Health Care Update

Posted by admin on October 6, 2009 · Leave a Comment

The idea of taxing high cost plans is relatively new, and there are many outstanding questions about how it would work. For example, how exactly how would this excise tax raise revenue? The Senate plan imposes a 40 percent excise tax on high value plans with a cumulative cost of more than $21,000. But medical loss ratios for private health insurance plans easily exceed 60 percent of premiums, so insurance companies confronted with a 40 percent excise tax will simply stop issuing those plans.

At the employer level, that means if an employer used to offer his employees a $30,000 package of health benefits, he will now offer them a $21,000 plan and pay the remaining $9,000 to them in the form of wages and non-health benefits. These extra wages, in turn, are subject to income and payroll taxes, resulting in higher tax collections by the federal government. The revenues raised from the excise tax come from higher income and payroll taxes on employees, not from excise taxes on insurance companies.

It’s this aspect of the Senate plan that has unions united in opposition. The excise tax is coupled with a refundable tax credit available to families making less than 400 percent of the federal poverty level (about $88,000 for a family of four). But many union members make more than that while most union members enjoy health insurance benefits that exceed the Baucus threshold. So for many union members, the Baucus plan would reduce their health benefits and raise their income and payroll taxes, but exclude them from the refundable tax credit.

What about S Corporations? How would they be impacted? Here’s chart we put together:

	Earns More than 400% FPL	Earns Less Than 400% FPL
Has High Cost Plan	Taxes Are Higher	Mixed
Has Low Cost Plan	Not Affected*	Taxes Are Lower*

We put an asterisk by the “low cost plan” results because of another quirk in the excise tax that deserves review, the indexing for its thresholds. As we mentioned, the Baucus bill sets the initial threshold for a family’s high cost plan at $21,000. This threshold includes all forms of health care spending — premiums, preventive care, flexible spending accounts — and is indexed not to health care inflation (about 8 percent), but to regular inflation plus one percent (about 3-4 percent). That means over time, the value of your low cost insurance plan is going to catch up to the threshold and become subject to the tax.

This aspect of the Baucus plan would have been fixed had it not been essential to the procedural challenges facing health care reform. Simply put, both the House and the Senate are attempting to offset health care spending, which grows at 8 percent per year, with tax increases, which rise at five percent per year. The costs of the plans grow faster than the offsetting taxes, resulting in deficits in the out years.

By comparison, the Baucus tax, because of the indexing details, grows faster than health care spending and produces surplus revenues in the out years. As much as the unions complain, coming up with an offset that keeps the President’s and congressional leadership’s promise not to make the deficit picture worse is going to be hard to find.

Thus, the friction between the House and Senate tax offsets, and yet another obstacle between healthcare reform and a signing ceremony. The House surtax targets closely held businesses while the excise tax targets union workers. Nobody said raising taxes by half a trillion dollars would be easy.

Estate Tax Update

We expect Round 1 in the great estate tax battle to take place this fall/winter. The tax goes away in 2010, and then returns in full form in 2011, giving just about everybody a reason to come to the table.

In preparation for this debate, forty-six trade associations, including your S Corporation Association, the Chamber of Commerce, NIFB, and the National Association of Manufacturers sent a letter to Congress urging them to support a permanent estate tax fix that includes a 35 percent top rate and a $5 million per spouse exclusion.

As Martin Vaughn of Dow Jones reported:

The groups said they will support a permanent rate of 35%, with the first $5 million of wealth exempted, and up to $10 million in the case of married couples. Those are the terms that are being pushed in the Senate by Sens. Jon Kyl, R-Ariz., and Blanche Lincoln, D-Ark.

On timing, the expectation continues to be that Congress will take up legislation to extend certain expiring tax provisions before the end of the year, and that the estate tax fix will be made part of that bill.

Tax Reform Panel Report Update

Remember the President’s Economic Recovery Board headed by Paul Volcker? The President announced its creation at the beginning of the year but it’s been quiet since then. The principle reasons for this silence are federal sunshine laws that require any gathering to be open to the public. It is hard to provide the President with critical insights into how to fix the economy when the whole world’s watching.

