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S Corporations and the Estate Tax

Posted by admin on June 26, 2008 · Leave a Comment 

  

With a large fraction of the tax code expiring in the next couple of years, the big surprise may be the growing consensus for compromise over the estate tax.  The estate tax is scheduled to go away in 2011 followed by its return in 2011 with a top rate of 55 percent and a $1 million exemption per spouse.  

How did the estate tax, perhaps the most contentious and divisive of taxes, get to the head of the line of possible compromises?  A couple of factors appear to be in play. 

For legislators who support full repeal, the prospect of allowing the tax to rise from the dead in 2011 is simply unacceptable.  These legislators could hold out for full repeal, but it’s highly unlikely they will get it.  Any effort on their part to block a compromise would ensure a higher estate for their constituents, not a lower one.  

For estate tax supporters, allowing the tax to go away entirely in 2010 is also problematic.  It means any comprise agreed to in 2010 would be a step backward from current law.  It also means that principals with sizeable estates in 2010 very well may choose death over taxes.  It would only take one well-publicized estate tax suicide to highlight all the reasons the estate tax repeal effort was so successful before 2001.  

The net result is that legislators on both sides of the issue have a strong incentive to compromise, and to do it sooner rather than later.  The estate tax rules in place in 2009 ($3.5 million exemption with a 45 percent top rate) may form the basis for the compromise.   

What does this mean for S corporations?  As small and closely-held businesses, we have more than our fair share of family-owned businesses.  And as much as tax simplicity, economic growth, and basic decency argue that the estate tax should be repealed, having some kind of certainty over the rules going forward is valuable too.  

It also means the S corporation valuation issue that has been litigated in the courts over the past decade will become more of a priority.  

For new readers, the issue is whether the value of an S corporation should be adjusted to reflect the future taxes paid by its shareholders on the business income.  Gross v. Commissioner held that these tax payments do not count.  The result is that when an S corporation is part of an estate, the IRS may try to value it at a 60 percent or higher premium over similar C corporations. 

Charging S corporations a higher estate tax merely because they pay taxes at the shareholder rather than corporate level is simply unacceptable.  S corporations need to be aware that this discrimination exists, and be prepared to fight it out with the IRS.  

Payroll Taxes and the Wage Cap 

Former Presidential Advisor Larry Lindsey wrote in the Wall Street Journal earlier this week about Senator Obama’s proposal to raise the wage cap on Social Security taxes.  

On several occasions, Senator Obama has suggested the Social Security payroll tax of 12.4 percent should apply to income above $250,000. This proposal would create a three-tiered payroll tax—workers would pay 12.4 percent on their first $102,000 of earnings, nothing on the next $148,000, and then 12.4 percent again on any income above $250,000. 

Setting aside the nonsensical rationale of imposing this tax doughnut hole on wage income, Larry focuses on the economic implications of raising marginal rates by 12.4 percent.  As Larry writes: 

The economics of what Sen. Obama is proposing should be at least as troubling. A high-income entrepreneur would see his or her federal marginal tax rate rise to 53% from 37.7% under Sen. Obama’s tax plan. He proposes a 4.6 percentage point hike in the personal income tax rate, a loss of some itemized deductions, and a 12.4 percentage point hike in the Social Security payroll tax. This would take a successful entrepreneur’s effective marginal tax rate higher than what it was under Jimmy Carter or Richard Nixon, when the maximum tax on an entrepreneur was 50%. 

As S Corp readers know, the S Corporation Association has fought the idea of raising payroll taxes on S corporation income for years.  Eliminating the wage cap is just one means of raising Social Security taxes.  Couple it with the Joint Committee on Taxation proposal to apply payroll taxes on all the S corporation income of certain shareholders, and you are looking at a tax hike of historic proportions on S corporations and their shareholders. 

Congressional Tax Update 

Another week—another vote on extenders.  As we reported last week, the House was going to take up another package of tax extenders, this time extending the AMT patch through the end of 2008.   

On Wednesday, the House adopted the package 233-189 and sent it to the Senate, where the Republican minority is expected to block its consideration.  They object to the revenue raisers attached to the patch.  The White House also objects.  According to the Statement of Administration Policy issued during the debate in the House: 

The Administration does not believe that the appropriate way to protect the 26 million Americans from higher 2008 AMT liability – including 22 million that would be newly exposed to the AMT – is to impose a tax increase on other taxpayers. The Administration urges Congress to reduce the risk of disruption to the 2009 tax filing season by eliminating tax increases from the bill.   

This is just the latest in what has the potential to be a very long dance between those legislators who want to offset the extension of existing tax benefits with tax increases elsewhere, and those who do not.  Last year, this debate lasted right up until Christmas.

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Senator Clinton’s Tax Policies—Bad for S Corporations

Posted by admin on March 31, 2008 · Leave a Comment 

Recently, we reviewed Senator Obama’s tax policies and how they might impact S corporations should he become President.  What about Senator Clinton?  If she becomes President, how would her tax policies impact small and closely-held businesses?

In general, Senator Clinton has opposed the rate relief and other tax reductions enacted over the past eight years.  As she told one audience:

I want to restore the tax rates we had in the ’90s. That means raising taxes on corporations and wealthy individuals. I want to keep the middle-class tax cuts, and I want to start making changes that will save us money, save money in our Medicare budget, save money for the average American.

