Congressional taxwriters, especially in the House, continue to express interest in raising payroll taxes on active S corporation shareholders as an offset to the tax extender package under consideration, and the business community has responded.
Small business groups urged in an April 28 letter that House Ways and Means Committee Chairman Sander Levin (D-Mich.) abandon a proposal that would raise payroll taxes paid by S corporation shareholders. The proposal is being considered as a possible way to raise additional revenues to pay for the annual tax extenders legislation (H.R. 4213) that includes $31 billion in extensions of popular tax cuts that expired at the end of 2009.
Setting aside the politics of raising taxes on small employers during an economic downturn, another significant challenge confronting tax-writers is the lack of an actual proposal. This idea has been around for years, yet the number of bills introduced with some form of this provision included is few — maybe only the Rangel “Mother” bill introduced in the fall of 2007. The association letters focused on that provision because it’s the only one out there.
A member of the American Institute of Architects had a chance to speak to this issue yesterday when he testified before the House Small Business Committee:
Although the details of the proposal currently under consideration are unclear, it is my understanding that the proposal would expand the application of payroll taxes to active shareholders of S corporations “primarily” engaged in “the performance of services.” I understand that there is concern that some S corporations misclassify salary compensation as earnings distributions in order to avoid paying payroll taxes. However, my fear is that the proposal will entrap millions of small business owners who are legitimately and correctly classifying salary and earnings distributions, with limited public policy benefit.
Yesterday’s hearing was unique in that, to the best of our knowledge, it was the first public testimony on this topic in years. The head of the Joint Committee on Taxation outlined a proposal to apply self-employment taxes to all partnership, LLC, and S corporation income before the Senate Finance Committee, but that was five years ago! We are unaware of any other legislative activity on this topic before last month, when the concept was floated to Ways and Means Members as a possible pay-for for extenders.
Overturning fifty years of tax policy should be a big deal and approached in an orderly fashion, not done at the last minute and on the run.
Payroll Taxes and the 3.8 Percent Investment Tax
With the S corporation payroll tax issue front and center, we’ve been revisiting the adoption of the 3.8 percent investment income tax as part of healthcare reform. There are a number parallels that deserve to be pointed out.
First, both taxes were introduced into the process at the eleventh hour. The 3.8 percent tax was introduced into the debate after both the House and Senate had passed their respective health reform bills and barely a few weeks before the whole package was signed into law. In terms of size and speed, the 3.8 percent investment tax is the LeBron James of the tax world. It’s likely nothing that size ($210 billion over ten years) has moved from introduction to law that quickly in the history of democracy.
Meanwhile, the S corporation tax is under consideration for the extender package. That package has already passed both the House and the Senate and the S corporation provision was not part of either bill. As with the 3.8 percent tax, it hasn’t actually been introduced in any legislation — it’s just a concept. And, like the 3.8 percent tax, this concept has never been subject to hearings or review.
Second, while both taxes are described generically as “payroll” taxes, they aren’t. The 3.8 percent tax is a tax on savings and investment only. It does not apply to wages or other forms of labor income. The same is true for the S corporation tax. For law-abiding shareholders, it’s a tax on returns from business investment.
Third, one of our arguments against the S corporation payroll tax is that it would, for the first time, fund Medicare with taxes on capital rather than labor. Some have suggested that the 3.8 percent tax broke that barrier already — not true.
There is no connection between the 3.8 percent investment tax and Medicare. The House struck the Medicare connection in the manager’s amendment filed the day before the package was adopted. So, while the tax still has “Medicare” in its title, none of the revenues raised by the tax go to the HI or related Medicare trust funds. Calling the 3.8 percent tax a “Medicare” tax, or even a payroll tax, is simply incorrect.
Finally, the 3.8 percent tax applies to just about all forms of investment income — rents, royalties, annuities, partnership income, etc. — except for business income earned by active shareholders of S corporations. Active shareholders of S corporations were explicitly exempted. Yet, the new S corporation payroll tax currently under consideration for the extenders package would effectively reverse this policy decision by applying a 3.8 percent tax to the business income of active shareholders!
Americans Love Small Business
The American economy’s reliance on small, closely-held businesses is unique in the developed world. Most other major economies focus their economic energies on large public corporations, but not the United States. Notwithstanding the financial crisis, the Jeffersonian concept of the yeoman farmer is alive and well and lives on Main Street.
As we’ve pointed out before, this emphasis on small and independent didn’t happen by accident. It was the result of conscious efforts by past Congresses — both Republican and Democratic — to empower Main Street business.
