Items Remaining on the Congressional “To-Do” List
With Christmas less than two weeks away, Members of Congress would like to leave soon, but a long list of to-do items still stands in the way:
- Health Care Reform: Majority Leader Reid is still pressing to get the Senate bill finished before Congress leaves for the New Year. He still might make it, but the odds against him are climbing rapidly.
- Government Funding: Congress passed a batch of spending bills — termed the “minibus” – this weekend, leaving just the Department of Defense (DoD) Appropriations bill to be done. DoD was held back to carry other items with it, potentially including a debt ceiling increase, extension of unemployment benefits, short term estate tax extension, and tax extenders. The DoD bill is definitely a “must-pass,” but that’s a long and heavy list. Look for DoD to pass with less on board rather than more. The House Rules Committee could move to this legislation as early as today.
- Debt Limit: The government will run out of room under the debt ceiling to continue borrowing in the next couple of weeks. Treasury has the ability to make additional room available, but it is an ugly process that undermines our financial credibility. With the government borrowing record amounts each week, the debt ceiling will have to be raised, possibly with a small increase that would be revisited later next year.
- Deficit Reduction Commission: Senate Budget Committee Chairman Kent Conrad (D-ND) and 10 colleagues have indicated they would oppose a debt ceiling increase unless it’s accompanied by the creation of a bipartisan deficit reduction commission whose recommendations would be brought straight to the Senate floor. Senate Finance Committee Chairman Max Baucus vehemently opposes this idea. Speaker Pelosi does too.
- COBRA & Unemployment: Funding for extended benefits runs out soon, as do extended COBRA benefits.
- Tax Extenders: Numerous tax benefits expire at the end of the year, such as the R&D tax credit and the S corp charitable deduction. The Majority would like to move them this week, perhaps on the DoD bill, but not everyone agrees, and extenders could end up being retroactively extended – yet again – early next year.
- Estate Tax: See below. Very unlikely anything moves this year.
The Washington Post reported this morning that the House “will move the year’s final must-pass piece of legislation without a long-term increase to the national debt and without a large boost in infrastructure funding that was aimed at creating jobs.” Meanwhile, Politico reports that UI and a one-year extension of 2009 estate tax rules now look like they are part of the bill.
Bottom Line: It’s a long list and just how it all gets resolved is anybody’s guess.
More on Estate Tax
The image of a train wreck comes to mind when viewing the prospects for moving some sort of estate tax solution in the next couple weeks.
Absent legislation, the estate tax disappears next year and is replaced with a capital gains tax imposed on appreciated property when the assets are actually sold. It’s more humane and workable than the current estate tax — no valuation issues, no liquidity issues, no taxes imposed when somebody dies — but it’s also not long for this world.
Estate tax repeal is only good for one year and then the estate tax returns in full force in 2011 with a 55 percent top rate and a $1 million exemption.
This makes the current delay and stalemate over some sort of permanent solution all the more inexplicable and troubling. Everybody knew it was coming. Everybody knew Congress would need to take action if they wanted to do something permanent. And yet, here we are with just three weeks left in the year and no real plan for action.
The current approach would attach the estate tax and several other process orphans onto to the last remaining spending bill that needs to get done this year — the DoD Appropriations bill. Also riding on DoD Appropriations will be an increase in the debt ceiling and several other “must pass” items. At some point, all those items could weigh the bill down and prevent its adoption.
Another option being considered is a temporary extension in the current estate tax rules. As Dow Jones reports:
“Obviously, the defense bill is the one remaining appropriation bill and one remaining conference report that will need to be passed before we adjourn for the year,” Hoyer said in a Friday press conference. Adding a temporary estate-tax measure to the bill “is an option,” he said.
“Temporary” could mean several things here, but it’s possible that it might mean a multi-month — not multi-year — extension of the current rules, kicking this issue into 2010. Just how that would appease folks, including Senators Lincoln (D-AR) and Kyl (R-AZ) who would like to see something better than the current rules, is unclear.
