobs and not raising taxes on employers, regardless of how many people they employ.
On the question of large S corporations, the IRS does a nice job of breaking down the S corporation community by size and industry in its SOI reports. The most recent numbers can be found in the IRS data book while more in-depth figures date back to 2007. Here’s a quick profile we pulled from the numbers:
- There are 4.5 million S corporations (2009);
- The average S corporation has $1.5 million in revenues and $100,000 in income (2007); and
- Assuming a wage of $40,000, the average S corporation has five employees (2007).
These are simple averages, but they provide a general sense of the S corporation world. In terms of revenues, the majority of S corporations can be found in wholesale and retail, followed by construction, manufacturing, and then professional services.
In short, S corporations are large and small. They are active in every industry and in every community, and they provide millions of much-needed jobs to families across the country — even the big ones.
After months of maneuvering, the Senate today adopted H.R. 5297, the Small Business Jobs and Credit Act. This legislation includes a number of business-friendly provisions, including the built-in gains tax relief so important to the S Corporation Community. This is a big (excuse the pun) victory for S corps everywhere!
The bill now moves back to the House, where it could take two paths. On the first path, the House takes up the Senate version, passes it intact, and sends it to the President for his signature. The second path would include House amendments and more floor debate. At that point the bill would return to the Senate, taking up time Congress simply doesn’t have.
For that reason, we expect the House to take the first path, so we should have a signing ceremony–and a five year BIG holding period starting next year–by the end of the month. Good news indeed.
Payroll Tax Dropped from Extenders
During consideration of the small business bill, Finance Chairman Max Baucus (D-MT) sought to add a new package of “tax extenders” to the bill. Republicans blocked the effort, pointing out that this was a wholly new package and that once again the minority was being blocked from offering amendments on the Senate floor.
The core of this package (the fourth or fifth version he has put together over the past year) would extend for 2010 all the provisions that expired at the end of 2009 — the R&E tax credit, state sales tax deduction, the S corporation charitable deduction, etc.; it also includes a number of unrelated spending items.
More good news for S corporations: the payroll tax hike included in earlier versions of the extender package is not included here. With the short calendar we don’t expect this issue to return this year, but it will return. We’ll continue to work to make certain any provision drafted to address this issue is well constructed and doesn’t target law-abiding S corporations.
House Moderates Oppose Tax Hike on Private Employers
As we mentioned in the last Washington Wire, a letter in support of extending all the expiring tax provisions was circulating among moderate Democrats in the House. If enough Democrats signed on, the letter had the potential to change the legislative prospects of blocking the pending tax hikes in the House.
Well, the letter is out, and 31 moderate Democrats signed on– more than enough to signal a tipping point on the issue. As the letter concludes:
We urge quick passage of legislation to extend the tax cuts so that American families and businesses have the certainty required to plan and make informed decisions. The sooner we act, the sooner our nation’s economy will benefit.
Added to the base of Republican support, this level of support from Democrats puts proponents of a full extension within spitting distance of majority support and increases the odds of a stalemate on this issue. After all, how does the Speaker limit extending the tax relief to the middle-class only if a majority of House members support a full extension?
This difficulty was reflected in the Speaker’s comments earlier this afternoon. As The Hill reported:
Pelosi argued at length for allowing the tax cuts on the top brackets to expire, but she could not say whether she had the votes to do so. Asked if there was any chance the top rates would be extended, even temporarily, the Speaker dodged. “The only thing I can tell you is tax cuts for the middle class will be extended this Congress,” Pelosi said.
Meanwhile, our friends on the Senate side are telling us nothing is likely to happen before November, at the least. The House is unlikely to move on this issue until the Senate acts, and the Senate lacks the necessary 60 votes to move anything, so it’s off to the “lame duck” we go.
After the elections, we continue to believe that of the three possible outcomes — no action, protecting the middle class only, or protecting everybody — the most likely outcome is “no action” this year. The next most likely outcome is a temporary extension of all the tax rates.
Legislation limited to extending the middle class provisions was always unlikely to move. This letter makes it less so.
Last night, the Senate voted 60-39 to close debate on a Landrieu amendment to restore the $30 billion lending facility to the small business bill. This amendment was made necessary because earlier in the week, the leadership had dropped the lending facility due to staunch opposition from key swing votes.
The Senate is now on an unrelated bill, but we expect it to resume debate on the small business bill sometime next week – which will likely push House consideration of the bill into September. What’s the prognosis? Here’s the S-CORP Crystal Ball:
- Progress on the bill had been slowed by two points of contention: opposition to the lending facility, and demands (mainly by Republicans) to offer amendments on the estate tax and other tax items. The 60 votes in support of the lending provisions should put an end to that debate. The Senate has worked its will and members will likely move on, at least until negotiations take place between the House and the Senate.
- The next step will be a cloture vote on the Baucus Substitute. This is the tax portion of the bill that includes some very good provisions, including the bonus depreciation and built-in gains relief. There’s a good chance the first attempt to get cloture will fall short, with Republicans holding together in an effort to get votes on key amendments; they support the tax provisions, but want their amendments, too.