One offshoot of the Board that has been active is the White House Tax Reform Panel. They had their first (and last?) public meeting last week, chaired by CEA Member Austan Goolsbee. During the meeting, Goolsbee made clear that the Panel was not seeking to create a new tax system but rather would focus its recommendations on three specific areas — tax simplification, enforcement and corporate tax reform. The panel is accepting public comments through October 15^th and then will make its own recommendations known to Treasury Secretary Geithner by December 4th.

In the past, it has been easy to dismiss the work of presidential or congressional tax reform panels. They tend to come and go, after all, with little to show for their efforts. This time, however, the combination of huge deficits and an expiring tax code make some sort of dramatic changes to the tax code almost a certainty. Given the landscape, we intend to follow the efforts of this group closely.

Filed under Tax Policy, The Washington Wire · Tagged with corporate tax reform, estate tax, excise tax, health benefits, health care, healthcare reform, income tax, payroll tax, tax code, tax credit, tax enforcement, tax simplification

Estate Tax & PAYGO

Posted by admin on July 21, 2009 · Leave a Comment

The House is scheduled to take up a Paygo bill — short for “pay-as-you-go” — this week that makes room for an estate tax fix. Paygo was established back in 1990 as a means of controlling the Federal deficit. Under Paygo, any increase in the deficit, either by a reduction in revenues or an increase in mandatory spending, must either be fully offset or it will be added to the Paygo scorecard and possibly trigger an across-the-board spending cut (called sequestration) at the end of the fiscal year.

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.

Filed under Job Creation, Tax Policy, The Washington Wire · Tagged with AMT, capital, effective tax rates, estate tax, income tax, Job Creation, Medicare, offsets, Paygo, tax burden, tax code, tax cuts

The Washington Post Discovers Small Employers

Posted by admin on April 28, 2009 · Leave a Comment

The Washington Post this week reported on an issue that shouldn’t come as a surprise for S-CORP readers: President Obama’s tax plans could hurt many of America’s small businesses. Small business owners who report their business profits on their personal income returns (like most small business owners do) are suddenly finding themselves classified as the “richest” Americans, and thereby subject to Obama’s tax increases. The Post explains:

Across the nation, many business owners are watching anxiously as the President undertakes expensive initiatives to overhaul health care and expand educational opportunities, while also reining in runaway budget deficits. Already, Obama has proposed an extra $1.3 trillion in taxes for business and high earners over the next decade. They include new limits on the ability of corporations to automatically defer U.S. taxes on income earned overseas, repeal of a form of inventory accounting that tends to reduce business taxes, and a mandate that investment partnerships pay the regular income tax rate instead of the lower capital gains rate.

The Washington Post is catching up to what S-CORP and its friends have been pointing out for a while now — if your goal is to reinvigorate the economy, placing additional burdens upon the very business that can help pull us out of this crisis is the wrong way to go. The example used by the Post — Gail Johnson of Richmond, Virginia — should give S corporation shareholders pause:

Johnson declined to say whether she voted for Obama. But she said she ignored his tax plans until her husband, who handles real estate and construction for the schools, mentioned it one day. “I’ve since talked to my accountant,” she said. “And, oh, my gosh!”

In a typical year, Johnson’s federal tax bill would be about $120,000. But starting in 2011, the higher marginal rates would add about $13,000 a year, Hurst said. Capping the value of itemized deductions at 28 percent would add another $10,000, for a total increase of $23,000.

And Johnson’s tax bill stands to grow dramatically if Obama were to revive a plan to apply Social Security tax to income over $250,000 instead of capping it at the current $106,800. Because Johnson is an employee and an employer, she would have to pay both portions of the tax, Hurst said, tacking another $30,000 onto her bill.

That’s a potential $50,000 tax increase for a small employer whose family earns about $500,000 a year, including the income from her business. It’s hard to see how increasing her federal tax bill (this does not include state and local taxes) from around $120,000 to $170,000 would not harm Gail’s plans to invest in her business and hire additional employees.

Budget Plan Finished

On that note, perhaps the most frustrating aspect of the tax increases outlined above is that they simply will not be enough. Federal deficits are going sky-high and higher taxes on the middle-class are all but inevitable. House and Senate negotiators this week put the final touches on the budget outline for next year. For S corporations, three major items stand out: total deficit estimates, the estate tax and the inclusion of reconciliation instructions for health care.