A recent poll by the Pew Research Center suggests this reliance on private enterprise is in synch with the American people. As reported in USA Today:
According to the just-released study by the highly respected Pew Research Center, small business is the most trusted institution in America. More than churches. More than colleges. More than technology companies. And certainly more than labor unions or large corporations.
The results were “striking,” according to Carroll Dougherty, Pew’s Associate Director. “At a time when a lot of institutions are viewed negatively, small business is viewed very positively. What’s really interesting is that large corporations are viewed almost as negatively as Wall Street. The contrast between large corporations and small business is enormous.”
“So much of this survey is partisan,” Dougherty continued. “In this case, it’s bipartisan. It crosses party lines.” 72% of Republicans, 70% of Democrats and 73% of independents say small businesses have a positive effect on the way things are going in the country.
Now if we could only translate those positive vibes into positive legislation.
So we’re still trying to figure out what happened between Thursday morning and Thursday afternoon last week.
On Thursday morning, the Senate Finance Committee released an $84 billion “Jobs” bill draft with all the expected items included — jobs provisions, tax extenders, unemployment and COBRA extensions, etc.
That same afternoon, Senator Reid rejected that approach and offered a “skinny” $15 billion bill instead. He called up the House-passed Jobs bill, offered his skinny package as an amendment, filled the amendment tree, and filed cloture on the new package. The skinny bill includes the Schumer-Hatch payroll tax credit, Section 179 expensing relief, Build America Bonds, and an extension of the Highway bill authority until the end of the year.
What happened? A couple of explanations are floating around town. The first version is Senator Reid got an earful over the contents of the Senate Finance bill and its “Christmas Tree” appearance and elected to go with a less costly approach. Version two is that Reid was unhappy with Senator McConnell’s willingness to allow the bipartisan bill to move forward and introduced the skinny package in response. Version three is that this has been the plan all along — to introduce and pass a series of more narrow, jobs oriented bills. Version two got a plug from the White House. As CongressDaily reported:
White House Press Secretary Robert Gibbs said the president is “eager to sign” the jobs bill as pared down by Reid, and he called its provisions “very akin to what the president had in mind,” adding there will be more bills to refine the jobs strategy.
Either way, the Senate is set to vote on closing out debate on the smaller bill next week when the Senate next reconvenes. As always, cloture requires 60 votes for adoption.
Current favorite topic of speculation: Does Senator Reid have the votes? There is a lot of pent up support for extenders, UI and COBRA extensions, and some of the other provisions dropped in the move to the skinny bill, after all, and the Leader’s move left lots of Senate offices scratching their heads. As The Hill reported this morning:
But since he announced his smaller jobs bill, it has been under siege by Republicans and Democrats alike. Absent political arm-twisting by Senate leaders to bring their rank-and-file in line, opposition to the bill is expected to be bipartisan, sources said.
All of which suggests the Senate will eventually return to the larger, bipartisan package and the votes early next week are merely a diversion. We’ll see.
Finance Hearing on Small Business Taxes and Trade
The Senate Finance Committee has announced it will hold hearings on “Trade and Tax Issues Relating to Small Business Job Creation” next Tuesday. The witness list is TBD, but we understand someone from the U.S. Treasury Representative will testify, in addition to a couple of think tank folks and a small business or two. The hearing’s focus on trade is consistent with the Obama Administration’s new focus on increasing exports. As the President outlined in his State of the Union address:
Third, we need to export more of our goods. Because the more products we make and sell to other countries, the more jobs we support right here in America. So tonight, we set a new goal: We will double our exports over the next five years, an increase that will support two million jobs in America. To help meet this goal, we’re launching a National Export Initiative that will help farmers and small businesses increase their exports, and reform export controls consistent with national security.
If Congress and the Obama Administration are looking for ways to promote small business exports, the first thing they should do is embrace the current tax treatment of IC-DISC dividends. Two years ago, taxwriters in the House and Senate tried to eliminate the IC-DISC under the guise of making technical corrections.
This effort came despite the fact that small business exporting has been an unmitigated “good news” story in the midst of all the recent financial and economic turmoil. Small business exports are up and the IC-DISC helps. Small and closely held businesses who invest in the United States, create jobs here, and export products overseas can use the IC-DISC to help manage their tax burden.
With a major debate over the correct tax treatment of dividends and capital gains on the horizon, we expect the tax treatment of IC-DISC dividends will once again be before Congress. As such, we’re revamping our efforts to ensure the IC-DISC remains in place to help the next crop of small business exporters break into new markets overseas. Let us know if you’d like to help.
