President Signs BIG Relief!
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.
Senate Passes Built-In Gains Relief
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.
Small Business Bill — Slogging Through the Senate
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.
S-Corp Priorities Included in Small Business Tax Relief Bill
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.
BIG Reform Included in Finance Committee Mark!
Big news for S corporations! S-CORP champions Senator Blanche Lincoln (D-AR) and Orrin Hatch (R-UT) have succeeded in securing BIG reform in Senator Baucus’ (D-MT) version of a stimulus package! As S-CORP readers know, BIG reform has been a top priority for S-CORP. BIG reform could potentially free up billions in locked-up capital that could be used to buy new equipment, build more plants and hire new workers – exactly what the economy needs during this economic crisis. As the Joint Committee on Taxation describes the provision:
“The proposal would reduce temporarily the S corporation built-in gains holding period from the current 10 year period to a seven-year period for taxable years that begin in 2009 and 2010.”
The Senate Finance Committee is debating the legislation today with the full Senate expected to take up the bill early next week, after which the House and Senate stimulus packages will have to be reconciled. Securing this provision in the Finance Committee mark is a great beginning, and your S-CORP team will be working with our House champions to ensure this provision survives into the final package passed by Congress.
More on Stimulus
One hurdle facing the stimulus package moving through the House is the perception that the fiscal help doesn’t occur rapidly enough. According to the Congressional Budget Office analysis, much of the bill’s $825 billion price tag would not actually get spent or returned to taxpayers until after 2011.
That’s just one more reason to include the BIG relief. As included in the Finance Committee mark, the provision would last for two years, so thousands of companies who converted to S corporation status or acquired another company would be eligible to divest themselves of underutilized assets in the next two years and put those resources to better use immediately. If the economy is suffering from a lack of capital, BIG is a small but important solution.
How many companies would benefit? Analysis from our friends at the Statistic of Income suggests that more than 350,000 firms could be freed to divest themselves of locked in assets. Also potentially benefiting would be those existing S corporations that acquired another company during those years.
| Year | Total S Corps | New S Corps | Newly Formed | Conversions |
| 2003 | 3.3 | 343000 | 253000 | 90000 |
| 2002 | 3.2 | 334000 | 243000 | 91000 |
| 2001 | 3 | 299000 | 206000 | 93000 |
| 2000 | 2.9 | 293000 | 211000 | 82000 |
Even taking into account business failures and other subtractions, the net result is that hundreds of thousands of small and closely-held businesses will potentially benefit from BIG relief in the next two years.
Estate Tax Compromise Under Development
Looks like Congressional Democrats and President-elect Obama’s economic team are already beginning work on legislation to prevent a full repeal of the estate tax in 2010. The Wall Street Journal reports that President Obama’s plan will come out in February as part of his FY 2010 budget proposal and could be acted on by the House and Senate soon after. As the Journal reports:
The estate tax would be locked in permanently at the rate and exemption levels that took effect this year. That would exempt estates of $3.5 million — $7 million for couples — from any taxation. The value of estates above that would be taxed at 45%. If the tax were returned to Clinton-era levels, it would exclude $1 million from taxation with the rest taxed at 55%.
As previously reported by your S-CORP team, while many of the big tax issues confronting Congress may get put on hold until the economy begins to recover, some sort of deal on the estate tax could be one of the few major tax items considered this year.
The question now is how will Senate Republicans respond? Will they accept a deal that extends partial estate tax relief into 2011 and perhaps beyond, or will they hold out for full repeal knowing it will only last for a year?
Small Business Committee Looks at Stimulus
The House Small Business Committee held a hearing this morning on how to best help the small business community in the proposed stimulus package.
Net loss carry-backs, bonus depreciation, and increased small business expensing were among the suggestions made by the Roofers, Associated General Contractors, Independent Bankers, and other groups testifying.
The S-Corporation Association supports all of these provisions. If the economy is suffering primarily from a lack of capital, however, reforming the BIG tax could provide more economic bang for the buck than any of these other provisions. S-CORP Chairman Richard Roderick makes this case for BIG reform to the Committee in a letter to its Chairwoman, Nydia Velazquez.
