Small Business Bill — Slogging Through the Senate
Last night, the Senate voted 60-39 to close debate on a Landrieu amendment to restore the $30 billion lending facility to the small business bill. This amendment was made necessary because earlier in the week, the leadership had dropped the lending facility due to staunch opposition from key swing votes.
The Senate is now on an unrelated bill, but we expect it to resume debate on the small business bill sometime next week – which will likely push House consideration of the bill into September. What’s the prognosis? Here’s the S-CORP Crystal Ball:
- Progress on the bill had been slowed by two points of contention: opposition to the lending facility, and demands (mainly by Republicans) to offer amendments on the estate tax and other tax items. The 60 votes in support of the lending provisions should put an end to that debate. The Senate has worked its will and members will likely move on, at least until negotiations take place between the House and the Senate.
- The next step will be a cloture vote on the Baucus Substitute. This is the tax portion of the bill that includes some very good provisions, including the bonus depreciation and built-in gains relief. There’s a good chance the first attempt to get cloture will fall short, with Republicans holding together in an effort to get votes on key amendments; they support the tax provisions, but want their amendments, too.
- At that point, our crystal ball gets fuzzy. We could end up with an agreement for one or two key votes and then final passage. Or the Leader could continue to block any additional amendments and try one last time to get cloture.
With two weeks left in the session, the Senate has two “must pass” items: the Kagan nomination and the small business bill. Getting both done is doable, but it’s going to require a concerted effort. With all of the bad policies on the horizon for small businesses, a friendly package of tax provisions would be a welcome respite. Here’s hoping the Senate succeeds in moving this bill.
Future of Expiring Tax Cuts: Update
Lots of conflicting news this week on future of the expiring tax cuts:
- “Democrats are considering a plan to delay tax hikes on the wealthy for two years because the economic recovery is slow and they fear getting crushed in November’s election.” The Hill, July 22nd.
- “In a speech on the economy and jobs, House Majority Leader Steny Hoyer (D-Md.) on Friday reiterated his party’s call to extend the Bush middle-class tax cuts and deemed Republicans’ call to extend breaks for the wealthy a ‘mistake [that] would be putting ourselves even deeper into debt.’” The Hill, July 22nd.
- “Senate Finance Committee Chairman Max Baucus (D., Mont.) is eyeing September for possible committee action on extending individual tax cuts that are scheduled to expire at the end of the year, according to Senate aides. Baucus held a meeting with Republicans and Democrats on his committee Thursday evening to begin discussing how to deal with the approaching expiration of the tax cuts. Baucus raised the possibility of a September committee vote, people present said. Aides cautioned that no conclusions about what to do or when to do it were reached at the meeting.” Dow Jones, July 21st.
- “Sen. Kent Conrad (D., N.D.), a senior Senate Democrat with influence over tax and budget policy, said Wednesday that Congress shouldn’t allow taxes on the wealthy to rise until the economy is on a more sound footing. Conrad told Dow Jones Newswires in an interview outside the Senate chamber that Democrats should cancel plans to let the top individual income-tax rates and capital-gains rates rise for the wealthy at the end of this year. He said a tax increase might imperil an economy already weakened by the effects of persistent unemployment and turmoil in European debt markets.” Dow Jones, July 21st.
So, the future of tax policy is clear as mud. What are the possible outcomes for the expiring tax cuts?
- Congress does nothing and all the tax cuts expire;
- Congress adopts a temporary (one- or two-year) extension of the middle class tax relief; or
- Congress adopts a temporary extension of all the tax relief.
It’s not intuitive, but we believe the second option — Congress extends the middle class tax cuts only — is the least likely outcome. It’s counterintuitive because that is the preferred policy of the leadership in Congress and the Obama Administration. It’s least likely because it will be hard for leadership, especially in the Senate, to cobble together the necessary votes. Republicans are likely to oppose en masse, and deficit hawk Democrats will object to the cost.
On the other hand, a one-year extension of all the tax cuts could carve out super majorities in both the House and the Senate, but that would require congressional leadership to move a bill over the objections of a significant portion of their conference. They might, but they haven’t been willing to do that to date.
Instead, faced with the no-win situation of dividing their base, leadership could choose to do nothing. With the legislative clock ticking, we see that as the most likely outcome. Congress does nothing, or makes a half hearted effort and falls short, and all the tax relief goes away.