Just before Congress left for the holiday break, Congressman Ron Kind (D-WI) introduced legislation to help improve the rules under which S corporations operate. The bill, H.R. 4840, is entitled the “S Corporation Modernization Act of 2007” and was cosponsored by a strong bipartisan set of members, including Representatives Jim Ramstad (R-MN), Stephanie Tubbs Jones (D-OH), Allyson Schwartz (D-PA), Phil English (R-PA), Sam Johnson (R-TX), and Steve Kagen (D-WI).
Congrats to the Kind office for introducing this important legislation and putting together this impressive list of cosponsors. Given that most of our S corporation challenges are tax-related, the fact that six of these cosponsors are also members of the powerful Ways and Means Committee is particularly important.
In addition to the S Corporation Association, seven other national business organizations have endorsed the legislation, including the National Federation of Independent Business, the American Council of Engineering Companies, the Associated Builders and Contractors, the Associated General Contractors of America, the National Beer Wholesalers of America, the Independent Community Bankers of America and the Printing Industries of America.
The bill itself includes reforms important to keeping S corporations competitive in coming years, including built-in gains reforms, expanding S corporation ownership through small business trusts and relief from the so-called “sting tax” passive investment rules. As the “Dear Colleague” letter Representatives Kind and Ramstad circulated yesterday outlining the legislation noted:
“Absent change, America’s 3.8 million S Corporations will be handcuffed with outdated rules that hinder their ability to grow and create jobs. That is why we recently introduced, along with our colleagues Reps. Stephanie Tubbs Jones, Sam Johnson, Schwartz, English, and Kagen, H.R. 4840, the S Corporation Modernization Act of 2007. Our legislation would make needed changes to the tax code to keep S Corporations competitive and would help ensure the continued success of America’s predominant small business model by:
· Modernizing the rules that apply to firms that have selected S corporation status;
· Increasing the ability of S Corporations to access needed capital; and
· Encouraging S Corporations to support charity through small business trusts.
These reforms would improve the ability of S Corporations to broaden their ownership and remove impediments that prevent them from competing on a level playing field here in the United States.”
On the Senate side, Senators Lincoln and Hatch have been working on a companion bill. S-Corp is looking forward to seeing that legislation introduced in the coming session. Given the strong support of these offices on S corporation issues in the past, we believe it is safe to say the S corporation community has never had a more active and broad based set of friends on Capitol Hill.
How can you help? S corporations are going to need all the highly-placed friends they can find in the coming years. Let your members of Congress know how these reforms are important to the success of your business and your ability to continue to grow and create jobs, and ask them to cosponsor HR 4840 as well.
For the past few months, we’ve been tracking the progress, or lack thereof, of legislation to protect taxpayers from the growth of the Alternative Minimum Tax. The two principle points of tension were:
- Conflicting approaches between the House and the Senate. The House, under the leadership of Chairman Charlie Rangel, was pressing to do something permanent. The Senate, on the other hand, made it clear that they were only interested in a one or two year “patch” to temporarily stem the growth of AMT taxpayers.
- Conflicting approaches on how to offset the revenue impact of addressing the AMT, or whether to offset the cost at all. Even a one-year AMT patch would reduce revenues by about $55 billion. Coming up with that level of corresponding, and politically salable, tax increases would be extremely difficult.
A couple of events occurred yesterday that brought these two tensions out into the open. First, Chairman Rangel, for the first time, acknowledged that a temporary AMT patch would be necessary this year. While he still intends to introduce a plan to permanently address the growth of the AMT, perhaps as early as next week, he is now suggesting that package may not be considered until next year. For most observers, the need to take up a one-year AMT patch was clear for some time, but this is the first time the House Ways and Means Chairman has confirmed it.
Second, CongressDaily reported this morning that Senator Conrad—Chairman of the Senate Budget Committee and senior member of the Finance Committee—walked out of a Finance members meeting yesterday when he learned that Chairman Baucus did not intend to offset the $55 billion cost of a one-year AMT patch. According to CongressDaily:
“Conrad stormed out of a bipartisan Finance Committee members meeting, telling reporters that the Baucus plan was “unbelievably irresponsible.” “The answer in that room is, ‘Borrow the money from China and Japan and stick the American people with debt as far as the eye can see,’” said a visibly outraged Conrad. According to other sources in the meeting, Baucus proposed to waive pay/go for the one-year AMT patch, while providing offsets for $45 billion in expiring business tax provisions, which would be extended through the end of 2009.”
Exactly what this means for the expected AMT/Extender/Miscellaneous tax package that needs to move before the end of the year is unclear. Congress will have to address the short-term AMT challenge. Otherwise, about 20 million taxpayers, mostly families with children, will see their taxes increase when they file on April 15, 2008. Two possibilities are a compromise between Baucus and Conrad on the level of offsets in the package, or an effort by Baucus to find votes for his package from the Republican members of his Committee.