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.
Last week, your S-CORP team sent a letter signed by 22 of our association allies to members of the House and Senate, urging them to cosponsor legislation to replace the dated rules that have governed S corporations for over fifty years. As the letter notes:
These outdated rules hurt the ability of S corporations to grow and create jobs. Many family-owned businesses would like to become S corporations, but the rules prevent them from doing so. Other S corporations are starved for capital, but find the rules limit their ability to attract investors or even utilize the value of their own appreciated property.
Well into the 21st century, America’s most popular form of small-business corporation deserves rules adapted to today, not fifty years ago. The S Corporation Modernization Act would ensure the continued success of these businesses.
Earlier this Congress, House Ways and Means Member Ron Kind (D-WI) and Senate Finance Committee Members Blanche Lincoln (D-AR) and Orrin Hatch (R-UT) introduced the “S Corporation Modernization Act of 2009” (H.R. 2910 and S. 996) in their respective chambers.
The legislation, designed to update and simplify the rules governing S corporations, enhances the ability of S corporations to attract and raise capital, makes it easier for family-owned S corporations to stay in the family, and encourages additional charitable giving by S corporations and the trusts that hold them.
In the coming weeks, S-CORP will be ramping up its efforts to gather additional support for these bills. At a time when America’s job creators struggle through the difficult economy and the Federal government struggles with massive deficits, smaller, targeted reforms like these are an attractive means of helping Main Street without breaking the bank.
Health Care Reform Outlook & S Corporations
Just about everybody agrees the political landscape has shifted to the point where, while there were once 218 House votes in favor of a reform package, now there are nowhere near that many.
This lack of support is evidenced by the Rube Goldberg-nature of the current efforts to resurrect reform and move it through the Congress. One popular idea is for the House to pass the Senate bill, and then take up a reconciliation package of items to “fix” what’s wrong with the Senate bill.
We are skeptical anything like that happens. Health care reform is unpopular and members are nervous and tired. Moreover, this approach would require House members to “vote on faith” that the Senate would follow-through and adopt the fix. There is rarely a lot of trust between House members and the Senate under normal circumstances, and these are not normal circumstances.
Our expectation is for the hand-wringing to continue for a month or so and then for other pressing items like the jobs bill and the budget to push heath reform aside.
For S corporations, it is hard to regret the demise of this particular reform effort. We have refrained from weighing in on the merits of health care reform — it is a little outside our focus, after all — but the impact of paying for health care reform was clearly going to be a negative.
The House bill would have raised marginal rates on upper-income S corporation shareholders by 5.4 percentage points, while the Senate bill would have increased the Medicare HI tax from 1.45 percent to 2.35 percent — not a direct shot at S corporations, but it would have increased pressure on the IRS and others to change the payroll tax treatment of S corporation income.
And before talks broke down, House and Senate negotiators were seriously considering tossing out those items and expanding the tax base for payroll taxes to include capital gains, dividends, interest income, and S corporation income instead. As the Los Angeles Times wrote:
Democratic congressional leaders are considering a new strategy to help finance their ambitious healthcare plan — applying the Medicare payroll tax not just to wages but to capital gains, dividends and other forms of unearned income. The idea, discussed Wednesday in a marathon meeting at the White House, could placate labor leaders who bitterly oppose President Obama’s plan to tax high-end insurance policies that cover many union members. It could also help shore up Medicare’s shaky finances, and the burden of the new tax would fall primarily on affluent Americans, not the beleaguered middle class.
It would have fallen on the beleaguered S corporation community, too. Moreover, these increases were going to take place when taxes on S corporations (and other flow-through businesses) already were going up. Current law has the top income tax rate returning to 39.6 percent at the beginning of next year, and we anticipate the President will propose to keep these rate hikes in place, at the very least.
Finally, with health care reform out of the way, taxwriters on the Hill will have time to address some of the many tax items that were pushed aside last year, including tax extenders and a broader tax reform effort. As BNA noted this morning:
Last December, Rangel told a group of executives that he planned to press his case for tax reform at the conclusion of the health care debate.