Some advocates in the estate tax world argued for having the tax expire next year, arguing that anti-tax members would have more leverage with the tax repealed than otherwise. We’re not sure we agree, but it looks increasingly likely that we’re about to find out.
Rep. Hare Introduces S Corporation Donation Legislation
Companies that donate excess inventory or equipment to charity are allowed to deduct up to twice the basis of the item (not more than the retail value) — but only if they are a C corporation. S corporations need not apply.
Congressman Phil Hare (D-IL) has introduced legislation to fix this disparity. The bill (H.R. 4069) would extend section 170 tax benefits to S corporations, ensuring they also have an incentive to donate items to schools and charities. As your S-CORP team wrote to Congressman Hare:
Now, more than ever, America’s charities are in need of assistance. They are being asked to serve more individuals with fewer resources. In 2008, the United Way saw a 68 percent increase in demand for basic needs such as food, shelter, and clothing. Your legislation would help fill this gap by making S corporations eligible for section 170.
The 111th Congress is half over, but the tax-writing community understands there are numerous tax bills on the horizon that Congress will need to debate and send to the President. Legislation like H.R. 4069 is an excellent candidate to be part of those bills, and we will be working to make sure it is.
S-Corp Modernization Bill Introduced in the House
The legislation is the companion bill to legislation (S.996) introduced in the Senate earlier this year, and represents the priorities of the S Corporation Association for the 111th Congress, including a provision to make permanent the built-in gains reform enacted as part of the larger economic stimulus package adopted earlier this year.
In a statement accompanying the legislation, Congressman Kind noted, “This bill is a commonsense tax code change that will have huge returns in terms of growth and investment for S corporations. Especially in this tough economic time, my goal is to look out for the small and family-owned businesses which drive our economy. This bill speaks to that, reducing a penalty on S corporations, and thus encouraging them to reinvest the savings into growing their business and creating jobs.”
“At a time when small, family and closely-held businesses are struggling to survive, it is encouraging to see that these Members of Congress are dedicated to ensuring the long term viability of S corporations,” said S-CORP Chairman Dick Roderick. “S-CORP would like to congratulate our champions on the timely introduction of this legislation, and express our gratitude for their commitment to the nearly 4.5 million S corporations across the country.”
With legislation now introduced in both the House and Senate, your S-CORP team will be working hard to garner additional support for the legislation. Reforming the rules governing S corporations will allow countless S corporations to reinvest in their businesses and create jobs – something the economy desperately needs at this moment.
S-CORP wishes to thank Representatives Kind, Herger, Schwartz and Reichert for their commitment to closely-held businesses and looks forward to working with these advocates to move this legislation forward this Congress.
Chairman Max Baucus today announced he now has a plan to cover the cost of reforming health care. Past options to cover the cost put forward by the President, the Senate Finance Committee, and the House Ways and Means Committee include:
- A value-added tax
- A rate increase on upper-income families
- A rate increase on Medicare payroll taxes
- Capping employer-provided health insurance benefits
- Capping itemized deductions
- A sin tax on alcohol and soda
None of these options is particularly attractive and, given the challenge of raising this much money, our expectation was that the overall scope of the House and Senate reforms would get smaller as the debate moves into July.
It appears that whittling down process is underway. According to his comments, the Finance Chairman now has in mind a $1 trillion expansion of health insurance coverage (down from previous drafts) to be paid for through an even split of spending cuts and tax increases, including a slimmed down version of capping the employer-provided health care exclusion.
“We are much closer on the scores for a health care reform package than we were at this point last week. We have options the Congressional Budget Office tells us would cost under $1 trillion and are fully paid for,” said Baucus. “Based on these developments, I’m even more confident in our ability to move forward. And as I’ve said before, we will not put out a mark until we are sure we have it right. I’ll continue to work with Senator Grassley and Senators on both sides of [the] aisle to turn these options into a package that can pass the Senate and become law this year.”
