Good news for investment and S corporations! The House yesterday adopted a five-year holding period for built-in gains as part of a larger small business tax bill; the temporary one-year provision would take effect in 2011. The bill now heads to the President and should be signed into law on Monday. As BNA reported:
The House voted 237-187 Sept. 23 to pass a small business bill (H.R. 5297) that includes $12 billion in tax cuts. The legislation includes a one-year extension of the 50 percent bonus depreciation provision created in the American Recovery and Reinvestment Act (Pub. L. No. 111-5), an increase in tax code Section 179 expensing limitations up to $500,000, and an increase in the phase-out threshold amount to $2 million for 2010 and 2011.
Reducing the holding period on built-in gains has been an S-CORP priority for years. This Congress, Senators Blanche Lincoln (D-AR), Orrin Hatch (R-UT), Chuck Grassley (R-IA) and Olympia Snowe (R-ME) led the charge by introducing this provision in their respective bills and working to see it enacted on the Senate side, while Ways and Means members Ron Kind (D-WI) and Dave Reichert (R-WA) led the effort in the House.
As a result of their work, tens of thousands of small corporations will have the freedom to access their own capital starting next year. In an economy short of capital, what could be better?
Rate Bill, Estate Bill, Stalled in Senate
The week began with the Senate awaiting legislation from Finance Chairman Max Baucus (D-MT) to extend many of the expiring tax provisions. According to press reports, the bill would:
- Extend the lower rates and tax credits for families making less than $250,000;
- Make permanent a 20 percent rate for both capital gains and dividends; and
- Clarify the rules for the estate tax for 2010 and beyond.
But its Friday now, and Majority Leader Reid made clear yesterday that the Senate would not take up the Baucus bill or related legislation before it adjourns for the elections, which will most likely occur at the end of next week.
This decision was foretold in recent days by a growing number of Senators saying that there just isn’t time to take up the issue. DowJones quoted one Senator yesterday saying, “I can see the value in that (taking up the bill), but because of the short time frame, it may be difficult.”
Your S-CORP team would point out that time isn’t short. Congress sets its own schedule. It’s not like farming, where if you delay you might miss the growing season. If they wanted to get this done, they would stay. The Chairman’s own comments are more to the point: as he told BNA yesterday, “We’re ready, but people want to leave town.” We’re with the Chairman.
So while everybody focuses on the top few tax rates, there is a growing chance that Congress may fail to act at all, allowing all the tax hikes to take place. Economist Mark Zandi examined the effects of inaction in his recent research. According to Zandi:
Based on a simulation of the Moody’s Analytics macroeconomic model, an across-the-board tax increase would precipitate a double-dip recession during the first half of 2011; the hit to after-tax income would undermine fragile consumer confidence and spending … Employment would decline throughout much of 2011, bottoming out some 8.6 million jobs below its late-2007 peak. Unemployment would remain near double digits into late 2012. Under this scenario, the economy does not return to full employment until 2015, eight years after the Great Recession began.
If the Senate needs to stay in an extra week to avoid a massive tax hike on families and businesses, it’s in their power to stay, and they should.
Last week, the S corporation community was put on high alert when we received word that an S corporation payroll tax increase similar to the provision from the old Rangel “Mother” bill (H.R. 3970) was being discussed as an offset to the extender package. The “Mother” provision (see Sec. 1211) would apply payroll taxes to all the service-related income of active shareholders of S corporations primarily engaged in service businesses. While we anticipate that the language of any new provision will differ somewhat from its 2007 predecessor, the general concept remains the same. As CongressDaily noted:
Sources familiar with the House Ways and Means and Senate Finance discussions said applying payroll taxes to certain S corporation profits could raise anywhere from $10 billion to $15 billion, depending on how it is structured. Revenues in that ballpark would go a long way toward closing a $30 billion gap tax-writers need to fill to pay for extensions of numerous expired provisions.
An earlier proposal floated in 2007 was estimated to raise $9.4 billion over a decade by subjecting S corporation and partnership income earned from providing services to payroll taxes, although the new healthcare law would raise the Medicare portion of the tax beginning in 2013 for wealthier earners. The 2007 proposal was scaled back from an earlier option outlined by the Joint Committee on Taxation that would have applied the payroll tax to all S corporation income, estimated to raise $57.4 billion over a decade.
Team S-CORP has had to fight this battle in the past, and we have been in to discuss this provision with Ways and Means on several occasions to get a better idea what they have in mind. Letters sent back in 2007 on behalf of S-CORP as well as our allied trade associations should give you a better sense of the history of this issue.