The Congressional Budget Office estimates that the Obama budget, if enacted, would result in deficits of $1.8 trillion, $1.4 trillion, $1 trillion, $658 billion, $672 billion, and $749 billion over the next five years. That’s a cumulative of $4.4 trillion over five years, or $1.7 trillion more than if we simply did nothing over the next five years and maintained current law.

The U.S. government has never run deficits of that magnitude and exactly how the debt will be financed is an open question. To put these five-year numbers in perspective, over eight years of President Bush — who is rightly criticized for not paying more attention to holding down spending – debt held by the public increased by $2.4 trillion. The budget offered up by conferees this week has deficit estimates that are smaller than the Obama budget, but not enough to address the question of who is going to finance all that debt.

Regarding the estate tax, the budget agreement calls for maintaining the 2009 rates and exemption levels of 45% and $3.5 million per spouse. While the Senate’s original budget allowed for higher exemption levels and a lower rate, the House ultimately prevailed and stuck with freezing the 2009 rules.

On the reform front, the resolution will include “reconciliation instructions” for health care reform. As S-CORP readers know, reconciliation is valuable to the majority in the Senate because it allows for controversial items to pass the Senate with a simple majority rather than the usual 60 votes.

There are limitations, however, because bills brought to the Senate floor under reconciliation may not increase the deficit outside of the budget window, which means whatever they enact under this budget would have to be sunset after five years.

S corporation shareholders know how these sunsets work — we have been dealing with the uncertainty of the estate tax repeal sunset for a decade now. How effective could broad-based health care reform be if it goes away in just five years?

Moreover, reconciliation bills may not include provisions with no or little impact on revenues and spending. The core provision in most health reform plans is to create a health insurance “exchange” similar to the Connector up in Massachusetts. This may or may not be a good idea, but it doesn’t have a significant impact on either revenues or spending and would likely fall outside of reconciliation. For a full review of these issues, we recommend reading the analysis of S-Corp ally Keith Hennessey.

Bottom line: Attempting to reconcile health care reform could cost the majority more than it’s worth, especially with Senator Specter now aligning himself with the Democratic Caucus.

Filed under Tax Policy, The Washington Wire · Tagged with estate tax, federal deficit, healthcare reform, income tax, marginal tax rates, tax increases

The Washington Post Discovers Small Employer

Posted by admin on April 28, 2009 · Leave a Comment

Budget Plan Finished

Bottom line: Attempting to reconcile health care reform could cost the majority more than it’s worth, especially with Senator Specter now aligning himself with the Democratic Caucus.

Filed under Tax Policy, The Washington Wire · Tagged with business taxes, capital gains, estate tax, federal deficits, health care, healthcare reform, income tax, itemized deductions, marginal tax rates, tax increase, Tax Policy

Congressional Budget Takes Form

Posted by admin on March 25, 2009 · Leave a Comment

Lots of budget related news in recent days with implications for small business taxpayers. First, the Congressional Budget Office weighed in last week with its analysis of the Obama budget outline and estimated that the Administration’s proposals, if enacted intact, would double the overall deficit over the next ten years. The numbers are truly staggering and should scare any reasonable person who plans to be a taxpayer over the next several decades. Starting with a deficit of around $1.8 trillion this year — easily the highest annual deficit since we were defeating Hitler — the ten year total is nearly $10 trillion dollars!

Obviously, deficits of this magnitude will have the effect of restraining efforts to increase Federal spending while placing additional pressure on Congress to raise tax burdens. That’s challenge number one for S corporation owners.

Next, both the House and Senate Budget Committees will take up their respective budget resolutions today, with the goal of getting a final budget in place before Congress breaks for the Easter recess in a few weeks.

For those who have bothered to look, the actual text of a budget resolution is disappointing. It’s primarily a list of budget functions and related spending numbers, most of which have little or nothing to do with the real process of establishing tax and spending policy.

The real meat in any budget is the total amount of discretionary spending allowed (the Appropriations Committee gets to divide it up from there), the overall ceilings on spending and floors on revenue, any reserve funds designed to protect specific initiatives from Budget Act points of order, and finally, and perhaps most importantly, any reconciliation instructions.

Reconciliation allows permanent changes in tax and mandatory spending to be enacted with a simple majority in the Senate, and usually signals what is really important to the leadership in Congress.