The reforms themselves seek to widen health insurance coverage by expanding Medicare and Medicaid while creating a new health insurance exchange for employers and families. The exchange would include both private insurance options as well as some sort of public alternative, and there would be carrots to encourage small employers and low-income families to participate as well as sticks for those who don’t.
The overall cost of these proposals is in the $100 to $200 billion range and would be added on to the $750 billion the federal government already spends on health care programs annually.
But even if Senator Baucus succeeds in offsetting half that cost through spending cuts elsewhere, there is simply no way to efficiently raise $50 billion a year by focusing on individuals making more than $250,000. To raise that kind of money, you need to reach down to the middle class, which is why options like capping the employer-provided health care exclusion are now part of the discussion.
For S corporations, the concern is that the new taxes (whatever form they take) are going to come on top of likely tax increases on income, capital gains and dividends, and estates. These taxes are already scheduled to go up, and with Congress operating at a deficit several times larger than average, they are unlikely to get pared back before they take effect in 2011. Congress simply can’t afford it. Whether Congress (and taxpayers) can afford an expensive expansion of health coverage too is certain to be part of the debate.
Obama LIFO Proposal and S Corps
Speaking of tax increases, the S Corporation Association has been fighting LIFO repeal ever since the issue first emerged as part of a 2006 bill to protect consumers from rising energy prices.
Over the years, we’ve made the case that LIFO is a perfectly legitimate inventory accounting method that can provide the IRS with a more accurate picture of a firm’s income, especially in an environment where prices are rising. (Has anybody looked at long-term Treasuries recently?)
And over the past three years, Ways and Means, Finance, the Joint Committee on Taxation, FASB, and the SEC have all taken positions that, to one degree or another, would undermine the ability of firms to use LIFO in the future.
The most recent shot in the LIFO wars was included in President Obama’s FY 2010 budget. The Obama proposal would repeal LIFO for tax purposes effective in 2012. This change would adversely affect LIFO firms in two respects. First, firms would no longer be able to use LIFO moving forward, likely resulting in higher reported income and higher taxes.
Second, firms would need to pay taxes on their so-called LIFO reserves — an accounting entry that doesn’t reflect real wealth or income. As we’ve observed, for firms that have been on LIFO for any significant period of time, their LIFO reserves are going to be substantial. The Obama proposal recognizes this double hit by allowing LIFO firms to pay tax on their reserves over an eight year period.
Firms will still be hit with a double tax increase for the privilege of switching to FIFO, but at least the second tax will be spread out over eight years. Of course, they’ll also be paying for health care reform and shouldering the 2011 tax increase and paying down record federal deficit…
Obama’s Tax Plans Take Shape
President Obama released a 140-page outline of his budget today that reflects his revenue and spending priorities for the next couple of years.
Chief among these is a major change in federal health care policies. As made clear in his speech to Congress the other day, health care reform is first among the several big reforms on the table and his budget sets aside $634 billion of the estimated $1 trillion he plans to spend on the plan.
To raise the $634 billion, Obama calls for: 1) limiting itemized deductions for families earning more than $250,000, starting in 2011; 2) cutting payments to Medicare Advantage plans; and 3) reducing Medicaid payments to hospitals and drug makers.
Other key proposals include:
- Beginning in 2011, increasing the top two income tax rates to 39.6 and 36 percent respectively while raising rates on capital gains and dividends to 20 percent, consistent with President Obama’s promise to raise taxes on families earning over $250,000.
- Raising $353 billion through the elimination of so-called business loopholes including limiting the ability of firms to defer tax payments on overseas income and LIFO repeal.
- Raising the tax rates applied to so-called “carried interest” earned by hedge fund managers and other professionals.
- Calling for a cap-and-trade program to limit carbon emissions with 100 percent of the credits auctioned off. The resulting revenue would be used to fund clean energy programs and be returned to families and small businesses.
- Locking into place the 2009 estate tax rate and exemption levels.
We will have more reports in coming days, but suffice it to say that the Obama outline, if enacted intact, would result in significantly higher tax rates for many S corporations that would be imposed on a significantly larger income base.