The future of this particular effort is still very much up in the air. Our communications with the Hill suggest there continues to be strong interest in legislating on this issue — you could characterize this as just one more legacy item left to us by former Senator John Edwards and his law practice — albeit it may take place on a bill other than extenders.
We have pledged to work constructively with taxwriters on a resolution to this issue, but unless they are willing to dramatically pare back the “Mother” provision to target only bad actors, it is going to be very difficult for business groups to support yet another tax increase on their members.
Stay tuned. More to come.
Latest on Dividends
Whither Tax Rates? The Hill’s On the Money Finance & Economy Blog had an excellent discussion this month on the topic, focusing on the future of dividend rates.
As On the Money notes, “President Barack Obama has proposed that the current rate of 15 percent on dividends be extended for most taxpayers. He’d raise the tax on dividends for individuals making $200,000 or more and families making $250,000 or more to 20 percent. There are several reasons to think wealthier taxpayers will get hit with a much higher tax.”
Meanwhile, The Hill mentions that one possible outcome would be for the dividend tax to fall somewhere between the current 15 percent rate and the top rate on ordinary income. Any divergence from the baseline, however, would require positive action by Congress. As The Hill observes, that’s not something to be taken for granted:
Finally, the lesson of the expired estate tax also has dividend-tax watchers nervous. Congress was expected to extend the estate tax last year, but instead let it expire when Republican and Democratic senators could not reach a compromise. The estate tax is set to kick in again in 2011 at a much higher rate if no action is taken this year.
Also at play is a possible House-Senate dynamic. Our impression is Senate leadership would like to keep capital gains and dividends taxed at the same rates, while their House counterparts are more comfortable seeing the rate on dividends go back to 39.6 percent.
In the end, we believe process will dictate outcome here. The recently enacted “pay-go” rules require Congress to offset any reduction in the dividend tax rate below 39.6 percent for 2011. Exactly what tax increases would Congress use to offset dividend tax cuts for folks making more than $200,000? We don’t know either, and expect the tax hikes already imbedded in current law will take place as scheduled.
Long To-Do List
Tax policy is in danger of becoming that honey-do list that never gets done. The traditional tax extenders — R&E tax credit, state sales tax deduction, etc. — all expired at the end of last year and, almost five months later, are still expired. Legislation to extend them is stuck between the House and Senate without a pay-for, yet (see above).
Meanwhile, the estate tax fix that was supposed to be done last year — before the tax took its one-year sabbatical — remains stalled in the Senate. Efforts to negotiate some sort of permanent fix are actively taking place in the Senate, so there’s hope. As with the extender package, however, the hold-up is primarily over offsets.
There’s also the most recent in the growing line of “jobs” bills being considered by Congress this year. The latest one passed the House under the banner of a “small business jobs” bill, despite the fact that most of its benefits went to Build America Bonds. We expect the Senate to take up a bill that’s more small-business oriented soon.
Finally, there’s the burning issue of all those tax cuts expiring at the end of the year.
With that as background, reasonable folks might ask themselves “What’s the plan?” Ways and Means Committee Chairman Sander Levin (D-MI) addressed this question earlier this month, stating he hopes to complete work with the Senate on both tax extenders legislation and the House-passed small business bill by the end of May, telling reporters, “These bills are a critical priority for the leadership of this Congress and the president…These are jobs bills … and we need to get these done.”
According to BNA, Levin met with Senate Finance Committee Chairman Max Baucus (D-MT) to discuss the two bills, but the two “did not discuss efforts to address the estate tax, which expired at the start of 2010, and no detailed plans have been set for how lawmakers will deal with the middle-class tax cuts of 2001 and 2003 that are set to expire at the end of the year.”
Your S-CORP team has numerous member companies who are intently interested in Congress moving forward on both the estate tax and the expiring tax provisions. We are five months into 2010 already. It’s time for Congress to act.
Built-In Gains in Play
Team S-CORP spent the last couple weeks on the Hill, educating members and staff on the virtues of reducing the built-in gains (BIG) holding period.
When a company converts to an S corporation, it must hold onto any appreciated assets for 10 years or face a punitive level of tax. This tax effectively locks up these assets, preventing the company from selling them and putting the resources to better use. We’ve raised this issue before, but allowing private companies access to their own capital makes lots of sense in an economy where capital is scarce. It also reflects the reality of today’s shorter lifespan for key business investments.
Last year, Congress agreed and included a shorter, seven-year holding period in the stimulus package. That seven-year period expires at the end of 2010 and needs to be made permanent. A five-year period would work, too. Last summer, Senator Grassley (R-IA) introduced legislation to reduce the BIG tax holding period to five years which we view as tremendously valuable to S corporations struggling to raise capital.