On the individual side, she advocates repealing the Bush tax cuts for those taxpayers making $250,000 or more.  In practical terms, that would mean the two top income tax rates would rise from 33 and 35 percent to 36 and 39.6 percent.

While her position on reforming the Alternative Minimum Tax is unclear, she has advocated cutting the AMT and raising taxes on “billionaires”:

I’ll tell you something that we are going to have to deal with, the alternative minimum tax, which falls heavily on a lot of you and your families. You know, for six years I’ve been saying, with all due respect, do the billionaires in America need more tax cuts? Don’t you think we ought to cut the taxes of middle income people, in particular those who are going to be hit by the alternative minimum tax?

For investment income—dividends and capital gains—there’s no ambiguity.  She supports raising the top tax rate on dividends from 15 to 39.6 percent, while raising the tax on capital gains above the old rate of 20 percent.

Regarding payroll taxes, she has expressed opposition to Senator Obama’s plan to eliminate the Social Security wage cap, but she has questioned why middle-income taxpayers are subject to Social Security taxes while wealthier taxpayers are not.  As she stated in a debate last year:

Middle-class and working families are paying a much higher percentage of their income. [Billionaires like] Warren Buffett pay about 17%, because don’t forget, it’s the payroll tax plus the income tax. And when you cut off the contribution at $95,000, that’s a lot of money between $95,000 and the $46 million that Warren Buffett made last year. We’ve got to get back to having those with the most contribute to this country.

Finally, on the estate tax, Senator Clinton has advocated freezing the law as of 2009, when the top rate is 45 percent and the exemption is $3.5 million per spouse.

So what does all this mean for S corporations?  On its face, it’s a mixed bag.  Senator Clinton’s support for freezing the estate tax rules at 2009 levels is an improvement over current law, which would have the estate return to its old robust self in 2011.  But all of her other positions represent a retrenchment back to pre-2001 tax policies or worse.

One challenge for Senator Clinton is how to pay for any AMT reform, middle class tax relief, or the numerous spending programs she has put forward.  Keep in mind, the congressional baseline assumes all the Bush tax relief goes away in 2011, including family tax relief such as the refundable $1000 child credit and estate tax reform and repeal.

Extending any of those provisions—even freezing the estate tax at 2009 levels—will be considered revenue losers by the Congressional Budget Office and will have to be offset so as not to add to the deficit.  Going beyond the Bush family tax relief by increasing the child credit for the child’s first year, as Senator Clinton advocates, would reduce revenues even more.  Where will a Clinton presidency turn for those additional revenues?

Details aside, it is obvious that Senator Clinton’s priorities do not include keeping a lid on tax rates or the overall tax burden.  She has other goals in mind.  Given the budget pressures we will face over the next decade, a Clinton Presidency will likely mean significantly higher taxes on S corporations and taxpayers in general.

LIFO Under Attack—Again

Last-In, First Out accounting has been under fire for the past two years.

Part of the rationale for eliminating LIFO is budgetary—repealing LIFO would raise lots of money for the Federal government; by some estimates, more than $100 billion over 10 years.  As you can imagine, numbers like that have caught the attention of policymakers desperate for new revenues.

Another reason is the on-going effort to conform U.S. accounting rules to those in Europe.  These talks are part of a broad-based initiative to create a single, uniform set of world-wide accounting rules, something the accounting industry has sought for years.

The problem is the Europeans don’t use LIFO, so any effort to conform U.S. and E.U. accounting rules would require somebody to make a change.  In some circles, the presumption is that the U.S. would repeal LIFO and conform to the Europeans.

Where does FASB (Financial Accounting Standard’s Board), the U.S. accounting standard maker, stand?  In the past, they have been reluctant to weigh in on an issue as politically charged as LIFO.

So imagine our surprise when we saw their submission to the Securities Exchange Commission from last Fall on the topic of allowing U.S. issuers to prepare their financial statements under E.U. rules.  In it, the chairmen of FASB and its Foundation advocate the U.S. adopting European rules:

Board members and Trustees strongly support the proposal described below that U.S. public companies transition to an improved version of international accounting standards; however, individual Board members and Trustees may have differing views on some of the other recommendations outlined in this letter.

Let us hope individual board members have lots of differing views, since part of the FASB recommendation is to eliminate LIFO.

It is unclear why the FASB would recommend for the United States to adopt the accounting rules of France, and not the other way around.  Moreover, all the talks appear to be with Europe.  The U.S. is talking with Europe.  Japan is talking with Europe.  The Chinese are talking with Europe.  Perhaps the U.S. should talk to Japan instead, and reinforce our respective support for this important inventory accounting method.  Unfortunately, Japan appears to be moving in the opposite direction.

LIFO is needed now more than ever.  With inflation rearing its ugly head again after 25 years of disinflation, policymakers on Capitol Hill should be reluctant to repeal the one accounting method that protects businesses from paying taxes on the phony, inflated value of their inventory.  Income taxes should apply to real income only, not phantom profits.