It appears health care reform is over, so we expect Congress to refocus on tax policy this year.
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.
The cost of the estate tax falls heavily on family businesses and farms. The cost comes not only from paying the tax itself, but also from estate tax planning costs. Resources diverted from businesses to pay for estate tax planning would be better invested in business operations and expansion.
The goal of the FBETC continues to be repeal of the estate tax, but this legislation will provide much needed additional relief above the current law. The higher exemption level and reduced rate will lessen the burden of the estate tax and provide family businesses and farms with more capital to reinvest in their business.
As S-CORP readers know, there are three key questions to any estate tax solution — what is the rate, what is the exclusion, and what is the base? Earlier this month, your S-CORP team was joined by fifteen other business groups to make sure Congress doesn’t increase the estate tax base for family owned businesses. This legislation would lock in the other two and help set the stage for continued estate tax relief in the future.
Taxes Are Going Up
The consensus in Washington is that taxes are going up. Just how high is debatable, but higher tax rates appear to be baked in whatever policy cake we are eventually served. So what does the Obama Administration think about higher rates? Obama economist Austan Goolsbee was on CNBC the other day and has this exchange on health care reform after CNBC Squawk Box host Joe Kernen pointed out marginal rates in his home state of New Jersey would soon approach 60 percent:
Goolsbee: We need health care reform so that small business can thrive. You know very well in every small business survey the unaffordability of health care is the thing that small business says is the number one barrier to their growth.
Kernen: But is there a marginal rate were you would say this is a disincentive for small businesses. Is there somewhere where you’re willing, where the administration is willing to draw the line?
Goolsbee: I don’t like high marginal rates, Joe, I agree with you. But to say the marginal rate is going to be 60 percent is totally nuts.
But Joe is right. Marginal rates are going much higher than what they were under Clinton if the House health care reform is adopted. Here’s a rough summary of tax rates in 2011 if the House health care bill is adopted:
|Rates in 2011*|
|Health Reform Surtax||5.4|
(S-CORP ally Bob Carroll at the Tax Foundation issued a nice paper last summer summarizing these concerns and pointing out that high marginal rates are an extremely inefficient means of raising tax revenue.)
The good news is that it is still just 50/50 that the House surtax will survive in health care reform and make it to the President’s desk. The bad news is that won’t matter much, since the fiscal pressures facing Congress are almost unprecedented. As former CBO Director Doug Holtz-Eakin testified before the Senate Budget Committee earlier this week:
Any attempt to keep taxes at their post-war norm of 18 percent of GDP will generate an unmanageable federal debt spiral. In contrast, a strategy of ratcheting up taxes to match the federal spending appetite would be self-defeating and result in a crushing blow to economic growth.
In other words, we’re stuck between the proverbial rock and the hard place. Federal spending levels far exceed their post-war averages and unless taxes are raised to match them, the resulting deficits will be enormous. On the other hand, raising taxes by the necessary amount will, at best, retard economic growth and job creation for years to come.
And what is team Obama doing about this? Downplaying valid concerns about higher marginal rates and supporting legislation that will add more than $1 trillion to our spending obligations over the next ten years.
Update on Healthcare Reform in the Senate
Senate Majority Leader Harry Reid (D-NV) is still working to combine the two health care packages passed by the Senate Finance Committee and the Health, Education, Pensions and Labor Committee. Word is the cost of the plan may be going up. He also is reportedly looking at raising the threshold for the “high cost” plan from $21,000 to $25,000, resulting in lower tax collections from the excise tax. As a result, the Majority Leader is apparently looking into a new way to help pay for the cost of the package by applying Medicare taxes to non-wage income earned by couples making over $250,000. As Bloomberg News reports:
Reid’s proposal would apply Medicare taxes to non-wage income earned from capital gains, dividends, interest, royalties and partnerships for U.S. couples earning more than $250,000, the aides said. He’s also considering an alternative that would simply increase the 1.45 percent Medicare tax on salaries of couples who earn more than $250,000, one of the aides said.