Predicting is risky and we’ve been wrong many times. We hope we’re wrong this time too.
Payroll Tax Hikes Back On The Agenda
Last week, the S corporation community was put on high alert when we received word that an S corporation payroll tax increase similar to the provision from the old Rangel “Mother” bill (H.R. 3970) was being discussed as an offset to the extender package. The “Mother” provision (see Sec. 1211) would apply payroll taxes to all the service-related income of active shareholders of S corporations primarily engaged in service businesses. While we anticipate that the language of any new provision will differ somewhat from its 2007 predecessor, the general concept remains the same. As CongressDaily noted:
Sources familiar with the House Ways and Means and Senate Finance discussions said applying payroll taxes to certain S corporation profits could raise anywhere from $10 billion to $15 billion, depending on how it is structured. Revenues in that ballpark would go a long way toward closing a $30 billion gap tax-writers need to fill to pay for extensions of numerous expired provisions.
An earlier proposal floated in 2007 was estimated to raise $9.4 billion over a decade by subjecting S corporation and partnership income earned from providing services to payroll taxes, although the new healthcare law would raise the Medicare portion of the tax beginning in 2013 for wealthier earners. The 2007 proposal was scaled back from an earlier option outlined by the Joint Committee on Taxation that would have applied the payroll tax to all S corporation income, estimated to raise $57.4 billion over a decade.
Team S-CORP has had to fight this battle in the past, and we have been in to discuss this provision with Ways and Means on several occasions to get a better idea what they have in mind. Letters sent back in 2007 on behalf of S-CORP as well as our allied trade associations should give you a better sense of the history of this issue.
The future of this particular effort is still very much up in the air. Our communications with the Hill suggest there continues to be strong interest in legislating on this issue — you could characterize this as just one more legacy item left to us by former Senator John Edwards and his law practice — albeit it may take place on a bill other than extenders.
We have pledged to work constructively with taxwriters on a resolution to this issue, but unless they are willing to dramatically pare back the “Mother” provision to target only bad actors, it is going to be very difficult for business groups to support yet another tax increase on their members.
Stay tuned. More to come.
Latest on Dividends
Whither Tax Rates? The Hill’s On the Money Finance & Economy Blog had an excellent discussion this month on the topic, focusing on the future of dividend rates.
As On the Money notes, “President Barack Obama has proposed that the current rate of 15 percent on dividends be extended for most taxpayers. He’d raise the tax on dividends for individuals making $200,000 or more and families making $250,000 or more to 20 percent. There are several reasons to think wealthier taxpayers will get hit with a much higher tax.”
Meanwhile, The Hill mentions that one possible outcome would be for the dividend tax to fall somewhere between the current 15 percent rate and the top rate on ordinary income. Any divergence from the baseline, however, would require positive action by Congress. As The Hill observes, that’s not something to be taken for granted:
Finally, the lesson of the expired estate tax also has dividend-tax watchers nervous. Congress was expected to extend the estate tax last year, but instead let it expire when Republican and Democratic senators could not reach a compromise. The estate tax is set to kick in again in 2011 at a much higher rate if no action is taken this year.
Also at play is a possible House-Senate dynamic. Our impression is Senate leadership would like to keep capital gains and dividends taxed at the same rates, while their House counterparts are more comfortable seeing the rate on dividends go back to 39.6 percent.
In the end, we believe process will dictate outcome here. The recently enacted “pay-go” rules require Congress to offset any reduction in the dividend tax rate below 39.6 percent for 2011. Exactly what tax increases would Congress use to offset dividend tax cuts for folks making more than $200,000? We don’t know either, and expect the tax hikes already imbedded in current law will take place as scheduled.
Long To-Do List
Tax policy is in danger of becoming that honey-do list that never gets done. The traditional tax extenders — R&E tax credit, state sales tax deduction, etc. — all expired at the end of last year and, almost five months later, are still expired. Legislation to extend them is stuck between the House and Senate without a pay-for, yet (see above).
Meanwhile, the estate tax fix that was supposed to be done last year — before the tax took its one-year sabbatical — remains stalled in the Senate. Efforts to negotiate some sort of permanent fix are actively taking place in the Senate, so there’s hope. As with the extender package, however, the hold-up is primarily over offsets.