For companies using LIFO, there are two policy responses.  First, we can and will defend LIFO before Congress.  There is no policy rational for repealing LIFO other than for its use as a revenue offset.  Second, we should look into eliminating the conformity requirement for companies that use LIFO for tax purposes to also use LIFO for their book accounting as well.  If FASB wants to abandon U.S. companies currently using LIFO, there is little reason the U.S. Congress and the tax code need to follow suit.

These issues will be debated and fought over the next year.  If your company is on LIFO and wants to keep it that way, please let us know and we will help connect you with your congressional representatives.

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Obama and S Corporations

Posted by admin on March 4, 2008 · Leave a Comment 

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.

With and Without Extension of Bush Tax Cuts

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.

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Higher Tax Rates on Horizon

Posted by admin on November 7, 2007 · Leave a Comment 

We’ve had numerous conversations in the past couple of weeks with S corporation owners about the tax outlook for the next couple of years, and it’s becoming apparent that the S-Corp community is underestimating the threat of higher tax rates on the horizon.  With that in mind, here’s our best assessment of what to worry about, and when to worry about it.

First, in case you have not heard, all the major tax relief provisions enacted since 2001 will expire at the end of 2010 unless Congress acts to extend them.  For S corporations, that means higher tax rates on your business income.  The top rate will revert back to 39.6 percent, while all the other rates will rise as well.  It also means higher tax rates on your investments.  The capital gains rate will revert to 20 percent, while the tax on dividends will return to 39.6 percent.

Second, proposals to eliminate the AMT currently include the provision of a 4 percent surtax applied to the adjusted gross income over $150,000 for individuals and $200,000 for couples.  This surtax would apply to wages, capital gains, dividends, and flow-through business income alike.

Third, both Congress and the Treasury Department are actively looking at a budget-neutral reduction in the corporate income tax.  What this means in general terms is to lower the marginal tax rate on C corporations—currently 35 percent—by broadening the tax base on which it is imposed.

What sort of base broadening are they looking at?  Eliminating the R&E tax credit, the manufacturing deduction, LIFO accounting rules, ESOP rules, etc.  For C corporations, the trade-off would depend on their particular profile.  Generally speaking, corporations with high effective tax rates would benefit, those with low effective rates would not.  For S corporations, however, there is no upside.  S corporations take advantage of all these tax benefits and will face higher effective tax rates if they are eliminated.

What’s the worst case scenario?

  • Congress allows the lower income tax rates to expire in 2011;
  • Congress imposes a new, 4 percent surtax on all income above a certain threshold to pay for eliminating the Alternative Minimum Tax;
  • Congress cuts C corporation rates and broadens the business tax base by eliminating tax provisions used by C and S corporations alike;
  • Congress expands the application of Social Security and Medicare taxes on S corporation income; and
  • Congress—as part of a Social Security fix—repeals the current income cap on Social Security payroll taxes.

For an S corporation whose shareholders pay the top rate, the net effect of these five tax events—which are either already included under current law or have been proposed by senior policy makers in Congress and Treasury—would raise the top potential tax rate on some S corporations from 35 percent to 58.9 percent!

That’s obviously the worst case scenario, and we’re not predicting that outcome.  But all five of those changes to the tax code are being actively considered and some are more than likely to become law between now and 2011.

Do we have your attention?

Estate Tax Hearing in Senate

Warren Buffet will headline a hearing in the Senate Finance Committee next week on the future of the estate tax.

Mr. Buffet is the second wealthiest advocate of the estate tax.  Bill Gates, of course, is the first.  Both gentlemen have argued strongly in favor of retaining a significant tax on estates when people die, yet both have committed to donate most, if not all, of their personal wealth to the Bill & Melinda Gates family foundation, thus avoiding paying the estate tax.

As S-Corp readers know, the current estate tax rules are in flux over the next couple of years.  The exclusion will rise from $2 million in 2008 to $3.5 million in 2009 with a tax rate of 45 percent that year.  The tax goes away entirely in 2010, but then returns to its former glory of a $1 million exclusion and a 55 percent top tax rate the following year.

So, if Congress does nothing, the estate tax will revert back to its old, miserable self in the year 2011.

Odds are that Congress will take some form of action between now and then.  Even Senator Clinton has endorsed making permanent the 2009 rules as part of a broader savings package.  When, how, and what actions are taken, however, remains very much up in the air.

The small business community will be represented at the hearing next week.  We’ll let you know who the rest of the witnesses are when they are announced.

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AMT Plan Imminent — House & Senate Moving in Different Directions

Posted by admin on March 8, 2007 · Leave a Comment 

The Ways & Means held a hearing yesterday on the Alternative Minimum Tax. While there is broad consensus in the tax world that the AMT is broken, there is little common ground on exactly how to go about fixing it. To date, Congress and the Administration have confined their efforts to temporary, one or two year “patches” that raised the AMT exemption just enough to limit the growth of AMT taxpayers. The current higher exemption runs through 2006, however, so Congress needs to act in the next year if it wants to prevent the number of taxpayers who pay the AMT from increasing dramatically next April 15th.

With that in mind, the lead from yesterday’s hearing was Congressman Richard Neal’s announcement that they would be offering a permanent solution to the AMT in the next three weeks, with a goal of resolving the issue in the next few months. What might that plan be? Fox News Sunday asked Ways and Means Chairman Charlie Rangel about his plans for the tax code over the next couple years. Here’s the part that caught our eye:

WALLACE: But are you talking about specifically, sir, rolling back the tax cuts, the Bush tax cuts?