Finance Committee Membership Taking Shape
In the wake of the Senate’s decision to seat Obama’s replacement, Roland Burris (D-IL), Senate Democrats have announced new committee ratios for the 111th Congress. Designed to reflect the overall ratio of Democrats to Republicans in the Senate, the Finance Committee will have 13 Democrats and 10 Republicans, an overall increase of 2 members (11-10) from last Congress.
This increase is something of a surprise — word was Chairman Baucus had hoped to reduce the size of the Committee to make it more manageable — and it means the Democrats have three new members (including replacing Sen. Ken Salazar (D-CO) who is leaving the Senate to become Secretary of the Interior) while the Republicans will pick two. The new Democratic members were also announced yesterday while we expect to hear from the Republican Leader today. New Democratic Members include:
Potential Republican contenders include Senators Mike Enzi (WY) and Richard Burr (NC). Senator George Voinovich was expected to be considered, but his retirement announcement this week took him out of contention.
Bailout Watch
The ongoing soap opera of the auto bailout continues, with Congress failing to find a means of balancing the needs of Detroit with the concerns of taxpayers and Senate Republicans. As a result, the bailout stalled in the Senate last week and the Administration appears poised to step in and use whatever authority it has — TARP, Treasury, Fed — to provide the companies with the liquidity necessary to survive into the New Year and the next Administration. A nice little Christmas present for the Obama economic team, indeed.
Whatever happens, what is clear is that the plight of Detroit will continue into next year and will provide yet another catalyst for a major stimulus package early next Congress. Just how early may surprise folks.
The Senate Finance Committee reportedly plans to begin formal consideration of a stimulus package January 8th, twelve days before President-elect Obama is sworn in. According to our friends at Dow Jones:
The package is expected to include between $600 billion and $700 billion to jump-start the economy, and congressional leaders say they want to pass it before President-elect Barack Obama takes office Jan. 20.
For those of us focused on the tax code, that means the next vehicle for tax provisions will be drafted over the next couple weeks. How much of the package will be devoted to tax relief?
The panel’s chairman, Sen. Max Baucus, D-Mont., said in a news conference last week that tax cuts for businesses and individuals could comprise as much as half of the package. U.S. House Speaker Nancy Pelosi on Monday estimated the tax portion of the package at closer to one-third.
With that time table in mind and with tax policies on the table, we’re working with our allies on the Hill to ensure that S corporation changes to the built-in gains rules are considered as part of this package. If the economy needs capital, S corporations are sitting on lots of it, and BIG relief would help put it to work. Our Hill champions are working the issue, armed with a letter from our association allies as well as a statement of support from four Senators to their leadership.
New Taxwriters Selected
The combination of Democratic gains and lots of retirees means the Ways and Means Committee will be welcoming at least eleven new faces when it reconvenes for the 111th Congress. Democratic gains shifted the ratio of the overall House close to two-thirds/one third, so Democrats last week set the new ratio of Members on the Committee at 26 Democrats to 15 Republicans — up from 24-17 in the 110th Congress — and selected four of the five new members necessary to fill the seats. New Democratic Members include:
Rep. Danny Davis (IL)
Rep. Bob Etheridge (NC)
Rep. John Yarmuth (KY)
Rep. Brian Higgins (NY)
Note: One of the seats was offered to Rep. Raul Grijalva (AZ) but apparently he turned it down, so an additional name will have to be selected. On the Republican side, Representative Dave Camp (R-MI) was selected Ranking Member following the retirement of current Ranking Member Jim McCrery (R-LA). Republicans did not make any other committee membership decisions but rather put off the appointment of six new members to fill the vacancies when Congress returns in January.
On the Senate side, the report is the same as just after the election, with leadership waiting to see how the election in Minnesota goes before setting committee ratios and picking new members. One new development is President Obama’s selection of Senator Ken Salazar (D-CO) to be Secretary of Interior. His departure from the Finance Committee means Democrats will likely have two new members on the committee next year rather than just one.