There’s also the most recent in the growing line of “jobs” bills being considered by Congress this year. The latest one passed the House under the banner of a “small business jobs” bill, despite the fact that most of its benefits went to Build America Bonds. We expect the Senate to take up a bill that’s more small-business oriented soon.
Finally, there’s the burning issue of all those tax cuts expiring at the end of the year.
With that as background, reasonable folks might ask themselves “What’s the plan?” Ways and Means Committee Chairman Sander Levin (D-MI) addressed this question earlier this month, stating he hopes to complete work with the Senate on both tax extenders legislation and the House-passed small business bill by the end of May, telling reporters, “These bills are a critical priority for the leadership of this Congress and the president…These are jobs bills … and we need to get these done.”
According to BNA, Levin met with Senate Finance Committee Chairman Max Baucus (D-MT) to discuss the two bills, but the two “did not discuss efforts to address the estate tax, which expired at the start of 2010, and no detailed plans have been set for how lawmakers will deal with the middle-class tax cuts of 2001 and 2003 that are set to expire at the end of the year.”
Your S-CORP team has numerous member companies who are intently interested in Congress moving forward on both the estate tax and the expiring tax provisions. We are five months into 2010 already. It’s time for Congress to act.
Built-In Gains in Play
Team S-CORP spent the last couple weeks on the Hill, educating members and staff on the virtues of reducing the built-in gains (BIG) holding period.
When a company converts to an S corporation, it must hold onto any appreciated assets for 10 years or face a punitive level of tax. This tax effectively locks up these assets, preventing the company from selling them and putting the resources to better use. We’ve raised this issue before, but allowing private companies access to their own capital makes lots of sense in an economy where capital is scarce. It also reflects the reality of today’s shorter lifespan for key business investments.
Last year, Congress agreed and included a shorter, seven-year holding period in the stimulus package. That seven-year period expires at the end of 2010 and needs to be made permanent. A five-year period would work, too. Last summer, Senator Grassley (R-IA) introduced legislation to reduce the BIG tax holding period to five years which we view as tremendously valuable to S corporations struggling to raise capital.
With the Senate actively considering provisions to help small businesses grow and create jobs, a shorter BIG holding period is going to give you more job-creating umph than any other tax provision we know. It would benefit Main Street firms located in every state and every sector of the economy and should be included in the final package.
President Releases 2011 Budget
The president released his FY2011 budget yesterday. According to the Office of Management and Budget (OMB), the administration begins with a ten year baseline deficit of $5.5 trillion dollars. Simply put, if Congress and the administration left current laws in place, the deficit would average over $500 billion per year for the next decade.
The president’s proposed policies would raise this deficit to $8.5 trillion. As a result, debt held by the public would increase from $5.8 trillion (41 percent of GDP) in 2008 to $17.5 trillion (76 percent of GDP) in 2019.
It always helps to look at the really big numbers — there aren’t any bigger than when you’re discussing federal budgeting — to put things in perspective. Under the president’s proposed budget:
- Total spending over ten years would be $45.8 trillion. Spending is scheduled to move from 24.7 percent of GDP in 2009 to 23.7 percent of GDP in 2020. The historical average is around 21 percent.
- Meanwhile, total revenue collections would be $37.3 trillion. Taxes are scheduled to rise from 14.8 percent of GDP in 2009 to 19.6 percent by 2020. The historical average is 18 percent.
On the revenue front, the president proposes just over $4 trillion in tax relief — most of which comes in the form of extending the 2001 and 2003 tax relief packages which targeted folks making less than $250,000. On the other side of the ledger, the president proposes a large “grab bag” of tax increases — LIFO repeal, carried interest, black liquor, etc. With the odd baseline the administration is using (see below), we’re not sure exactly what the tax increases total, but it’s somewhere in the neighborhood of $1 to $1.5 trillion.
As expected, the budget calls for allowing taxes on upper-income families (and businesses) to rise back to their pre-2001 levels. As the Wall Street Journal reports this morning,
The two top income-tax brackets would rise to 36% and 39.6%, from 33% and 35% respectively. For families earning at least $250,000, capital gains and dividend tax rates would rise to 20% from 15%. All told, upper-income families would face $969 billion in higher taxes between 2011 and 2020.