The one piece of good news is that the budget, reflecting the current economic climate, does not attempt to accelerate the rate increases on upper-income families, but rather allows the current rules to take effect whereby the lower rates expire beginning in 2011.
As students of government know, the President’s annual budget submission is required by Congress and is just the first step in the year-long process of establishing the government’s spending and revenue limits. Given the current make-up of Congress, however, we expect the plan outlined today to be the presumptive starting place for congressional deliberations — especially in the House. For S corporations, that means we will be playing a lot of defense for the next few months.
Do Marginal Rates Matter?
Perhaps the biggest tax debate in the next couple years will be over President Obama’s proposal to raise top tax rates back to their pre-2001 levels. Tax cutters argue that higher marginal tax rates will hurt small businesses and the economy as a whole.
Increasingly, we are hearing the counter argument that marginal rates don’t matter. Policymakers on the Hill have told us that and President Obama’s budget outline appears to endorse that notion as well. A back-and-forth on CNBC this morning does a nice job of outlining the debate.
Your intrepid S-CORP team was around in 1993, and we recall that the Clinton rate increases took place in an extremely positive economic and global climate — the Cold War was over, the Thrift Bailout had run its course, and much of the developed world was moving towards market-based policies. Attributing any effect of higher tax rates to economic performance in that climate is a stretch at best.
In many ways, the climate today is just the opposite of what Bill Clinton inherited in 1993, and we are not at all comfortable that higher tax rates applied to a broader tax base will have limited or minimal impacts on economic activity.
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.
More Details, Little Clarity on the Tax Front
Just to keep everybody up to speed, there are a couple recent tax items of note.
First, CongressDaily reports the House may take up yet another extender package prior to the Memorial Day recess. This package reportedly includes energy provisions as well as the expired extenders like R&E and the state and local sales tax deduction. An extension of the Alternative Minimum Tax “patch” does not appear to be under consideration.
Regarding the central issue of whether the revenue impact of the package will be offset by accompanying tax increases, Majority Leader Steny Hoyer is quoted saying, “We want it paid for and it will be paid for.”
If that remains the case, then this exercise is similar to those that preceded it—the House passes a tax package with revenue raisers and the Senate rejects them. A similar stalemate kept Congress in session right up until Christmas last year.
As further evidence of the divide, on Tuesday the White House issued a veto threat against a housing stimulus package to be considered by the House yesterday. The veto is tied to both a new first-time buyer tax credit included in the package as well as the tax increase offset used to pay for the package.
With the Senate and Administration drawing a hard line against offsets on the one side, and the House digging in its heels for offsets on the other, we could be in for a long, post-election ride on tax policy.
On a related note, Senate Democrats are working on a package of provisions to provide relief from rising energy prices. At first glance, the package introduced this afternoon is heavy on taxing and regulating oil companies and light on actual relief for consumers from rising energy prices. The bill:
- Repeals the manufacturing deduction for large oil and gas companies;
- Imposes a 25 percent windfall profits tax on certain oil companies;
- Suspends filling the Strategic Petroleum Reserve; and
- Increases certain government regulatory authority over energy pricing and related securities.
Notably absent from the package is the gas tax holiday proposed by the Clinton campaign. It is also unclear what all the revenues from the windfall profits tax and Section 199 repeal would be used for.
As with so many tax bills being considered by either the House or Senate these days, prospects for this legislation moving beyond the Senate appear to be slim to none. Candidates and Capital Gains CNBC had a nice segment Tuesday morning on the Presidential candidates and the capital gains tax rate. Which candidate has the best plan?
The current rate is 15 percent. Candidate Obama would to raise it to 28 percent, Clinton to 20, and McCain would hold it at 15.
Here at the S Corporation Association, we believe the bias in the next couple years is towards higher rates, regardless of who is President. Current law has the rate reverting to 20 percent in 2011 unless Congress proactively passes a different rate. That means 41 Senators opposed to lower capital gains rates (or rates higher than 20 percent for that matter) can block any effort to legislate something different.