- At that point, our crystal ball gets fuzzy. We could end up with an agreement for one or two key votes and then final passage. Or the Leader could continue to block any additional amendments and try one last time to get cloture.
With two weeks left in the session, the Senate has two “must pass” items: the Kagan nomination and the small business bill. Getting both done is doable, but it’s going to require a concerted effort. With all of the bad policies on the horizon for small businesses, a friendly package of tax provisions would be a welcome respite. Here’s hoping the Senate succeeds in moving this bill.
Future of Expiring Tax Cuts: Update
Lots of conflicting news this week on future of the expiring tax cuts:
- “Democrats are considering a plan to delay tax hikes on the wealthy for two years because the economic recovery is slow and they fear getting crushed in November’s election.” The Hill, July 22nd.
- “In a speech on the economy and jobs, House Majority Leader Steny Hoyer (D-Md.) on Friday reiterated his party’s call to extend the Bush middle-class tax cuts and deemed Republicans’ call to extend breaks for the wealthy a ‘mistake [that] would be putting ourselves even deeper into debt.’” The Hill, July 22nd.
- “Senate Finance Committee Chairman Max Baucus (D., Mont.) is eyeing September for possible committee action on extending individual tax cuts that are scheduled to expire at the end of the year, according to Senate aides. Baucus held a meeting with Republicans and Democrats on his committee Thursday evening to begin discussing how to deal with the approaching expiration of the tax cuts. Baucus raised the possibility of a September committee vote, people present said. Aides cautioned that no conclusions about what to do or when to do it were reached at the meeting.” Dow Jones, July 21st.
- “Sen. Kent Conrad (D., N.D.), a senior Senate Democrat with influence over tax and budget policy, said Wednesday that Congress shouldn’t allow taxes on the wealthy to rise until the economy is on a more sound footing. Conrad told Dow Jones Newswires in an interview outside the Senate chamber that Democrats should cancel plans to let the top individual income-tax rates and capital-gains rates rise for the wealthy at the end of this year. He said a tax increase might imperil an economy already weakened by the effects of persistent unemployment and turmoil in European debt markets.” Dow Jones, July 21st.
So, the future of tax policy is clear as mud. What are the possible outcomes for the expiring tax cuts?
- Congress does nothing and all the tax cuts expire;
- Congress adopts a temporary (one- or two-year) extension of the middle class tax relief; or
- Congress adopts a temporary extension of all the tax relief.
It’s not intuitive, but we believe the second option — Congress extends the middle class tax cuts only — is the least likely outcome. It’s counterintuitive because that is the preferred policy of the leadership in Congress and the Obama Administration. It’s least likely because it will be hard for leadership, especially in the Senate, to cobble together the necessary votes. Republicans are likely to oppose en masse, and deficit hawk Democrats will object to the cost.
On the other hand, a one-year extension of all the tax cuts could carve out super majorities in both the House and the Senate, but that would require congressional leadership to move a bill over the objections of a significant portion of their conference. They might, but they haven’t been willing to do that to date.
Instead, faced with the no-win situation of dividing their base, leadership could choose to do nothing. With the legislative clock ticking, we see that as the most likely outcome. Congress does nothing, or makes a half hearted effort and falls short, and all the tax relief goes away.
Predicting is risky and we’ve been wrong many times. We hope we’re wrong this time too.
Just prior to the July 4th break, Senator Chuck Grassley (R-IA) introduced a package of small-business friendly tax provisions, including one of our S-CORP priorities – built-in gains relief! Specifically, the legislation (S. 1381) includes:
- Reducing the BIG holding period from 10 to 5 years;
- Providing a 20 percent deduction for flow-through business income for businesses with less than $50 million in annual gross receipts; and
- Increasing Section 179 expensing, lowering corporate rates, exempting business credits from the AMT, and other items.
As Senator Grassley stated when introducing the bill, “My bill contains a number of provisions that will leave more money in the hands of these small businesses so that these businesses can hire more workers, continue to pay the salaries of their current employees, and make additional investments in these businesses.”
S-CORP is excited to see Senator Grassley include S corporations in this package and we will keep you apprised of any movement on this legislation. While much of the news coming from Capitol Hill lately has been cause for concern for S corporations (see below), it’s great to see that our S-CORP champions on the Hill continue to recognize the importance of our community to growth and job creation.
S Corporations Survive Scrutiny!