For other big ticket items — health care reform and cap-and-trade — the budget includes only cursory references. These placeholders are consistent with the administration’s approach to date of delegating these policy decisions to Congressional leadership.
As we have observed in previous posts, the president’s budget is always an odd duck. The president has no tangible authority to tax or spend — the Constitution reserves that right for Congress, after all — yet there is a leadership quality to any presidential budget that can effectively set the tone for the budget decisions to be litigated through the legislative process.
In the case of this budget, that leadership appears wholly absent. No details on his biggest policy priorities. No meaningful proposals for holding down spending or bringing down the deficit No hints at entitlement reform. There is a proposed deficit reduction commission, but it has no teeth.
Congress this year will face as difficult a budgeting challenge as any in recent memory. The economy has stabilized and a continued financial meltdown is no longer imminent. The biggest threat to economic growth now is the federal deficit and its impact on interest rates and prices. As this budget release makes clear, Congress will be addressing these challenges alone.
Estate Tax Update
On the estate tax front, the president continues to call for making permanent the estate tax rules from 2009 — a 45 percent top rate and a $3.5 million exemption — but you’d be hard-pressed to find much discussion of this policy in the budget. That’s because the administration is using something other than the usual “Current Law” baseline. As Treasury’s Green Book notes:
The Administration’s primary policy proposals reflect changes from a tax baseline that modifies current law by “patching” the alternative minimum tax, freezing the estate tax at 2009 levels, and making permanent a number of the tax cuts enacted in 2001 and 2003. The baseline changes to current law are described in the Appendix. In some cases, the policy descriptions in the body of this report make note of the baseline (e.g., descriptions of upper-income tax provisions), but elsewhere the baseline is implicit.
In other words, they have taken a projection of current policy and modified that baseline to accommodate changes to AMT, Medicare Physician Payment policy and the estate tax. In budget world, no mention of the estate tax in the budget means an extension of current policy. A footnote on page 158 of the budget makes clear the “current” policy they’re referring to for the estate tax is the 2009 policy, not the 2010 policy currently in place. Not exactly a strident endorsement for the 2009 rules, but it’s there nonetheless.
The second set of estate tax proposals in the budget looks similar to last year’s budget proposals. There are three, the headings are the same, and the revenue estimates are similar:
1. Require consistent valuation for transfer and income tax purposes: Ten Year Estimate — $1.8 billion (2010 budget); $2.1 billion (2011 budget);
2. Modify rules on valuation discounts: Ten Year Estimate — $19.0 billion (2010 budget); $18.7 billion (2011 budget);
3. Require a minimum term for grantor-retained annuity trusts (GRATS): Ten Year Estimate — $3.3 billion (2010 budget); $3.0 billion (2011 budget).
We spent the past year working on issues related to provision 2 — the valuation discounts. While the write-up of the administration’s proposal refers to “estate freezes” rather than the “family attribution”, we remain wary that restoration of the old “family attribution” approach is part of the policy mix being discussed at Treasury and on Capitol Hill. With that in mind, we will continue our work to educate policymakers on why family attribution is a really bad idea.
Regarding work on an estate tax compromise, the Finance Committee has been working with key offices to come up with some sort of process to move a compromise forward in the next couple months. They appear to be still working on what that compromise might look like, even at this late date. Possible policies range from restoring 2009 rules to implementing a more business-friendly compromise centered around a 35 percent top rate and $5 million exemption.
The bottom line question for everyone involved remains the same — is there a proposal out there that can garner 60 votes? If not, expect to see the current repeal stay in place through the rest of the year, followed by the restoration of the old pre-2001 rules. The longer this process takes, the more likely that is the final outcome.
Estate Tax Update
Where to start? The August break is nearly over and Congress is scheduled to return after Labor Day with a full agenda that includes finishing (or finishing off) health care reform, wrapping up all the spending bills, increasing the debt ceiling, doing something on the energy front, and adopting a package extending expiring tax provisions, including a possible estate tax compromise.
Earlier this month, Martin Vaughan of the AP had a nice piece outlining the current state of play on the estate tax. While the House is poised to enact a simple extension of 2009 rules into 2010, we don’t expect the Senate to follow suit quickly or easily for the simple reason that it would surrender any leverage Senate Republicans have to negotiate a deal beyond 2011. The only thing bringing Democratic leadership to the table is their wish to avoid next year’s repeal.