This new pay-for is an attempt to scale back the previously proposed tax on so-called “Cadillac” health plans. So what does this mean for S corps? More pressure on rates, higher taxes on business income, and less capital to invest and hire new workers. And these hikes would take place during the worst economy since at least 1980 and maybe before. What are they thinking?
Of interest to S-CORP readers, the bill to be considered by the House (H.R. 2920) specifically exempts four policies from the Paygo rules:
- Adopting the doctor payment fix proposed to Medicare;
- Extending the higher exemption levels under the Alternative Minimum Tax;
- Extending select tax cuts from the 2001 and 2003 tax bills; and
- Extending the 2009 estate tax rules to 2010 and beyond.
In other words, Congress is seeking to ensure it pays for any tax cuts or spending increases, except for the four policies listed above. As the Congressional Budget Office reported, “In effect, that rule would allow the Congress to enact legislation that would increase deficits by an amount in the vicinity of $3 trillion over the 2010-2019 period without triggering a sequestration.”
The theory behind the exemption is to allow Congress room to continue “current policy” in each of these areas. The $1000 child tax credit, for example, expires at the end of 2010. Extending the credit would reduce revenues by $243 billion over ten years. H.R. 2920 shields this cost and the cost of other similar policies from Paygo.
What does this signal for estate taxes? The policy exempted in H.R. 2920 is an extension of estate tax rules for 2009. As the bill outlines:
(B) with respect to the estate and gift tax, assume that the tax rates, nominal exemption amounts, and related parameters in effect for tax year 2009 remain in effect thereafter without change;
The exempted policy is consistent with the Obama Administration’s budget proposal and was scored by the JCT to reduce revenues by $243 billion over ten years. What doesn’t get exempted is any further reduction in the estate tax beyond the 2009 rules.
For example, Members have been working on a compromise that would lower the estate tax rate to 35 percent and increase the exemption to $5 million per spouse. That’s certainly better than the 2009 levels of 45 percent and $3.5 million but, under H.R. 2920, the increased revenue reduction from the compromise would need to be offset with tax increases elsewhere.
Where would Congress find offsets to a potential estate tax compromise? Both the Obama Administration and Congressman Pomeroy (D-ND) have proposed targeting family businesses for higher taxes by inflating the value of their estates. Exactly how much revenue this would raise is unclear, but family businesses need to be on alert.
A package that lowers rates below 2009 levels while inflating the tax base has the potential to raise, not lower, estate taxes on family-owned enterprises and may be no compromise at all.
Do Small Businesses Really Create All Those Jobs?
A recent paper by Alan Viard at the American Enterprise Institute raises two fundamental questions: Are smaller firms responsible for creating a majority of new jobs in our economy and is there a bias towards smaller firms in the tax code? With small businesses at the epicenter of the debate on reforming our health care system, clearing the record on these questions is critical.
The “small businesses do not really create all those jobs” argument has been around for a long time. However, it is usually raised by folks with a history of supporting Big Government and Big Business. Thus, having someone with Alan’s background on the other side is a new twist.
Regardless of who asks the question, however, the answer is the same. Yes, small businesses really do create all those jobs. Here’s what the Small Business Administration’s (SBA) Office of Advocacy writes:
Since the mid-1990s, small businesses have created 60 to 80 percent of the net new jobs. In the most recent year with data (2005), employer firms with fewer than 500 employees created 979,102 net new jobs, or 78.9 percent. Meanwhile, large firms with 500 or more employees added 262,326 net new jobs or 21.1 percent.
Critics argue that this analysis suffers from several flaws, including how to best classify firms using longitudinal data. For example, if a firm begins at 450 employees and grows to 550, the SBA says that’s 100 jobs created by small business. But if the same firm shrinks from 550 to 450 employees the next year, it’s a loss of 100 jobs for big business. Classifying the firm based on its initial size biases the results in favor of smaller firms.
But seriously, how many firms “cross the threshold” each year? There simply are not that many firms with more than 500 employees. Adjusting for these instances may move some numbers around, but the basic tenet remains intact — businesses employing fewer folks create most of the new jobs and policymakers should pay attention.