RANGEL: No, we’re not talking about that, but we are — we may be talking about redirecting those tax cuts. You know, we have 23 million people in this country that have Alternative Minimum Tax burdens, close to $1 trillion over the next 10 years, and that’s not even on the president’s radar screen.

And so within the system, there can be more equity without increasing the tax burden.

WALLACE: So you’re suggesting that you might do something about the president’s tax cuts for the wealthy before they expire in 2010?

RANGEL: Well, all I can say at this point in time — that we in the majority and the minority on the Ways and Means Committee are working very closely with the secretary of treasury, Hank Paulson, not only on taxes, but on Social Security and trade and a lot of other areas, to see whether we can find more equity within the system without having partisanship.

So taxes is one of the issues that we’re looking at, yes.

WALLACE: So it’s on the table.

RANGEL: Everything is on the table. How much we can accommodate each other is something else.

To date, the S CORP Association and its allies have focused on targeted tax threats like expanding the application of payroll taxes to include more S corporation income, raising or eliminating the Social Security earnings limit, or changing accounting rules such as eliminating LIFO.

But raising overall individual tax rates would have just as dramatic an impact on S corporations as individuals – since S corporations pay taxes at the individual shareholder level. Remember, when S corporations were created, the top personal tax rate was 91 percent! Today, that rate is 35 percent. Any effort to roll back the rate relief that has occurred over the past half a century, under both Republican and Democratic administrations, would obviously harm S corporations and partnerships. Something to be wary of.

Meanwhile, BNA reports Finance Chairman Max Baucus is pressing for a two-year extension of the so-called AMT patch. “I think its good policy to extend it for another year because we’ll have to do it anyway,” he told reporters. While obviously less expensive than a permanent fix, a two-year extension still would reduce projected federal revenues by more than $100 billion. Under the current pay-go budget approach, the tax writers would need to find offsets to cover that revenue impact.

Note: For more background on the AMT, the Joint Committee on Taxation has released a comprehensive summary of the issue.

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TAX BILL IN LAME DUCK?

Posted by admin on December 1, 2006 · Leave a Comment 

Real quick, here’s what we’re hearing on the prospects of tax legislation moving when Congress returns next week:

Congressmen Hastert, Boehner, and Thomas are gathering today to decide what the House tax bill should look like. As we’ve previously reported, the best guess is a narrow bill that extends for a couple years expiring tax provisions like the R&D tax credit, together with some non-controversial trade proposals. Targeted provisions outside the usual extenders may get included, but that’s not clear right now.

On the Senate side, the limiting factor appears to be whatever can get adopted by voice vote. With the Senate leadership eager to finish the Lame Duck session next week, they just don’t have time for an extended debate over a tax bill. If that’s correct, then it’s likely the proposed technical corrections and any revenue offsets (read tax increases) are extremely unlikely.

WSJ ON FUTURE PAYROLL TAX HIKES

Among the many threats facing America’s S Corp community in the coming Congress, yesterday’s Wall Street Journal highlighted yet another — a possible deal on Social Security that would include a payroll tax increase.

As the Journal notes, “The Bush Administration has been around long enough that by now we can smell a retreat in the making. To wit, the White House is getting ready to throw personal retirement accounts over the side in an attempt to cut a Social Security deal with the new Democratic Congress. Will a tax increase be the next concession?”

There are a couple ways Congress could raise Social Security taxes, and both would adversely affect S corporations.

They could widen the Social Security tax base by increasing the types of income that pay Social Security taxes — like applying payroll taxes to all S Corp income regardless of whether its paid in wages or not.

Or they could eliminate the Social Security wage cap. This cap limits the application of the 12.4 percent Social Security tax to the first $97,500 (in 2007) in wages a worker earns.

Or they could do both, presenting S Corps with a double whammy of eliminating the wage cap while applying payroll taxes to all S Corp income. The result of this combined tax hit would be to raise federal marginal rates for S Corps making over $97,500 from 37.9 percent (income tax rates plus the 2.9 percent Medicare tax) to over 50 percent!

Such an increase would not only eliminate the tax relief of 2001 and 2003, it would fully offset all the tax relief dating back to the Tax Reform Act of 1986 – and pretty much eliminate the whole reason S Corps were created in the first place.

As you can imagine, your friends here at S Corp are extremely worried about any potential deal on Social Security that includes tax increases, and we’ll keep on the lookout to make sure you’re fully apprised of any developments.

S CORP AUDITS INCREASE – TAX GAP GROUP CONVENES

Finally, INC Online reports that the IRS increased audits of S Corporations by 34 percent this year, while audits of corporations with more than $10 million in assets declined. With the increased emphasis on the Tax Gap, particularly in the Senate, we’re expecting more of the same for 2007. As INC reports:

“We have placed more emphasis in the growing area of these flow-through returns involving S corporations and partnerships,” IRS Commissioner Mark Everson said in a statement, noting that S corporation audits are at their highest level since 2000, and audits of partnerships are now at their highest level since 1998.