This year, the Senate chose not to include any reconciliation instructions while the House included them for health care reform. Cap and trade only got a reserve fund (see below for more on cap and trade), which reinforces the growing perception around town that of the three big reforms on the table — health care, climate change, and tax reform — the Administration and Congress have decided to make health care reform their priority for this year.

Small Business Roundtable

Last week, your S-CORP team spent a morning with House Small Business Committee Chair Nydia Velazquez, several other members of the Committee, and a large percentage of the small business organizations around town.

The point of the meeting was for Committee members to hear directly from small business groups on the issues important to them. Frequently mentioned topics included estate tax reform, LIFO repeal, depreciation and several deductions that are important when businesses have little or no income. Only two groups, your S Corporation team and the National Association of Manufacturers, raised the issue of individual tax rates and how they impact job creators.

Another S-CORP ally — Bill Rys from the National Federation of Independent Business — did a great job of making the same case on MSNBC the other day:

Visit msnbc.com for Breaking News, World News, and News about the Economy

Chairwoman Velazquez has been extremely proactive in making the small business perspective part of the debate in the House, especially when it comes to tax issues. Legislation she introduced last Congress included a number of small business friendly provisions, including full repeal of the non-resident alien restriction for S corporations (a priority of the S Corp Association).

With so many tax items on the table for this year and next, we expect to see many of the topics raised last week explored by the Committee in future hearings and really appreciate the willingness of Chairwoman Velazquez to reach out and listen to the concerns of the small business community.

Climate Change Coming

There’s the old line that everybody talks about the weather but nobody ever seems to do anything about it. Apparently, our friends over at the EPA don’t understand that it’s supposed to be a joke.

Last week, they sent the White House recommendations to make an endangerment finding for greenhouse emissions under the Clean Air Act. This finding is in response to the Supreme Court decision in Massachusetts vs. EPA.

If the White House signs off on the EPA’s recommendation — and all indications are it will within the next couple months — then that agency will have the ability to regulate an enormous percentage of economic activity taking place in the United States. If whatever you are doing has the potential to emit greenhouse gases into the atmosphere, then the EPA may have something to say about it.

We usually try to stick to tax policy here at the S Corp Association, but this issue is simply too big to ignore. Plus, the solutions being considered in Congress — primarily carbon cap and trade — are market based and would have the effect of placing a tax levy on carbon emissions.

Given the choice between the EPA regulating carbon under the forty year old Clean Air Act or Congress addressing it through a cap and trade system, many folks will choose cap and trade. For that reason, the failure of the Budget Committee to reconcile instructions for a cap and trade bill this year does not mean the issue will not come up. The EPA’s action last week may ensure that it does.

Filed under Federal Budget, The Washington Wire · Tagged with corporate tax reform, deficit, estate tax, federal deficit, healthcare reform, income tax, Job Creation, tax burden

President to Sign Fiscal Stimulus

Posted by admin on February 11, 2008 · Leave a Comment

The President is expected to sign the fiscal stimulus package on Wednesday. After two weeks of hand ringing and posturing, the Senate finally adopted a slightly modified version of the bill the House and the President originally had negotiated.

As sent to the President, the package would:

Send checks of $600 per filer and $300 per child to families with joint incomes of less than $150,000. Actual amounts will be calculated based on income tax filings for 2007, so expect the actual checks to be in the mail by late spring and early summer.
Encourage new business investment by increasing the limit on small business expensing from $100,000 to $250,000 as well as allow for 50-percent bonus depreciation. Both of these tax breaks are available for equipment placed in service in 2008 only.
Allow for a temporary, 2-year increase, from $417,000 to $729,750, in the so-called conforming loan limit and limit on FHA-guaranteed loans.

Whether this package benefits the economy will have to be seen. Certainly the speed with which Congress and the Administration came together, even with the delay in the Senate, was impressive and should send a positive signal to families and businesses. The size of the package is significant as well. The short term cost of the family checks and increased expensing—not counting the mortgage relief—is about $150 billion in 2008, or slightly more than 1 percent of the economy.

The challenge, as always for fiscal stimulus, is how to get it done quickly enough to be effective. Under the current time frame, both the rebate checks and the mortgage relief will not be felt until well into the third and fourth quarter of 2008. The remaining question is whether the economy will still be in its mid-cycle slowdown or will be in a recession at that time.