A study from the Bureau of Labor Statistics adjusting for these statistical challenges found that firms with fewer than 500 employees created about 80 percent of net new jobs. Enough said.
The question of whether the tax code is biased towards small businesses is more difficult. The tax code, after all is incredibly complex and it does include numerous provisions — like Section 179 — targeted to help smaller enterprises. How do you tally up all the variables?
S-CORP readers may remember Dr. Viard from the LIFO debate. Alan pointed out that, if LIFO accounting is an undeserved tax windfall, why is the effective tax burden under LIFO similar to that tax burden shouldered by other forms of capital investment? How could it be a windfall if the tax burden is the same?
The same approach may work here as well. If the tax code is too small business friendly, then the effective tax burden on S corporations, partnerships, and sole proprietorships should be lower than for other taxpayers. But a study commissioned by the Small Business Administration found that the effective tax burden for small businesses (including small C corporations) in 2004 was 19.8 percent, or 3.5 points above the average for all taxpayers that year. S corporations, by the way, faced the highest effective rate of 26.9 percent.
Moreover, limiting the analysis to income and payroll taxes does small business a disservice. Home Depot doesn’t worry about the estate tax, the family-owned lumber yard down the street does. And studies show that the burden of federal regulations falls more heavily on smaller firms than larger ones.
Finally, we believe Alan’s argument misses a broader point. Your S-CORP team is not comprised of legal theorists, but we do recall that government grants corporations the same legal status as individuals in order to encourage their creation and economic growth. Corporations can enter into contracts and appear in court. Perhaps most importantly, the owners of corporations are shielded from liability.
The S corporation was created, in part, to counter the advantage the corporate structure gives to larger firms. The idea behind the S corporation was to allow smaller firms to thrive by extending some of the essentials of the corporate structure without the onerous tax rules. But S corporation rules also limit their ability to grow and raise capital. They limit the number and type of shareholder and they limit how the firm can be structured. How do these rules enter into the question of bias in the tax code?
The bottom line is that the effective tax rate on small businesses is higher than the rate for taxpayers in general. Given that reality, it’s difficult to see how small businesses are somehow advantaged. If Congress wants to help larger businesses by cutting the corporate rate, we’re all for it. But don’t forget who creates most of the jobs out there. It’s small business, and during economic downturns, the role they play is more important than ever.
Good news for S corporations! S-CORP allies Senator Blanche Lincoln (D-AR) and Orrin Hatch (R-UT) today introduced the “S Corporation Modernization Act of 2009.” This legislation is similar to bills offered in previous Congresses and includes many of our Association’s priorities for the year. In a statement accompanying the bill, Senator Lincoln noted:“A strong economic recovery will depend on the health and strength of our small business sector,” Lincoln said. “Over four million of our small businesses across the nation are organized as S corporations, including more than 40,000 in Arkansas, and at least 60 percent of the new jobs created over the last decade have come from small businesses. Congress has not updated many of the rules governing S corporations, and as a result many privately-held businesses are not ideally positioned 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.”
The bill is designed to update and simplify S corporation rules — some that date back 50 years — to make it easier for these small and closely-held businesses to raise capital and compete in a difficult economy. The “S Corporation Modernization Act” 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.
The whole S-Corp team thanks Senators Lincoln and Hatch for continuing their support of America’s small and closely-held businesses and we look forward to working with them to get these important reforms enacted into law this Congress!
More S Corps than Ever!
Just in time for our advocacy of the S Corporation Modernization Act, our friends at Statistics of Income have published their taxpayer Data Book for 2008 and guess what?
For 2008, there were nearly 4.4 million S corporations, an increase of more than 300,000 firms from 2007 and 1.7 million more than just 10 years ago.
Now if the SOI folks would only update their more in-depth “S Corporation Returns” study, we could dive into these numbers and get a better sense of the source of this growth. The most recent study is from 2003, and newer analysis is long overdue.
Obama Administration’s Tax Hikes
This week President Obama released the details of his proposals to raise taxes on multinational corporations. The two main components of the plan are new limits on deferral and the foreign tax credit and additional enforcement tools targeted at overseas “tax havens.”