For that reason, the staffs of Senate Finance Committee members are using the August break to finalize the outline of a possible compromise, including provisions to reduce the overall cost of the package. The budget resolution allows for an estate tax fix that extends 2009 rules into 2010 and beyond to be adopted without needed offsets. Negotiators in the Senate would like to go beyond the 2009 rules, so they would need offsets for any additional relief.
S-CORP members are worried that the old IRS “family attribution” concept for valuing family business assets at a premium might make an appearance during these talks. The IRS unsuccessfully pushed this idea back in the 70s and 80s and lost repeatedly in court. They gave up in 1993, but as we all know, no bad idea ever dies in Washington D.C.
Legislation to resurrect the concept has been introduced in the House, the concept is part of the Obama budget this year, and the Treasury Department has been looking into promoting it administratively. All of this activity should be troubling to family businesses. Our S-CORP team continues to work with friendly members of Congress to educate them on the harmful impact this would have on family businesses across the country.
SOI on S Corporations
After a multi-year year hiatus, the Statistics of Income folks over at the IRS have issued a new update on their S Corporation analysis, this time for 2006. The report is along the same lines as previous efforts, outlining the general size and nature of the S corporation community, but a few items stand out.
First, “Sting Tax” collections — the tax applied to excess passive income — took a big 108 percent jump from 2005 to 2006. Not sure why, but we’re hoping that the Sting Tax relief enacted in 2007 helps ensure that fewer S corporations get stung by this unreasonable tax.
Bottom Line: S corporations are an important segment of the economy, a key contributor to job creation, and their success is important to economic recovery.
Deficit Implications for Closely-Held Businesses
The Obama Administration released its mid-session budget review last week on the same day the Congressional Budget Office updated its ten-year budget outlook. The headlines for both reports are the dramatic — really dramatic — deficit levels for the next ten years and beyond.
| Mid-Session Review Deficits and Debt | ||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | |
| Deficits | 459 | 1580 | 1502 | 1123 | 796 | 775 |
| Debt Held by the Public | 5803 | 7856 | 9575 | 10590 | 11443 | 12281 |
| Source: Office of Management and Budget | ||||||
Consider what this means for managing the public debt. Over 2009 and 2010, deficits will exceed $3 trillion. Add to that Treasury’s need to roll over maturing existing debt and it means the Treasury will be auctioning around $50 to $75 billion in new bonds, bills and notes every week for 100 weeks in a row. Wow.
For closely-held businesses, our take away is that taxes are going to rise in the next few years. This chart from the CBO is instructive. Historically, federal revenues have been around 18 percent of national income, while federal spending has been in the 20 percent range. The growth of entitlements in the next decade will take federal spending to 23 percent of national income and beyond. Meanwhile, tax receipts are expected to rise to above 20 percent, largely reflecting the growth of the Alternative Minimum Tax and the expiration of the Bush tax cuts.
So even if Congress allows all the Bush tax cuts to expire — including repealing the lower marginal rates, the $100 child credit, and the marriage penalty relief — the gap between revenues and spending will still grow. To shrink this gap and get deficits under control, Congress will need to raise taxes even further, reducing spending by a large amount, or some combination of the two.
Given that the current health care plans before Congress would expand federal health care spending, not reduce it, we doubt the ability of Congress to effectively reduce spending and expect the policy bias will be towards higher taxes instead.
Estate Tax & PAYGO
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.
Value-Added Tax Coming to America?
Two weeks ago, the Senate Finance Committee released its summary of options to pay for health care reform. As expected, the list was long and could be divided up any number of ways. One item missing from the list, however, is a source of revenue folks are talking about for health care reform and other spending priorities too — a value added tax (VAT).
The Finance Committee summary followed the release of papers on improving health care delivery and expanding coverage. The key to all three papers is that, while they give the reader a sense of where the Committee is headed, the exact plan remains shaded by options and generalities. So are the costs.
Exactly how much will health care reform cost? Some advocates — including the Obama Administration’s top economists — argue that a properly structured plan would save the taxpayer money, but that’s mere rhetoric. Expanding health care coverage to more Americans will cost money. Lots of it.