In a related development, concerned business associations are gathering next week to convene a new coalition to ensure fairness in the on-going Tax Gap discussion. With Congress, especially the Senate, displaying an increased focus on the Tax Gap and possible proposals to close it, the business community needs to ensure that its concerns are heard as the legislative process moves along. S Corp promises to be an active part of this new group.

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Congressional Efforts to Close Tax Gap Means S Corp Payroll Tax Increase Is Still A Threat

Posted by admin on February 15, 2006 · Leave a Comment 

Today the Senate Budget Committee held a hearing on “the causes of and solutions for addressing the federal tax gap.” Witnesses included IRS Commissioner Mark Everson, Government Accountability Office Comptroller General David Walker, and Nina Olson, National Taxpayer Advocate. The tax gap is the difference between what taxpayers owe and what they pay (or at least, what they pay on a timely basis).

This hearing stems from the release of the President’s FY’07 budget (which makes funding recommendations for the IRS and includes other proposals to improve disclosure and tax administration) and the IRS’ announcement yesterday that the 2001 “tax gap” (the difference between the amount Americans should pay on income from legal activities and the amount they do pay) was $345 billion, a substantial sum that – if collected – might help to pay for a variety of programs and proposals. As such, attacking the tax gap is a politically attractive prospect.

S-CORP Alliance members will recall that both Treasury and the Joint Committee on Taxation have previously identified S corporation payroll tax “avoidance” (the H.I. tax) as being an element of the tax gap.  Addressing that problem one way or another (meaning raising payroll taxes on S corporation shareholders) has been cited by both as a way to raise tens of billions of dollars.  As today’s hearing demonstrated, S-CORP must stay actively engaged and involved in discussions of how to address the tax gap. Senate Finance Chairman Charles Grassley (R-IA), who also serves on the Budget

Committee and attended the hearing, made specific reference to the S corporation payroll tax proposal today, noting that the Finance Committee had “looked at the payroll tax system in a hearing.” In a nod to our lobbying efforts last year, Grassley also indicated that addressing S corporation HI taxes would be “controversial to fix … because they affect small businesses and might be easier to handle in the context of Social Security reform.” Yet it’s clear that S corporation payroll taxes are very much on the radar of key policymakers. Indeed, Budget Committee Chairman Judd Gregg (R-NH) noted that Congress “must do something on entitlement accounts” and has “an obligation to do something sooner rather than later.”  It’s also noteworthy that IRS Commissioner Everson referenced the S corporation audit project the IRS has undertaken and noted the IRS “plans to do more on C corporation” compliance.

As sizable federal deficits continue into the future, Congress will face increased pressure to narrow the tax gap and find other revenue offsets to pay for tax cuts. Thus, S-CORP must continue its mission to protect small businesses that are in compliance with the law from facing new, unfair tax levies.

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S-CORP Fights Proposed Tax Increases As Congress Searches for Revenue

Posted by admin on October 12, 2005 · Leave a Comment 

As S-CORP members will recall, this year began with a Joint Committee on Taxation (JCT) proposal to impose a nearly 3 percent additional tax on the full distributable share of profits for S corporation shareholders. The proposed tax would raise an astonishing $57.4 billion over ten years by applying to shareholders of S corporations as well as to partnerships.  Then in May, the Department of Treasury’s Inspector General for Tax Administration in testimony before the Senate Finance Committee (May 25, 2005) also endorsed the proposition that the net earnings of S corporations should be subject to payroll taxes. This was in the context of suggesting ways to close the payroll tax gap to reform Social Security .

S-CORP reacted to these proposals by launching the S Corporation Alliance – a group led by S-CORP which includes dozens of other trade associations and expert advisors. Among the Alliance’s members are the National Association of Manufacturers, the National Federation of Independent Business, the Associated General Contractors, and the Chamber of Commerce.  One of the first priorities of the Alliance has been to encourage other trade associations to sign on to a letter to Senate Finance Chairman Chuck Grassley and Ranking Member Max Baucus strongly opposing S corporation tax increases. This is an open letter; if your companies are members of any trade associations not listed on the letter, we encourage you to ask them to sign on, or to provide us with contact information so that we can reach out to them directly.

S-CORP has also been active on Capitol Hill, leading Alliance meetings with tax advisors to members of the powerful Senate Finance Committee to apprise them of the dangers of S corporation tax hike proposals, and to make them aware of the broad interests lining up against such initiatives should they advance. These efforts will continue throughout the fall.  The importance of these Congressional education and outreach meetings was underscored just weeks ago, when — seven months after the Joint Committee on Taxation (JCT)’s proposal to hit S corporations with a massive new tax — the New York Bar Association weighed in supporting key elements of the JCT proposal. In a letter dated September 23rd (attached), the Chair of the NY Bar tells Congress’ tax analysts at the JCT that the organization supports broadening the application of payroll taxes to S corporation owners who ‘materially participate’ in the operations of the business. In S-CORP’s view, giving credibility or support to any elements of the JCT proposal is a dangerous step for the S corporation community.

That said, we should note that the NY Bar letter does point out that a proposal such as the JCT’s, which would simply raise payroll taxes on all S corporation shareholders, fails to distinguish between income derived from labor and income derived from capital, S-CORP remains concerned . As the letter states, “(W)e believe that the JCT Proposal goes too far in the direction of extending self-employment taxes to income from capital, as opposed to income from labor, thereby widening the gap in treatment between otherwise similarly-situated employees and self- employed persons.”