Energy Tax Provisions Move Forward—Again

As expected, the introduction of the President’s budget for fiscal year 2009 fell flat last week, with few, if any, of its proposals getting serious attention.

A week later, in a bit of irony, the House is planning to take up a package of renewable energy tax provisions that were dropped from the President’s budget this year. Given the price of oil, why the Administration would pick this year to end its call for extending renewable energy tax incentives is slightly inexplicable.

The House action is curious as well, given the repeated failure of Congress and the Administration to agree how to pay for the extension of these and other tax items in 2007. Staff involved in the drafting expect the bill to look very similar to the House energy tax package from last year, despite the failure of that package to get past the Senate. As BNA noted this morning:

Democrats in both chambers produced energy tax packages in 2007 that were designed to encourage the use of alternative and clean energy at the expense of oil and gas producers. But resistance from Senate Republicans–and a firm stance by President Bush that he will not sign into law any bill that would raise taxes–killed Democratic efforts.

Absent the emergence of a new, non-controversial offset, the fate of this effort is likely to be similar to the energy tax packages considered late last year.

For S corporations, the lesson should be clear. The consensus that brought Congress and the President together on the stimulus package has vanished.

Tax extenders like the energy tax credits, AMT patch, and the R&E tax credit are considered to be “must-pass” items. To get them done, however, congressional leadership will need to bridge the competing interests of “pay-as-you-go” budgeting with the concerns of the President and others who oppose seeing the overall tax burden increase under their watch.

Moving the same energy tax package that failed previously suggests congressional leaders haven’t worked that out yet, and all the positive tax policy initiatives that benefit S corporations and other actors in the economy will have to wait until they do.

Filed under Economic Stimulus, The Washington Wire · Tagged with alternative minimum tax, AMT, Economic Stimulus, energy tax, income tax, Paygo, tax breaks, tax package

Tax Bill Offset Tally

Posted by admin on June 11, 2007 · Leave a Comment

To simplify tracking of the various tax bills under consideration by Congress, we’ve put together a chart of what’s moving and what’s being discussed, including separate tax bills on the AMT, energy production, education, housing, family tax relief, children’s health insurance, and international tax provisions.

As you can see, the total cost of the bills contemplated could exceed $1 trillion (!) over ten years. That’s a lot of offsets for Congress to generate, which suggests many of these bills will be delayed and/or scrapped as Congress weighs the benefits of action with the liability of the revenue raisers.

Another AMT Plan Floated

As you can see from the chart, the primary challenge in stemming the growth of the Alternative Minimum Tax is cost. Any change to the AMT reduces revenues by hundreds of billions over the 10-year budget window. That enormous cost is likely why the House has repeatedly delayed plans to produce a permanent fix to the alternative tax.

A recent plan proposes to offset this cost by imposing a new surtax on high income taxpayers. According to press accounts, the income threshold would be $500,000 and the surtax would be in the 4 to 5 percent range. That tax increase would offset a higher, permanent $250,000 AMT exemption ($125,000 for singles) that is indexed for inflation in future years.

If you are interested in the details, a similar plan has been outlined by Tax Policy Center here in town. The TPC plan would 1) raise the AMT exemption to $200,000 for families ($100,000 for singles) and 2) offset the cost of this increase with a new 4 percent surtax applied to a taxpayer’s Adjusted Gross Income above the $200,000 threshold.

The net effect of this plan on any particular taxpayer is complicated, as are all issues surrounding the AMT. Some taxpayers will pay more tax, some will pay less, and some will pay the same amount. But to date, all the AMT proposals floated in the House have embraced, to one extent or another, marginal rate increases for non-corporate taxpayers.

S corporations should pay attention. This new surtax would apply to all income above the $200,000 threshold, including your S corporation business income as well as any capital gains and dividends you receive. As a surcharge, this tax is applied on top of existing income taxes, resulting in a sizable increase in your effective marginal tax rates.

Big Four Weigh in on Tax Gap

In response to an IRS request for comments and suggestions in their on-going analysis of the tax gap, the large accounting firms have penned a 19-page white paper that outlines the issue as well as putting forward suggestions.