Estate Tax Update
We’ve forecast that one of the few tax challenges likely to get addressed in 2009 will be some sort of deal on the estate tax. As readers know, the estate tax is scheduled to go out of existence in 2010 only to return from the grave the following year, looking very much like the youthful and hungry estate tax of the year 2000. This repeal and restoration routine gives both sides a strong incentive to come to a compromise — estate tax apologists don’t want to face its repeal in 2010 and estate tax critics don’t want to see its resurrection in 2011.
We noticed that Len Burman over at the left-leaning Tax Policy Center agrees. In an open letter to President-elect Obama, he raises the red flag over the pending estate tax repeal from the pro-estate tax perspective:
One more thing. You probably want to fix the estate tax before the end of 2009. Otherwise, the tax disappears for only a year in 2010, returning in full force in 2011. We just don’t want to see how greedy potential heirs would respond to the incentives created by a one-year “death tax” holiday…
Yeah, Len just wants to make the world safe from greedy heirs. Thanks. Setting aside the obvious question of who’s greedier — individuals with money or policy makers who want to take it from them — his point just reinforces our notion that the estate tax is going to be front and center of policymakers come next summer.
S Corp Champions Push BIG Relief
As Congress moves forward on the stimulus bill, the S Corporation Association continues to push Built-In Gains tax relief as a vital part of the package. If the economy is suffering from a lack of capital, BIG relief can help S corporations access capital currently locked-in by punitive tax rates.
As part of that effort, S-Corp allies Senators Lincoln (D-AR), Hatch (R-UT), Cardin (D-MD), and Snowe (R-ME) sent Senate leadership a letter today advocating for including BIG relief in the stimulus package. Their letter states:
Our proposal, as included in the S Corporation Modernization Act of 2008 (S. 3063), would provide timely relief for many businesses that have converted to S corporation tax status by reducing the BIG tax holding period from 10 to 7 years. This modest reduction preserves the original policy intent of the holding period, while allowing many businesses that have long been S corporations to immediately access their own capital without penalty.
In the meantime, S Corporation Association Chairman Richard Rodrick submitted a letter to Ways and Means Committee Chairman Rangel (D-NY) advocating for BIG’s inclusion, arguing that the benefits of BIG relief would be significant and widespread:
According to government statistics, hundreds of thousands of S corporations nationwide may be sitting on “locked-up” capital that they cannot access or redeploy due to the prohibitive tax implications of BIG. This “lock-in effect” is widespread and results in these businesses unable to access billions of dollars in assets that could be used to grow the business and hire new employees.
Forcing companies to hold on to appreciated assets for a decade is harmful to their businesses and harmful to the communities in which they operate. Congress is coming back in mid-November. Your S-Corp team will work between now and then to build the case for Built-In Gains relief and get it enacted.
Ways and Means Looks at Another Stimulus
So where is the stimulus in the process? With the elections less than a week away, a large number of House members took a break from campaigning today to consider the struggling economy and a possible fiscal stimulus package.
The House Ways and Means Committee held a hearing this morning (and afternoon — it was a very long hearing) on the need for a new fiscal stimulus package as well as exactly how large and what provisions should be in that plan.
Comments by the Chairman and others suggest the Committee is looking at a $150 billion package made up of extended unemployment insurance benefits, expanded food stamp payments, increased spending on highways and other infrastructure, and select tax provisions.
In the meantime, House Minority Leader John Boehner preemptively put forward an alternative package more focused on tax relief, including doubling the $1000 child tax credit, suspending the capital gains tax, and reducing the corporate tax rate from 35 to 25 percent.
As to the timing of congressional action, it appears the Ways and Means Committee intends to act on a package when Congress returns in mid-November, with the full House taking up the Committee-passed package shortly thereafter.
What happens next is unclear. Whether the Senate can take up and pass something depends very much on the content as well as whether the bill has a chance of getting signed into law. The more spending and less tax relief the package includes, the less likely the President will sign it.
Press Secretary Dana Perino suggested last week that the White House would not propose its own stimulus package and, while it remained open to suggestions by Congress, they were not engaged in discussions and would take a critical view of any package put forward.