With the Senate actively considering provisions to help small businesses grow and create jobs, a shorter BIG holding period is going to give you more job-creating umph than any other tax provision we know. It would benefit Main Street firms located in every state and every sector of the economy and should be included in the final package.
2009 started off with a bang when we successfully secured temporary relief from the built-in gains (BIG) tax as part of the economic stimulus package adopted in February. With the enactment of that bill, firms that converted to S corporation status or existing S corporations that acquired other businesses between the years 2000 through 2003 are now able to dispose of their built-in gains assets without paying a punitive level of tax.
Built-in gains relief was a great win for S-CORP and we plan to build on that success by pushing for permanent BIG tax relief in 2010, as well as a broad range of other tax reforms important to the S-CORP community. Many of these items are included in the S Corporation Modernization Act (S. 996, H.R. 2910) introduced in both the House and the Senate in record time last year. This legislation forms the core of our S-CORP advocacy and would:
Enhance the ability of S corporations to attract and raise capital;
Make it easier for family-owned S corporations to stay in the family; and
Encourage additional charitable giving by S corporations and the trusts that hold them.
Congress is expected to consider multiple tax bills in 2010 and we will continue to push to get these and other reforms included. Based on our success in 2009, I am confident our S-CORP team and its allies on the Hill are well poised to deliver.
As we move into 2010, however, to say there is significant “policy risk” facing the S-CORP community is a true understatement. Never have the rules and rates that govern our community been under more pressure. For a community whose existence is defined by the tax code, we plan to step up our efforts to defend those rules and make certain policymakers in Washington understand the economic importance of closely-held businesses.
One challenge we face in 2010 is ensuring that closely-held businesses are treated fairly when subject to the estate tax. We expect the estate tax to return in 2011, if not sooner, and some influential members of Congress would like to charge family-owned businesses a premium when they are part of an estate. This idea is simply un-American and wrong, and S-CORP took the lead in 2009 and put together a coalition of 15 major trade associations to educate lawmakers on the need to protect family-owned businesses from arbitrary valuation rules. Estate valuation issues will be front and center in 2010, and S-CORP will continue to fight the good fight.
Pressure on marginal rates is another challenge in the coming year. Rates are set to increase in 2011 without congressional action. Meanwhile, all of the proposals on the table to date would raise them even further. S-CORP has spent years educating policymakers on the massive amount of economic activity currently being taxed at individual rates — closely-held businesses create more jobs and produce more income than public firms — and raising their taxes at a time of economic stress is a recipe for a double-dip recession. We are currently working on new options, and policies, to get this message heard.
Finally, for the growing ranks of exporters in the S corporation community, we plan to continue our efforts to block tax increases on closely-held exporters. S-CORP led the charge to block such an increase in 2007, and with dividend and capital gains tax rates in play in 2010, we expect another effort to single out exporters for higher tax rates.
Now more than ever, it is imperative that policymakers on Capitol Hill and at the White House are reminded of the important role the S corporation plays in our nation’s economy. Through our Washington Wires, recruitment of trade associations and other allies, shoe-leather advocacy, and media outreach, the S Corporation Association continues to do just that.
To assist in these efforts, your S-CORP team relies on a long list of Hill allies with a history of supporting closely-held businesses. Members like Senators Blanche Lincoln (D-AR), Orrin Hatch (R-UT), Chuck Grassley (R-IA), Olympia Snowe (R-ME), Mike Enzi (R-WY) and Ben Cardin (D-MD) and Representatives Ron Kind (D-WI), David Reichert (R-WA), Nydia Velazquez (D-NY), Allyson Schwartz (D-PA), Wally Herger (R-CA) and Danny Davis (D-IL) and others have supported our efforts in the past, and we plan to rely on their support and expertise in the coming year as well.
The S Corporation Association is the only organization in Washington D.C. exclusively devoted to promoting and protecting the interests of America’s 4.5 million S corporation owners. To carry on with this important work, we need your continued participation and support. Let us know of the tax issues most important to you and spread the word to other closely-held businesses. Your increased participation can make an important difference to our continued success.
Sometimes, Congress meets a deadline. Six weeks ago, congressional leadership and the new Obama Administration had set out the Presidents’ Day recess as the deadline for getting the economic stimulus package to the President’s desk.
With the House’s vote on final passage today and the Senate expected to consider the bill as early as this evening, all indications are they’ll make it. Here’s a quick summary of the $789 billion package as outlined by the conferees:
- $301 billion in family and business tax relief (down from $350 billion in the Senate bill).
- $70 billion in renewable and energy efficiency provisions.
- $140 billion in higher payments to states through Medicaid and a new State Fiscal Stabilization Fund.