Tax Legislation Update

Because any tax measure in Congress could contain revenue ‘offsets’ such as the one proposed by JCT, S-CORP staff is actively monitoring all tax bills coming out of the congressional tax-writing committees. Right now, the focus of the tax -writing committees is on legislation to aid the victims of Hurricane Katrina and encourage job creation and economic incentives for the disaster area.  A bill to ‘reconcile’ the Congressional budget, which is slated to cut taxes by $70 billion over 5 years, was also scheduled to have been considered by September, but the measure has been pushed back, at least until the end of October and perhaps longer. The House Republican Leadership, which has gone through some significant changes themselves in the wake of Congressman Tom DeLay’s recent indictments, has announced that they still intend to move ahead with a process to reconcile the federal budget, but the timing on this effort is unclear. Senate Finance Committee Chairman Chuck Grassley (R-IA) shed some light on the challenges this measure faces when he said, at a recent Finance Committee hearing, that disagreements over a bill to provide health care to Katrina victims could endanger the “chances of our getting the reconciliation bill out of my committee if we don’t get this behind us.”

Additionally, both the House and the Senate still plan to consider and pass major pension reform bills this Fall, and tax measures are likely to be part of such a package too.

IRS Audit Update

Many S corporations were surprised this summer when the IRS announced it plans to audit some 5,000 S corporations to ensure compliance with federal tax laws.  On September 20th, several weeks after this announcement was made, the IRS held an informational meeting to explain the progress of their National Research Program. In a panel called “Reporting Compliance Studies of Small Business,” there was considerable discussion of the IRS’ rationale for focusing the next round of audits exclusively on S corporations. As a document circulated by the IRS called “Why Study Subchapter S Returns” explained, the IRS views that such an audit is appropriate because:

  1. The last S Corp compliance study occurred in 1984;
  2. Since that time, the S Corp population has grown rapidly (S corps made up 59 percent of all corporate returns in 2002); and
  3. IRS plans to use the results of the audit study to “more accurately gauge the extent to which the income, deductions, and credits are properly reported” on S Corp returns.

IRS representatives indicated that audits will begin this month and continue for about three years.

The S corporation national audit is actually the second of five rounds of audits planned under the NRP. The first round focused on high income individuals, with an emphasis on those who file as sole proprietorships and farms. The third round, tentatively scheduled for 2008, targets C corporations, the fourth (2009) partnerships, and a final audit will focus on individuals filing under 1040 (2010).  While S-CORP fully supports better IRS enforcement of the tax code, the multi-year timeframe of the NRP, coupled with its initial focus on high income individuals, sole proprietorships and S Corps, has created the impression that small and family owned businesses are the sole cause of the so-call “tax gap.” This impression, in turn, lends credibility to patently unfair tax proposals such as the JCT proposal to increase payroll taxes on S Corps and partnerships. The S Corp Alliance, together with our friends on Capitol Hill, will continue to monitor this issue. And again, this is why S-CORP has ratcheted up its advocacy and education efforts in Washington, working actively to help policymakers understand the very serious adverse consequences to all S corporations of these and potentially other S corporation tax hike proposals.

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S CORP ALLIANCE LETTER – 36 SIGNORS AND COUNTING!

Posted by admin on July 1, 2005 · Leave a Comment 

Good news! We’re up to 36 groups on the S Corp Alliance letter (see attached). Thanks to all who signed on in the last week: American Council of Engineering Companies, Associated Builders and Contractors, Associated Industries of Massachusetts, Delaware State Chamber of Commerce, Independent Community Bankers of America, Indiana Manufacturers Association, Louisiana Association of Business and Industry, Michigan Manufacturers Association, Mississippi Manufacturers Association, Nebraska Chamber of Commerce & Industry, Non-ferrous Founders’ Society, Oklahoma State Chamber of Commerce, Utah Manufacturers Association, and Wisconsin Manufacturers & Commerce.

Please remember we’re keeping the letter open, so if you know of any organization that would like to sign on, please let me know so I can add them to the growing list supporting our effort.

CQ: FINANCE CONSIDERING MAKING S CORP PAYROLL TAX PROPOSAL PART OF SOCIAL SECURITY REFORM

The June 29th CQ Today raises the very real possibility that the Finance Committee may use the S Corporation payroll tax issue to help pay for reforming Social Security:  Grassley said his plan would entail slowing the growth of benefits by changing the indexes used to calculate them. It also would require an increase in the retirement age that aides described as small, and unspecified revenue increases. Grassley and a Finance Committee aide said his bill would not raise either Social Security’s 12.4 percent payroll tax rate or the $90,000 cap on wages subject to the tax.

The aide would not say specifically how Grassley intended to boost revenue, but pointed to testimony during a Finance Committee hearing earlier this year on ways that Congress could require more people to pay Social Security payroll taxes, such as small-business owners who take profits from their companies in lieu of salary.