We remain open to listening to all good ideas that people want to put forward. What we’ve seen so far in regards to what’s been called a second stimulus package is a series of proposals that actually would not stimulate the economy that are being talked about as something that would assist people — but we actually don’t think it would help the economy.
Another possibility is for the Democratic leadership to wait until the new year and the new president to move a sizeable package through both chambers. A President Obama would be more friendly to many of the spending provisions under consideration than the current President. He would also benefit from the timing of coming into office and immediately signing something into law that is designed to help the economy.
Either way, the content, the size, and the timing of a second stimulus are all on the table right now.
More on Marginal Rates and Small Business
S-Corp allies over at the Tax Foundation have done some more work on the impact raising marginal tax rates will have on America’s small business community. Just to rehash our major points outlined in the past:
- One half of all business income is taxed under the individual rather than corporate tax codes;
- Two thirds of business income subject to the individual tax code is subject to the top two marginal tax rates; and
- 40 percent of all small businesses with between 20 and 250 employees pay the top two rates.
The Tax Foundation paper emphasizes the adverse impact raising marginal tax rates will have on small businesses. As scholar Bob Carroll writes:
The top individual tax rates are particularly important because a disproportionate share of the flow-through income reported by small business owners is taxed at those rates. Among the small share of tax returns that are subject to the top two tax rates, most receive small business income.
Perhaps the most important finding of the new Tax Foundation paper is that of the higher revenues collected by raising the top two individual tax rates, more than one half comes from raising rates on small businesses.
In other words, the core provision in proposals by Senator Obama, Ways and Means Chairman Charlie Rangel, and others is to increase the top two tax rates back to their pre-2001 levels — or even higher — despite the fact that half of that tax increase will be shouldered by small business owners.
Congress to Consider Lame Duck Session Stimulus
What time is it when the market is down, unemployment is up, personal consumption is falling and manufacturing activity is contracting? Time for another economic stimulus package.
Last week, the Ways and Means Committee confirmed it will hold a hearing on the economic stimulus package on October 29th. The specifics have yet to be worked out and several House and Senate Committees are expected to have a hand in crafting the bill. Politico lists the most likely contenders:
It could include a permanent tax cut for lower- and middle-income families, in addition to the expected extension of unemployment benefits, increased money for food stamps and the states and more federal funds for bridges and other transportation projects.
House Speaker Nancy Pelosi and Senate Leader Harry Reid have made clear in recent days that both the House and the Senate will come back for a lame-duck session. The Senate is scheduled to come back for the week of November 17th. Earlier reports from the House indicated they may convene before the elections, but Speaker Pelosi has refused to put a timeline on consideration of a second stimulus package.
Regardless of the timing, Congress is set to consider another stimulus package following the elections and your S-CORP team is committed to ensure our Built-in Gains (BIG) reforms are included. If the business community needs access to capital, BIG reform can help. Here’s some more on Built-in Gains reform:
- Letter from Associations Supporting for BIG Reform
- Letter from S-Corp Chairman Supporting BIG Reform
- Background on “Small Business Growth & Opportunity Act” — H.R. 3874
- Section by section summary of “S-CORP Modernization Act” – S. 3063
Presidential Candidates Revise Economic Plans
In response to the continuing economic crisis, Senators Obama and McCain have put forward new additions to their economic proposals. Here is a quick summary of each of the candidate’s plans.
Obama’s plan would:
- Create a new temporary tax credit for companies that add domestic jobs. Through 2009 and 2010, existing businesses will receive a $3,000 refundable tax credit for each additional full-time employee hired; eliminate all capital gains taxes on investments made in small businesses and start-ups;
- Create a $25 billion Jobs and Growth Fund for infrastructure projects and schools; $25 billion in aid to states, and $25 billion in loan guarantees for auto companies to retool their plants;
- Instruct the Treasury Department to allow those 70 and ½ and older to delay required withdrawals from their 401(k)s and IRAs and allow others penalty free withdrawals of 15% up to $10,000 from IRAs and 401(k)s (although subject to the normal taxes);
- Direct the Secretaries of Treasury and Housing and Urban Development to aggressively modify mortgages; 10% refundable tax credit on mortgage interest for those who don’t itemize their taxes; Reform bankruptcy code to allow for broader mortgage restructuring; Put in place a 90 day foreclosure moratorium for homeowners who are trying to pay mortgages; and
- Extend Treasury’s authority to purchase assets aside from mortgage backed securities to unfreeze other markets for student loans, car loans and other types of loans.