So if Obama is President and wants to raise the tax on capital gains up to 28 percent, Senate Republicans will want to block that effort in defense of a 20 percent rate instead. If McCain is President and wants to keep the rate at the current 15 percent, Senate Democrats should have the ability to block that effort and preserve the 20 percent rate instead. If Senator Clinton is President, Congress can just sit on its hands and the rate will revert to her preferred level.
This analysis applies to several other tax items as well, including the lower individual tax rates, the rate on dividend income, and the estate tax. Absent consensus for a particular change, current law has these items reverting back to their pre-2001 levels in 2011.
All of which suggests the any deviation from current law will require Republicans and Democrats to reach some consensus on a compromise package.
What motivation do they have? Lots. Bi-partisan challenges like the growth of the AMT, $1000 child credit, and the on-going challenge of paying for tax extenders should give the leadership of both parties sufficient incentive to work something out.
Obama and S Corporations
The Texas and Ohio presidential primaries are dominating the news today, so we thought we’d take a look at the candidates’ tax policies and see how they would affect S corporations. We’ll start with Illinois Senator Barack Obama.
So would an Obama presidency be good for S Corps? Here’s a quick summary of his positions and how they might affect Main Street.
Income Tax Rates: Obama supports letting the top tax rates revert to their pre-2001 levels. In other words, the top tax rate would rise from 35 back to 39.6 percent, the 33 percent bracket would rise to 36 percent, and the 28 percent bracket would likely rise to 31 percent.
Capital Gains and Dividends: While the Senator initially indicated he would like to see the tax rates on investment income rolled back all the way to their pre-2003 levels, some campaign advisors are now suggesting that he would support some middle ground rates of around 25 percent for both dividends and capital gains. Either way, he supports increasing rates on investment from current levels.
Estate Tax: Obama has called for a $3.5 million exemption per spouse, and while he has been quiet on what rate would be applied to the remainder, the impression we have is that the law as it exists for 2009 — a $3.5 million exemption coupled with a 45 percent top rate — is probably close.
Social Security Taxes: The Senator has come out in favor of raising the Social Security earning cap from its current $102,000 to an undisclosed amount to help make Social Security more solvent. Under current law, workers pay Social Security taxes (12.4 percent) on the first $102,000 they earn and Medicare taxes (2.9 percent) on the rest. The Obama plan apparently imposes the full combined tax (15.3 percent) on incomes above a certain level, perhaps $200,000.
Alternative Minimum Tax: We can’t find any indication of what he would do about the growth of the AMT.
S Corp readers know that payroll tax issues are of particular importance to our members. Some in Congress and the IRS would like to have payroll taxes apply to all S corporation income. Combine that desire with an increase in the payroll tax wage cap, and you’re looking at a truly historic tax rate increase on thousands of small and closely-held businesses.
Even without payroll tax convergence, the economic plan outlined above represents a large tax hike on S corporations. Right now, C corporations and S corporations pay a similar top marginal tax rate on their undistributed earnings — 35 percent. Under the Obama plan, the rate for S corporations would rise to nearly 40 percent, while the rate on C corporations would remain the same.
Meanwhile, while public corporations are immune to the estate tax, a family-owned S corporation worth more than a few million dollars would be subject to estate tax rates as high as 45 percent when the business is transferred from one generation to the next.
On the tax cut side, there’s little in the Obama plan to encourage S corporations. Rather than broad policies, he is offering instead a series of small tax credits for low-income workers, tuition expenses, a larger child tax credit, and a small savers tax credit. He would also allow seniors to earn up to $50,000 before they have to pay taxes.
On net, tax policy under a President Obama would mean higher taxes for S Corporations, but not on their larger C corporation competitors.
Alternative Minimum Tax & the Candidates
Senator McCain favors of repealing it. Senator Clinton wants to reform it. And Senator Obama has yet to mention it (as far as we can tell).