Our friends at BNA reported yesterday that the preliminary results of the IRS “tax gap” look into S corporations are in. For the past seven or eight years, the IRS has been conducting a National Research Program that seeks to get a better idea of how much Americans underpay their taxes. For reasons known only to the IRS, the agency has targeted S corporations for closer inspection while largely ignoring other business structures. Regarding the new numbers, BNA reported:
An Internal Revenue Service study preliminarily found that S corporations underreported $50 billion in 2003 and $56 billion in 2004, an IRS employee in the Research, Analysis, and Statistics Division said July 8 at the IRS Research Conference. Drew Johns, citing the 2003-2004 National Research Program S Corporation Underreporting Study, said the net misreporting percentages, or ratios of the net misreporting amounts to the sum of the absolute values of the amounts that should have been reported, for these years were 12 and 16 percent, respectively. The error rates for each year were 69 percent and 68 percent, respectively, he said.
So what’s your S-Corp team’s take on this? Pretty positive, actually. Total compliance by all US taxpayers is around 84 percent (best in the world), so the IRS is telling us that S corporations are better taxpayers than the population in general. Moreover, that 69 percent error rate is eye-catching only until you realize that he’s talking about any error, even small ones that are immaterial to the amount owed.
One question we do have is why the total noncompliance rate jumped from 12 to 16 percent between 2003 and 2004? A 33 percent increase in non-compliance from one year to the next would appear to be a statistical outlier and deserves a closer look.
So to sum up, the IRS spent the last three or four years diving into S corporation tax returns and what they found is that S corporations are solid taxpaying citizens. Combine that finding with the SBA’s report that S corporations shoulder the highest effective tax burden of any business form, and our conclusion is that S corporations should be praised by policymakers rather than targeted for increased enforcement and higher taxes.
Paying for Healthcare Reform
Speaking of higher taxes, July may be the month when taxpayers learn how Congress intends to pay for health care reform. As we’ve reported, the plans in both the House and the Senate have price tags around $1 trillion over ten years.
About $400 billion of that amount will be offset by spending cuts to Medicare and Medicaid, so the remaining $600 billion would need to come from higher taxes. Finance Committee Chairman Max Baucus (D-MT) stated yesterday he needs to identify about $320 billion in new taxes, so he’s apparently comfortable he’s got about $280 billion in revenue raisers ready to go.
Where will the revenues come from? Until this week, the Finance Committee was focused on raising the revenue within the health care world, creating the expectation that some sort of cap on the employer-provided health care exclusion would be part of the mix. It’s health care, after all, and it’s the largest tax expenditure out there. But, it’s losing favor. The Wall Street Journal reported yesterday:
Sen. Kent Conrad (D., N.D.) and others involved in talks on a health bill said Tuesday that the idea of taxing health benefits is unpopular with voters, though they stressed that it hasn’t been completely swept off the bargaining table.
A proposal to cap the exclusion just above the cost of plans for federal employees would have raised $320 billion. It’s now apparently off the table, so that’s the revenue hole Senator Baucus was referring to in yesterday’s remarks.
Given the size of the tax expenditure, we still think some form of exclusion cap will make it into the final bill, maybe with a much higher cap of around $25,000. That “only” raises $90 billion (seriously, who knew that many health plans cost that much?) so other tax increases will have to be added.
What’s on the list? A proposal mentioned in both the House and the Senate would place a 2% surtax on families making more than $250,000. Bloomberg reported on Tuesday:
Two people familiar with closed-door talks by committee Democrats said a House bill probably will include a surtax on incomes exceeding $250,000, as Congress seeks ways to pay for changes to a health-care system that accounts for almost 18 percent of the U.S. economy. By targeting wealthier Americans, a surtax may hold more appeal for House Democrats than a Senate proposal to tax some employer-provided health benefits.
If this surtax is like the one proposed by Chairman Rangel in 2007, it would be assessed against AGI and it would apply to wages and investment income alike. As you can imagine, a surtax like that raises lots of revenue.
Another potential item would expand the Medicare payroll tax to income like capital gains and dividends — and possibly S corporation income too. Like the surtax, the last time something similar was proposed was back in 2007 in Chairman Rangel’s “Mother” bill. That proposal targeted S corporations engaged in services only, though, and would have raised about $9 billion. The new proposal is much broader and raises a reported $100 billion. The S Corporation Association led the effort to educate policymakers why this was a bad idea back in 2007, and you can bet we’ll have something to say about this broader proposal in 2009.
Other items under consideration — seriously or otherwise — include increased taxes on drug companies and insurers, capping the value of charitable and other tax deductions (preferred by the Obama Administration), taxing sodas and other sugared beverages, and increasing reporting requirement by corporations.
When will all this be put forward? We were hearing the House might make its plans known as early as tomorrow with the Senate following next week. The most current word, however, is both releases are going to be pushed back, perhaps weeks in the Senate’s case. As to the question of what will be in the plan, if we had to guess today, we’d say the revenue package could include:
- A surtax on income;
- Caps on charitable and other deductions;
- The soda tax;
- An expansion of payroll taxes to new income; and
- Modest caps on the employer-provide health benefit exclusion (Senate).
Some mixture of these could easily raise $600 billion or more over ten years. Whether they could pass Congress, particularly the Senate, is another question entirely. The fact that several raise marginal tax rates on job creators in the middle of a recession is certain to be a central part of the debate.