McCain’s plan would:
- Increase the amount of capital losses which can be used in tax years 2008 and 2009 to offset ordinary income from $3,000 to $15,000;
- Reduce the maximum tax rate on long term capital gains to 7.5 percent in 2009 and 2010;
- Allow up to $50,000 to be withdrawn from IRAs and 401(k)s at a tax rate of 10% through 2008 and 2009; Suspend required withdrawals from IRAs and 401(k)s for seniors over 70 ½;
- Purchase mortgages directly from homeowners and mortgage servicers and replace them with an FHA-guaranteed fixed-rate mortgage.
Whichever plan moves forward – Congressional, Obama, or McCain – will add to the deficit in fiscal year 2009 and put additional pressure on Congress to raise overall tax revenues. As the Washington Post reported Saturday (about two weeks after your intrepid S-Corp team alerted its readers), the federal budget deficit is currently projected at $650 billion in 2009, and is likely to go up from there — to $1 trillion or more.
Bailout Update
The Treasury Department announced over the weekend that it would infuse $250 billion directly into the banking system, starting with approximately $125 billion targeted at nine major institutions including Goldman Sachs and Citigroup.
Combined with the coordinated efforts of central banks around the world, the announcement appears to have successfully staunched the record erosion of equity prices over the past two weeks. Interest rates and other indicators are moving in a positive direction as well, indicating that the credit markets may finally loosen up.
If you are keeping track, the latest move by Treasury is just the last in a remarkable and unprecedented list of actions by Treasury and the Fed to respond to the ongoing credit crisis. These actions include:
- $250 billion to recapitalized banks;
- $40 billion per month to purchase troubled assets;
- FDIC insurance raised to $250,000;
- Coordinated rate cuts around world;
- Inter-bank loan guarantees;
- $100 billion Fed intervention in repurchase agreement markets;
- Fed pays interest on balances;
- $300 billion to insure mortgages;
- Mark-to-market accounting changes; and
- Fiscal stimulus.
All told, it is about $2 trillion worth of liquidity, capital, and insurance backstops for the markets! Assuming it works and restores function to the credit markets — and we certainly hope it does — how all this will unwind is wholly unclear. It took a year for the Treasury and the Fed to reach this level of intervention. It will likely take several times that to get back to square one.
Another Stimulus Package Considered
There is more talk of a potential stimulus package. The most recent NFIB survey released today signals continued recession levels in America’s small business community. Meanwhile, today’s Politico outlines the possible response for Congress when they return November 17th:
A post-election session of Congress seems all but certain next month with House Democrats beginning to focus on more permanent tax breaks for middle- and working-class families, along with shorter-term spending proposals to stimulate the economy.
Treasury’s action this weekend reaffirmed what economists have been saying for months — the economy suffers from a lack of capital. Banks and businesses alike have seen their capital reserves dwindle in the past year to the point where investors worried about their solvency.
It is not $700 billion, but changing the rules governing the Built-in Gains tax would free up billions in locked up capital that could be used to build new plants, buy new equipment, and hire new workers — exactly what the economy needs right now. As S Corporation Association Chairman Richard Roderick wrote back in May:
According to government statistics, hundreds of thousands of S corporations nationwide may be sitting on “locked-up” capital that they cannot access or redeploy due to the prohibitive tax implications of BIG. This “lock-in effect” is widespread and results in these businesses unable to access billions of dollars in assets that could be used to grow the business and hire new employees.
If Congress does take up another stimulus package in November, we will be in there pushing for BIG reforms.
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