The full article is attached below, and provides further evidence that the Senate Finance Committee is giving serious consideration to the JCT and Treasury Inspector General for Tax Administration’s recommendation that payroll taxes should be levied against all distributable earnings of certain businesses, including S Corporations. This would be an unprecedented expansion of payroll tax collections and represents a dramatic increase in the marginal tax rates potentially faced by millions of small and family-owned businesses.

S CORP ASSOCIATION IN THE NEWS

Also, many of you may have noticed that the S Corporation Association has been making headlines in the recent days with several news outlets picking up the story about Brian Reardon being appointed the Executive Director of the S Corporation Association. Yesterday’s BNA article read:

S Corporations — Former White House Official to Lobby for S-CORP:  The S Corporation Association (S-CORP) board of directors has named Brian Reardon as the group’s new executive director, according to a June 27 news release. Reardon recently served as special assistant to President Bush for economic policy, working as the chief tax aide in the President’s National Economic Council, S-CORP said. Prior to serving on the White House staff, Reardon was staff director and chief economist for the Senate Republican Policy Committee. He has also been chief tax lobbyist for the National Federation of Independent Business. Reardon is a principal with the Washington, D.C., lobbying firm of Venn Strategies LLC, which serves as political counsel to S-CORP.

Several other news outlets (including The Hill News and K Street Project Online) also picked up on the story.

Talk of Social Security’s Solvency Gets Diluted as GOP Pushes Personal Accounts
By Alex Wayne, CQ Staff

The idea of securing Social Security’s solvency has been relegated to a sideshow as congressional Republicans focus on a proposal to create individual accounts from the program’s surplus.  House Ways and Means Committee Republicans backing the plan for new individual accounts will brief the rest of their caucus Wednesday.

The plan, which would dedicate Social Security surpluses to individual accounts for workers younger than 55, does little to address the program’s long-term financial imbalance. And its backers express little interest in the kinds of benefit reductions or tax increases that other Republicans say are necessary to keep Social Security solvent.

“We do not subscribe to pain,” said Republican Rep. E. Clay Shaw Jr. of Florida, one of the Ways and Means Republicans behind the new accounts plan. “We’re going to do everything we can to try to solve this thing. But there’s no sense in rolling out something that’s not going to go anywhere.”

Shaw and other Ways and Means Republicans, however, caution the committee’s chairman, Republican Bill Thomas of California, is responsible for a larger “retirement bill” that is expected to include the surplus accounts proposal, and they say Thomas is still considering other measures to fix Social Security’s financial problems. They declined to elaborate on their discussions with Thomas, who has been tight-lipped about details of his legislation.

But in the face of continuing Democratic opposition to a Social Security overhaul that includes individual accounts, Republican leaders — especially in the House — are reluctant to ask their members to vote for legislation that includes Social Security benefit reductions that might prove unpopular with the public, such as raising the retirement age. Thomas’ bill could instead package personal accounts with pension changes, incentives for private saving and cuts to taxes on capital gains and dividends — and leave out the more politically risky Social Security changes.

“That is certainly one of the options that’s being pursued,” said Jade West, a senior vice president at the National Association of Wholesaler-Distributors, which is leading a coalition of trade associations and business groups promoting President Bush’s Social Security overhaul. But she cautioned that Thomas has not been open about his plans, even with political allies.

“There is a certain school of thought that they should address the personal accounts only, through . . . locking up the Social Security surplus and having it used for personal retirement accounts,” she said. “I don’t know that the president is headed in that direction, and I don’t know that Congress will move in a direction entirely disconnected from where the president wants to go.”

But ignoring the solvency question could cost backers of an overhaul the support of some Republicans. Republican Rep. Jim Kolbe of Arizona, said he and other moderates would vote against a bill that included personal accounts without “tough choices” on reducing the program’s costs. He believes the number of members in this “pain caucus,” as some have called it, is large enough to persuade Thomas to address solvency in his bill.

On the other side of the Capitol, Senate Finance Chairman Charles E. Grassley, R-Iowa, is still hopeful that his panel’s Republicans can agree on a bill that combines some of the tough choices Kolbe favors.  Grassley said Tuesday that he believes he has reached a “rough consensus” with his panel’s Republicans on legislation to address Social Security’s financial problems.

Grassley said his plan would entail slowing the growth of benefits by changing the indexes used to calculate them. It also would require an increase in the retirement age that aides described as small, and unspecified revenue increases. Grassley and a Finance Committee aide said his bill would not raise either Social Security’s 12.4 percent payroll tax rate or the $90,000 cap on wages subject to the tax.

The aide would not say specifically how Grassley intended to boost revenue, but pointed to testimony during a Finance Committee hearing earlier this year on ways that Congress could require more people to pay Social Security payroll taxes, such as small-business owners who take profits from their companies in lieu of salary.  The aide said “there is a majority of the Republican members who have more or less agreed to some basic things that move us toward solvency.”

An aide for Sen. Olympia J. Snowe, R-Maine, said Grassley has not made as much progress as he seems to think. “If anything, it feels like in the last couple weeks the group as a whole has gone backward on consensus,” the aide said. “I don’t understand how he gets to that conclusion unless he’s got everybody but us.”

Snowe has made clear she will not support a Social Security bill that includes individual accounts created from the program’s payroll tax revenue.  Grassley will present new Social Security proposals to his committee’s Republicans — including an individual accounts plan — at a meeting this week, the Finance aide said.