That’s why President Obama’s budget set aside $326 billion in tax increases to help pay for health care reform, but that may not be enough. Most observers believe the ultimate price tag will be several times higher while many of President Obama’s proposed pay-fors are simply non-starters with Congress. Enter the latest idea of a pay-for — the value-added tax. The Washington Post reported last week:
With budget deficits soaring and President Obama pushing a trillion-dollar plus expansion of health coverage, Some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax… A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.
The story points out that, in addition to several well-placed congressional advocates, there are a few folks within the Obama Administration who support a VAT, such as Office of Management and Budget health advisor Ezekiel Emanuel (who also happens to be White House Chief of Staff Rahm Emanuel’s brother).
While this proposal is clearly far from becoming a reality, it is indicative of just how hungry Washington is for money these days that perhaps the most feared of all taxes — the VAT — is being floated as a possible revenue source.
How Progressive is Progressive?
The American economy is remarkably dynamic, with a large percentage of folks moving from one income group to another every couple years. This movement is often the product of life-cycle earnings, where workers earn little when they start out and then slowly increase their incomes until they reach their peak earnings years of around 40 to 65.
It stands to reason that mature job-creating businesses are highly profitable too. If they are structured as S corporations, then their income is subject to the effective tax rates illustrated above. Something to think about as the unemployment rates approaches 10 percent.
Canada Runs Surpluses
Who knew Canada was running surpluses these days? How did they do it?
First, they cut spending at the Federal level from more than half of their national income to less than 40 percent. That, in turn, produced budget surpluses that were used to pay down their national debt.
What’s the lesson here for S corporations? While Congress and the new Administration search the tax code for new revenues to offset new spending and reduce the deficit, the experience of Canada and others demonstrates that deficit reduction begins with spending restraint — not tax increases.
Middle-Class Tax Increases on the Horizon
Last Wednesday’s The Hill included a comprehensive overview of the exploding spending and deficit picture and calls into question President Obama’s ability to live up to his long-held promise not to raise middle class taxes. It’s worth a look.
For the past half-year, your S-CORP team has focused on President Obama’s long-stated goal to pay for health care reform and his other spending priorities by raising taxes on American families making more than $250,000 per year, all while cutting taxes for middle-class families.
With the Federal deficit approaching $2 trillion this year, however, just how does one expand government, reduce the deficit, and cut taxes for a large swath of taxpayers – all financed by less than five percent of the population? As The Hill reports, skepticism that the Administration can pull it off is on the rise:
“President Obama’s proposed changes to the tax code, combined with exploding entitlement costs, will lead to ever-growing debt, according to independent estimates. The big question for Obama and his economic team will be whether he can meet the rising costs with increased tax revenue only from small slices of the electorate…Many economists, including some who voted for Obama, do not believe that he can indefinitely avoid imposing tax increases much further down the income scale — on the middle class.”
It is becoming increasingly obvious that taxes on the middle class – not just the “wealthiest” – will need to go up to pay for the Obama Administration’s ambitious goals. Exactly what sort of taxes? Len Burman at the Tax Policy Center thinks a value-added tax is inevitable. Just like France. Great.
CBPP to States — Tax Your Way to Prosperity
If higher taxes at the Federal level weren’t enough, the folks over at the Center on Budget and Policy Priorities (CBPP) have a novel recommendation for states hurt by the current recession — balance your books by taxing job creators!
In a report entitled “Reforming the Tax Treatment of S-Corporations and Limited Liability Companies Can Help States Finance Public Services,” the CBPP provides a blueprint for and encourages states to “consider imposing meaningful levies on S-Corps and LLCs as a source of additional revenue to help close the major budget gaps many of them are facing.” Sure, gaps like those created by the extra unemployment checks for folks laid-off when their over-taxed business closes.
Enough said.
Private Enterprise and Job Creation
On a more positive note, our friends at the Kauffman Foundation have taken the new Business Dynamics Statistics series at the Census Bureau and crunched the numbers a bit.
What they have found is presented in a series of short papers that does a great job of demonstrating the critical importance of start-up businesses to job creation. Key findings include:
- More than 100 percent of all net new jobs in any particular year can be attributed to start-up businesses. Or put another way, absent new business creation every year, employment in the United States would shrink.
- Remaining net job growth comes from firms more than a quarter century old. Their job creation levels are low compared to younger firms, but unlike younger firms, surviving older firms create more jobs than are lost when older firms close.