What is it? The alternative minimum tax, and together with the expiring Bush tax cuts, it presents Congress with the dominate tax policy challenge of the next three years. This chart from the Tax Policy Center does a better job of outlining the AMT challenge than any words we could write.
Simply put, absent change the AMT will take over the individual income tax, with most of the revenue collected by the federal government coming from the AMT. Taxpayers most likely to get hit by the AMT include those with children and those that live in high tax states like New York and California. Since S corporations pay their business tax as individuals, the growth of the AMT has particular importance to our members.
One interesting aspect of the current presidential run is that all three of the remaining viable candidates are members of the United States Senate and will have the opportunity to vote on many of these critical tax issues over the next few months. Repealing the AMT is a $1.5 trillion challenge, so just how the candidates reconcile their other tax priorities with possible Senate votes to protect taxpayers from the AMT this session will be very telling.
Treasury Holds Conference on Business Tax Issues
Treasury Secretary Hank Paulson will hold a one day conference on July 26th to focus attention on the US tax treatment of business income and how it might be improved. The conference will include a larger meeting in the Treasury Cash Room open to the press followed by at least two “break out” sessions for conference participants.
Why focus on corporate tax policy now? The Wall Street Journal, Bloomberg Markets, and other publications have recently observed how the United States’ corporate tax rate is now the highest among our major trading partners. While our corporate tax has stagnated, other countries have been cutting rates. The Wall Street Journal writes:
There’s a trend here. At least 25 developed nations have adopted Reaganite corporate income tax rate cuts since 2001. The U.S. is conspicuously not one of them. Vietnam has recently announced it is cutting its corporate rate to 25% from 28%. Singapore has approved a corporate tax cut to 18% from 20% to compete with low-tax Hong Kong’s rate of 17.5%, and Northern Ireland is making a bid to slash its corporate tax rate to 12.5% to keep pace with the same low rate in the prosperous Republic of Ireland. Even in France, of all places, new President Nicolas Sarkozy has proposed reducing the corporate tax rate to 25% from 34.4%.
What do politicians in these countries understand that the U.S. Congress doesn’t? Perhaps they’ve read “International Competitiveness for Dummies.” In each of the countries that have cut corporate tax rates this year, the motivation has been the same — to boost the nation’s attractiveness as a location for international investment. Germany’s overall rate will fall to 29.8% by 2008 from 38.7%. Remarkably, at the start of this decade Germany’s corporate tax rate was 52%.
Aside from high rates, other aspects of our corporate tax code are also blamed for hamstringing American corporations’ ability to compete, including our policy of taxing US citizens on their income worldwide, rather than just within our borders.
Flow-through businesses like S corporations and partnerships will also be addressed at the conference. Speakers and panelists will be asked to address the impact of the tax code on business formation and structure and what impact the overall tax burden has on entrepreneurial activity. Anytime tax writers get together to discuss the divergent tax treatment of C and S corporations, S-Corp members should pay attention.
The different tax treatment of C versus S corporations and partnerships parallels recent policy discussions of the treatment of hedge fund earnings. When different types of income are taxed at different rates, activity tends to flow into the activity that faces the lower tax. As CBO Director Peter Orzag observed at Wednesday’s Finance Committee hearing on hedge fund taxation:
Much of the complexity associated with the taxation of carried interest arises because of the differential between the capital gains tax rate and the ordinary income tax rate, which creates an incentive to shift income into a form classified as capital gains. Further widening of the differential between the taxation of ordinary income and of capital gains would create even stronger incentives to shift income into the tax-preferred capital form.
Those of us who know Peter can guess how he’d close the gap — raise the tax rate on capital gains and dividends. But that would increase the double tax on corporate income, exaggerate the tax gap between C and S corporations, and put additional pressure on the S corporation community to defend its current tax treatment.
There is another way to close a tax rate gap — cut them for the disadvantaged party. As the Treasury tax conference will highlight, the rest of the world is cutting tax rates and making their corporate citizens more competitive. Will the United States follow?
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