- Extended unemployment and increased food stamp benefits.
- $45 billion in highway and transit funding.
- $35 billion in Health IT, basic scientific research, and comparative effectiveness.
Built-In Gains Relief in Final Stimulus Package!
A provision to provide built-in gains relief to hundreds of thousands of S corporations is part of the final stimulus package moving through Congress. The President is expected to sign the package into law early next week.
Once he does, firms that converted to S corporation or existing S corporations that acquired other businesses in the years 2000, 2001, 2002 and — beginning next year — 2003 will be able to dispose of built-in gains assets without paying the punitive level of tax.
This provision, which originated in the Senate and was championed by Senators Blanche Lincoln (D-AR), Orrin Hatch (R-UT), Olympia Snowe (R-ME), Mike Enzi (R-WY) and Ben Cardin (D-MD), survived the conference process between the House and Senate due in large part to our S-CORP Champions in Congress including key House advocates Representatives Ron Kind (D-WI), Steve Kagen (D-WI), Nydia Velazquez (D-NY), Allyson Schwartz (D-PA), and Danny Davis (D-IL). Our House allies sent a letter to House Leadership this week urging for the inclusion of the Senate’s BIG relief provision.
S-CORP Chairman Dick Roderick noted, “Built-in gains relief has been a priority of the S Corporation Association for years. Congress’ adoption of this provision is the result of lots of hard work educating policymakers on the importance of allowing closely-held businesses access to their own capital.”
Roderick also had words of praise for Senator Lincoln and Representative Kind. “Senator Lincoln and Representative Kind have worked tirelessly to improve S corporation rules. They really understand the important role closely-held businesses play in economic growth and job creation.”
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.
Good news for the S corporation community! Senators Blanche Lincoln (D-AR), Orrin Hatch (R-UT), Gordon Smith (R-OR) and Ben Cardin (D-MD) introduced the S Corporation Modernization Act of 2008, S. 3063, last evening.
The introduction of this legislation helps us move forward on our list of priority reforms, including critical relief from the built-in gains and passive investment rules while expanding the list of potential S corporation shareholders to allow for direct investment from foreign sources and retirement vehicles.
As S-Corp readers know, Senator Lincoln has been a long-time champion of our issues. In her statement introducing the bill, she made clear the importance of these reforms:
“Because Congress has not updated many of the rules governing S corporations– such as allowing better access to capita – I am concerned that these privately-held businesses are not in the best position to deal with the current downturn in the economy. We must modify our outdated rules so that these businesses that are starved for capital have the means to expand and create jobs.”
In a press release sent out by the S Corporation Association, Chairman Richard Roderick praised Senators Lincoln and Hatch for introducing this legislation.
“While the S corporation community has grown, many of the rules governing their operations have remained the same. This legislation makes important and timely improvements to those rules, making it easier to our members to raise capital, plan their estates, and create jobs. Senators Lincoln and Hatch are to be congratulated for their long-term commitment to helping S corporations succeed.”
Finally, a broad coalition of trade associations and S-Corp allies sent the Senate sponsors a letter of support. Signed by the S Corporation Association, the National Federation of Independent Business, the Association of Manufacturing Technology, the Independent Community Bankers of America, the Printing Industries of America, the Associated General Contractors, the National Beer Wholesalers Association, the Plumbing-Heating-Cooling Contractors-National Association, the National Association of Manufacturers, the U.S. Chamber of Commerce, and the American Council of Engineering Companies, the letter states:
“Well into the 21st century, America’s most popular form of small-business corporation deserves rules adapted to the economy we live in today, not fifty years ago. The S Corporation Modernization Act would ensure the continued success of these businesses by increasing access to capital by reducing S corp ownership restrictions, modernizing the rules that apply to firms that have selected S corporation status, and encouraging philanthropy by S corps through small business trusts.”
The introduction of S. 3063 means we now have companion S corporation reform bills in both the House and the Senate with the sponsors sitting on the critical House Ways and Means and Senate Finance committees. With six months of legislative session to go and numerous must-pass tax issues to resolve, we are gearing up to ensure that the priorities of the S corporation community are represented in any tax bill headed to the President for his signature.
As the news reported over the last couple of days, Administration and House leaders have agreed to a package of temporary tax relief to provide the economy with fiscal stimulus. As reported, the package would reduce revenues by about $150 billion over ten years. The major provisions are:
- Rebate checks (tied to a temporary cut in the 10% tax bracket) to families—$600 for singles making less than $75,000 and $1,200 for couples earning less than $150,000.
- Fifty percent bonus depreciation for business investment through the end of 2008.