Reaction on Capitol Hill was somewhat underwhelming. Senate Finance Committee Chairman Max Baucus (D-MT) referred to the proposals as “controversial,” and noted, “We’ll look at it. I don’t know how much is going to be enacted this year.” Despite this less than glowing review, we do expect some form of the President’s proposal to move through the Congress this year — their need for new revenues is just that strong.
What about S corporations? These proposals do not directly affect S corporations, but they are a worrisome indicator of the Obama Administration’s overall approach to business taxation. This Administration is looking to the business community to raise the tax revenues. During his press conference yesterday, Obama decried the “broken tax system, written by well-connected lobbyists on behalf of well-heeled interests and individuals. It’s a tax code full of corporate loopholes that makes it perfectly legal for companies to avoid paying their fair share.”
But businesses don’t pay taxes — people do — and the burden of raising taxes on corporations will fall primarily on the workers of those companies. Capital can and does move from one country to the next. For workers, it is just a little more difficult. It’s more difficult for S corporations too.
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.”
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|
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.
Following a closed-door planning session today of members of the Senate Finance Committee, we expect the Committee will mark-up the tax portions of a stimulus package as early as January 22nd. As we indicated previously, committee members are committed to exerting their jurisdiction over the tax portions of the package. Moreover, there appears to be a growing debate over certain provisions in the Obama plans. As Dow Jones reports this afternoon:
“When asked about specific tax cut proposals made by Obama, Kerry said, “I think there are cuts that are not going to stand the test of whether they will create jobs. Coming in for specific criticism were an Obama plan to give companies a $3,000 tax credit to offset the cost of new hires, and a $500 tax credit for workers that would be spread out over a period of time in take-home pay. “Is a $3,000 tax credit going to get you to hire somebody to build cars that nobody’s buying?” asked Sen. Kent Conrad, D-N.D., speaking to reporters after the committee meeting.”
Exactly what replaces those unpopular tax cuts — more tax relief or more spending — is an open question. Let’s hope it’s more tax relief for businesses. Having both the Ways and Means and Finance Committee members weigh in on the stimulus package, however, gives our S corporation allies a better chance to make the package more small business friendly, especially with regard to built-in gains reform. We expect the Ways and Means Committee to also hold a mark-up as early as the week of the inauguration. S-CORP In the News
Speaking of small business tax relief, the Baltimore Sun published an op-ed by S-CORP Executive Director Brian Reardon highlighting the history of the small business corporation and outlining how Congress can best help ensure the small business community is adequately armed to respond to the on-going economic recession:
What should Congress do? First, follow President-elect Obama’s lead and make small business tax relief the center of any economic stimulus plan. Relief that increases small business’ access to capital would be especially timely. For S corporations, the tax code forces many of them to sit on appreciated assets rather than sell them and put the money to better use. Another rule prohibits them from accepting direct foreign investment. Changing these out-of-date rules would free up capital and encourage new business formation.
Second, keep the rates on small business income low – certainly no higher than what large corporations pay. Actions like these would signal to millions of small businesses that they will not be punished to pay for the excesses of Wall Street, which should make it easier for them to grow their businesses and create jobs.
New Members on Ways and Means
The House Ways and Means Committee for the 111th Congress is now complete, with both Democrats and Republicans announcing their final additions to the committee. House Republicans had six seats to fill and announced their selections yesterday. New members include:
Rep. Charles Boustany (LA-07)
Rep. Ginny Brown-Waite (FL-05)
Rep. Geoff Davis (KY-04)
Rep. Dean Heller (NV-02)
Rep. David Reichert (WA-08)
Rep. Pete Roskam (IL-06)
Earlier this week House Democrats filled their one remaining spot on the Ways and Means Committee with the selection of Linda Sanchez (D-CA), after Representative Raul Grijalva (D-AZ) turned down the position in December. Combined with the Democrats’ earlier additions, that’s a total of 11 new members for the tax-writing Committee.
You can bet your S-CORP team will be reaching out to new and old members alike in coming weeks. Small business tax relief is on the table, and we need to get the message out.
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.