Perhaps an accurate summary of the paper would be: “Big business pays its fair share so the IRS should focus on small business instead.” Here’s the section related to S corporations and other pass-through businesses:

Mid-Size Corporations and Pass-Through Entities

Another potential area of high-risk involves taxpayers and entities that have been subjected to little or no enforcement in recent years. While larger corporations are examined with relatively high frequency (44 percent), mid-size corporations, S corporations, and partnerships are reviewed with much less frequency. The number of S corporations and partnerships has grown rapidly over the last several decades with very little enforcement activity occurring. IRS recently launched a new research project focused solely on S corporation returns. This is an important project to assess the level of compliance for S corporations, which should be completed as soon as possible. Gaining access to timely information from pass-through entities (e.g., partnership Forms K-1) remains a challenge to the ability of individuals, trusts, and estates (and their tax return preparers) to prepare an accurate income tax return on a timely basis. This issue should be considered as part of any effort to evaluate and improve compliance of pass-though entities.

Summary Observation

As IRS continues to reengineer the examination process for larger corporations to provide close to real-time currency and streamlined examinations, and as IRS winds down a number of abusive tax shelter efforts, these resources should be redeployed to the task of assessing the level of compliance of mid-size corporations and pass-through entities and to identify noncompliance trends that should be addressed.

On a related note, the last time Treasury Secretary Hank Paulson appeared before the Senate Finance Committee to talk about the tax gap, he was asked to return in 90 days to let the Committee know what new approaches they were prepared to take. That 90 day window expires around July 18th — so expect some sort of hearing or meeting on the Tax Gap around that time. Exactly what new policies Treasury produces in the 90 days they were given remains to been seen.

Filed under The Washington Wire · Tagged with alternative minimum tax, AMT, income tax, international tax provisions, marginal tax rates, offsets, pass-through, surtax, tax gap, tax increase, tax relief

S Corps Everywhere!

Posted by admin on September 22, 2006 · Leave a Comment

You couldn’t swing a dead cat in Washington last week and not hit somebody busy touting the benefits of S corporations to the American economy, job creation, and retirement security. First, the President highlighted S corporations while defending his record on tax policy at a news conference last week :

I believe if the Democrats had the capacity to, they would raise taxes on the working people. That’s what I believe. They’ll call it tax on the rich, but that’s not the way it works in Washington, see. For example, running up the top income tax bracket would tax small businesses. A lot of small businesses are subchapter-S corporations or limited partnerships that pay tax at the individual level. And if you raise income taxes on them, you hurt job creation. Our answer to economic growth is to make the tax cuts permanent, so there’s certainty in the tax code, and people have got money to spend in their pockets.

Then, on Wednesday, the Finance Committee held their third hearing on the challenges of tax reform, where Chairman Grassley and other members of the Committee heard excellent testimony from Jeff Johannesen from RSM McGladrey in Des Moines on the importance of modernizing S corporation rules to enable them to better compete. As Mr. Johannesen said in his prepared testimony:

An S Corporation structure is extremely efficient for a growing midsized business. We believe more businesses would benefit from and be able to use the S Corporation structure if the rules governing them were simplified. We think there is a strong argument that the tax rules that distinguish the activities of both S Corporations and LLCs may benefit from a more standard approach.

Jeff then went on to advocate for many of the reforms that are included in H.R. 4421. S. 3857, and S. 3838 – bills designed to remove ancient rules that hold S corporations back from succeeding in the Twenty-first century. During Q&A, Senator Grassley asked Jeff if we had too many choices of business structures. Jeff responded that, rather than eliminate business structures, making smaller reforms to harmonize the different rules would have little impact on revenues and would greatly benefit businesses.

Finally, employee-owned S Corporations were on the Hill en mass on Thursday to ensure that S corporations continue to enjoy the option of being owned by their employees. Armed with a powerful study conducted by the National Center for Employee Ownership showing that S corporation ESOP employees accumulate three to five times(!) the retirement assets of employees with more traditional 401(k)s, these current and former S corporation employees made the strong pitch that Congress and the Department of Treasury should protect both S corporations and ESOPs as they consider big and small changes to the tax code.

Filed under Tax Policy, The Washington Wire · Tagged with income tax, Job Creation, tax cuts, Tax Policy

The S Corporation Association