Source: CQ Today

BNA:

S Corporations Former White House Official to Lobby for S-CORP The S Corporation Association (S-CORP) board of directors has named Brian Reardon as the group’s new executive director, according to a June 27 news release.
Reardon recently served as special assistant to President Bush for economic policy, working as the chief tax aide in the President’s National Economic Council, S-CORP said. Prior to serving on the White House staff, Reardon was
staff director and chief economist for the Senate Republican Policy Committee. He has also been chief tax lobbyist for the National Federation of Independent Business.

Reardon is a principal with the Washington, D.C., lobbying firm of Venn Strategies LLC, which serves as political counsel to S-CORP.

K STREET PROJECT ONLINE: Rising Reardon

June 29 2005 11:36 AM

Brian Reardon, a recent hire at Venn Strategies lobby shop, has been named Executive Director for the S Corporation Association by its Board of Directors. Reardon previously served as President George W. Bush’s Chief Tax Aide for the President’s National Economic Council. He has also held the position of Staff Director and Chief Economist for the Senate Repubican Policy Committee. Additionally, Readorn is no stranger to the lobbying world as he was the head tax lobbyist for the National Federation of Independent Business.

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S CORP ALLIANCE CONTINUES TO MAKE HEADLINES!

Posted by admin on May 18, 2012 · Leave a Comment 

For those who missed it, Monday’s Congress Daily does an excellent job of outlining the challenge confronting S Corporations and other flow-through businesses as Congress prepares to take up reconciliation, tax reform, an extension of expiring tax provisions, and other tax legislation this Congress. Continued interest by the press regarding the Joint Committee’s recommendation is a clear signal this issue is not going away… JCT and the Treasury Department’s Inspector General for Tax Administration have proposed changing the rules to ensure that payroll taxes are levied on all a firm’s income, regardless of how it is counted. Concern in the small business community that Treasury might back a rule change of that nature was heightened when the IRS announced late last month that it was auditing 5,000 S-corporations with an eye toward recommending potential policy changes.”

SOME STARTING TO QUESTION THE IRS’ AUDIT OF S CORPORATIONS…

Last Friday’s BNA Tax Report suggests the IRS’ announcement that it intends to randomly audit 5,000 S Corporations over the next couple of years has left some tax practitioners questioning why the IRS is only targeting S Corporations.

“While several practitioners could list areas of possible S corporation noncompliance, many also said they were not aware of any egregious, widespread violations currently occurring. Other practitioners noted several compliance problems may be more prevalent in S corporations than with other types of corporate structures.”

August 8th, 2005

CONGRESSDAILY PM

TAXES

Business Groups Prep For Battle Against S-Corp. Change

Small businesses are fighting a proposal to collect more payroll taxes from millions of S-corporations and partnerships, a plan they fear might be used by tax writers to help underwrite expensive Social Security or tax overhaul efforts. The proposal was floated earlier this year by the Joint Committee on Taxation, which estimates it would raise $57 billion over the next 10 years. That represents one of the largest revenue sources from a single legislative change, as congressional tax writers seek options to shore up the long-term solvency of Social Security and to change the tax code. Congress is awaiting recommendations from President Bush’s tax panel at the end of next month.

“The tax panel’s charge is to report recommendations that are revenue-neutral … They’re going to have to come up with offsets someplace,” said Brian Reardon, a former White House economic adviser who is coordinating business efforts against the tax change.

At issue are amounts that small businesses organized as partnerships, limited liability corporations or S corporations claim as compensation for tax purposes. Current law requires Social Security and Medicare taxes to be levied on all “reasonable compensation” of employees of these pass-through entities. But according to a January JCT options paper, owner-employees have an incentive to under-report their wages to avoid paying excessive payroll taxes. They might take a large chunk of income as a distribution, which would not be subject to those taxes. JCT and the Treasury Department’s Inspector General for Tax Administration have proposed changing the rules to ensure that payroll taxes are levied on all a firm’s income, regardless of how it is counted.

Concern in the small business community that Treasury might back a rule change of that nature was heightened when the IRS announced late last month that it was auditing 5,000 S-corporations with an eye toward recommending potential policy changes.  A broad coalition of business groups that includes the National Federation of Independent Business, the National Restaurant Association, National Association of Manufacturers and a number of state chambers of commerce has been formed to lobby against the payroll tax change. The coalition is being coordinated by Reardon of Venn Strategies, which represents the S Corporation Association. Opponents of the JCT proposal claim that the IRS already has the ability to determine whether a taxpayer’s claims of “reasonable compensation” are accurate, and to collect whatever taxes it thinks have gone unpaid.

“Our goal is to educate members and educate staff to make sure they understand these are bad policies; they’re bad economics. They would represent a direct, unfair tax on a lot of employers,” said Reardon. But the coalition also faces a unique challenge when communicating the problem to Republican lawmakers in particular: The problem highlighted by JCT was earlier identified by Vice President Cheney in a debate last summer with then-Sen. John Edwards of North Carolina, the Democratic vice-presidential nominee. Cheney raised questions about whether Edwards was avoiding payroll taxes by structuring his law practice as an S-corporation and underreporting his “reasonable compensation.”

– by Martin Vaughan

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