- An increase in small business expensing (section 179) from $125,000 to $250,000.
- A temporary increase in the conforming mortgage limit from $417,000 to $625,500.
Hill leadership has pledged to take up the agreement quickly and get something to the President in the next four weeks.
Couple of observations: the negotiations took place between the Secretary of Treasury and House Leadership. Senate Leadership chose not to be part of the mix. Apparently, in an effort to encourage a conclusion to the discussions, Senators Reid and McConnell removed themselves from the room and pledged to take up whatever the remaining negotiators could agree to.
Pledging to take up the House-passed package, however, is the not the same as guaranteeing its adoption without changes. We expect to see considerable effort on the Senate side to amend the agreement. Republicans will likely attempt to strike the income caps for families receiving checks while Democrats will push to add extended unemployment insurance benefits (UI) to the mix. The Senate Finance Committee has scheduled a markup of its own stimulus plan—details uncertain—for next week.
One challenge facing advocates of extending UI is that unemployment continues to be historically low at just 5 percent. Two decades ago, that was considered full employment. And while the percentage of long-term unemployed workers is higher than in the past—meaning those workers who have lost their jobs are having a more difficult time finding a suitable replacement—weekly jobless claims are hovering around 300,000 for the past couple weeks, nowhere near the 400,000 to 450,000 level usually associated with a deteriorating job market and recession.
Nonetheless, expect the UI issue to be fully debated in the Senate, and if history is any guide, an extension of UI benefits is likely to be part of the package that goes to the President. Perhaps a trade combining the UI extension with the elimination of the income caps is in the cards.
Built-In Gains and Stimulus
As the Senate considers what else should go into the stimulus agreement worked out this week, the S Corporation Association and its allies have been pushing to add relief from the built-in gains tax (BIG) as a means of freeing up much needed capital.
According to government statistics, hundreds of thousands of S corporations nationwide are potentially sitting on assets that they would like to sell in order to grow their businesses and create jobs, but they can’t because of the prohibitive tax implications of BIG.
This “lock-in effect” results in billions of dollars in assets being used at less than their full potential. This can have a particularly adverse impact on S corporations since, as closely-held businesses without access to the public markets; they have fewer options for raising capital. In an economy where a one or two percent decline in growth can mean the difference between a recession and a moderate, mid-term slowdown, eliminating that lock-in effect and allowing those assets to become fully productive again could be significant.
Bipartisan legislation to reduce the harmful impact of the built-in gains tax has been introduced on the House side by Congressman Steve Kagen (D-WI) and Ways and Means Members Ron Kind (D-WI), Jim Ramstad (R-MN) and Phil English (R-PA). The bill, H.R. 3874 would reduce from 10 to 7 years the holding period required for built-in capital gains.
On the Senate side, Finance Committee Members Lincoln, Hatch, and Smith all have a history of supporting this reform, and we expect to see legislation introduced in that body in the near future. If the Senate is intent on attaching additional items to the stimulus deal, this is one provision that promises big benefits to the economy and job creation relative to its revenue impact.
November has been an active and exciting month for the S Corporation Association and we have much to be thankful for:
- TWO S corporation modernization provisions approved by the Senate as part of a larger tax package
- Efforts to oppose increased payroll taxes on S corporations continue to be successful
- Congressman Clay Shaw along with Congressman Jim Ramstad introduce S corporation reform legislation in the House
- Joint Committee on Taxation estimates revenue loss on built-in gains tax relief legislation
Before adjourning for a three-week recess, the Senate approved its reconciliation tax package that includes two provisions from the Subchapter S modernization and reform bill that we have been working on: increasing the 25% passive income threshold to 60% and eliminating the rule terminating S corp election if an S corp has excess passive income for three consecutive years AND allowing entities donating S corp stock to charitable organizations to receive a deduction for its fair market value.
Senators Blanche Lincoln (D-AR) and Orrin Hatch (R-UT) worked diligently with us to have this passive income relief included and we are continuing to aggressively work this issue to have this provision signed into law this year. We are mobilizing other trade associations with S corp members and interests for a meeting on November 29th to engage their help with our strategy to take the sting out of the sting tax. Please let me know if you have a specific interest in this provision and if you would like to participate in the meeting by phone.
We are also extremely pleased to report that last Friday, Representatives Clay Shaw and Jim Ramstad introduced the Subchapter S Reform Act in the House. We will now work to add cosponsors to the bill. We hope this will give us momentum once the House approves its tax reconciliation bill (that is limited to basically extending expiring tax provisions and does not include S corp provisions) and the very different Senate and House bills head to a Senate House conference committee, so that the S corp provisions in the Senate bill survive the conference and can be signed into law.