- States differ substantially on the portion of employment attributed to younger companies (less than 3 years old). In the West and Southeast, it’s up to 12 percent, while in the Midwest and Northeast, it’s about 6 percent.
How does this add to our understanding of job creation and job creators? The important role of start-ups and entrepreneurs has been examined for hundreds of years, but who knew that older, more mature firms were a source of net job creation? Findings like this put the whole estate tax debate and the importance of transferring businesses from one generation to the next into a whole new light.
Your S-CORP team is often amazed at the gulf between the rhetoric over jobs and the actions of some policymakers. Everybody talks about the importance of jobs and job creators, but the policies supported by some folks make you wonder just how deep their understanding and commitment goes.
The work at the Kauffman Foundation gives us critical insight into the job creation process. We hope policymakers — especially those engaged in estate tax discussions — will pay attention.
Stimulus Update
The Washington Post reports that the Senate Stimulus bill is short of the 60 votes needed for it to move through the chamber. As the Post noted:
Senate Democratic leaders conceded yesterday that they do not have the votes to pass the stimulus bill as currently written and said that to gain bipartisan support, they will seek to cut provisions that would not provide an immediate boost to the economy.
The vote in the House did not help, with all Republicans and 11 Democrats opposing the House version of the package. The unified Republican opposition in the House will likely empower Republicans in the Senate to stand together as well.
But the opposition rests not just with Republicans. Some Democratic members have expressed opposition as well. $800 billion in new spending and tax relief is a huge package, especially with the deficit already projected to exceed $1.1 trillion in 2009.
So what’s likely to happen? Look for moderates in both parties to put together a list of spending items that need to be cut in order for them to support the remaining package. As the Post reports:
Nelson said he and Collins have agreed to “tens of billions” in cuts, although he said he is skeptical that the effort will reach Collins’s target of $200 billion in reductions. The pair has counted up to 20 allies in their effort, with more Democrats than Republicans at this point.
Whether Senators Susan Collins (R-ME) and Ben Nelson (D-NE) find the right balance, or another group of Senators come to the table, we expect a compromise to be worked out over the next couple days. The Senate may be in this weekend, but it’s unlikely to leave without passing some form of the package first.
S Corps Lose an Ally
The S corporation community lost one of its greatest advocates the other day with the passing of Don Alexander. As our friend Martin Vaughn with Dow Jones reports:
Donald C. Alexander, who served as Internal Revenue Service Commissioner from 1973 to 1977, died Monday night at 87. Besides leading the IRS, Alexander held a wide range of other public service positions, including serving on the Commission on Federal Paperwork and as commissioner of the Martin Luther King Jr. Federal Holiday Commission. He was director of the U.S. Chamber of Commerce for five years in the 1980s. Most recently, Alexander was a partner at the law firm of Akin Gump Strauss Hauer and Feld LLP, from 1993 until his death. He was awarded the Silver Star and the Bronze Star for service in the 14th Armored Division during World War II.
Don was always a southern gentleman, and he was always focused on improving the rules for S corporations. He testified on behalf of the community before Congress many times. Here is just one sample of his views.
Stimulus Package Discussed
Following a closed-door planning session today of members of the Senate Finance Committee, we expect the Committee will mark-up the tax portions of a stimulus package as early as January 22nd. As we indicated previously, committee members are committed to exerting their jurisdiction over the tax portions of the package. Moreover, there appears to be a growing debate over certain provisions in the Obama plans. As Dow Jones reports this afternoon:
“When asked about specific tax cut proposals made by Obama, Kerry said, “I think there are cuts that are not going to stand the test of whether they will create jobs. Coming in for specific criticism were an Obama plan to give companies a $3,000 tax credit to offset the cost of new hires, and a $500 tax credit for workers that would be spread out over a period of time in take-home pay. “Is a $3,000 tax credit going to get you to hire somebody to build cars that nobody’s buying?” asked Sen. Kent Conrad, D-N.D., speaking to reporters after the committee meeting.”
Exactly what replaces those unpopular tax cuts — more tax relief or more spending — is an open question. Let’s hope it’s more tax relief for businesses. Having both the Ways and Means and Finance Committee members weigh in on the stimulus package, however, gives our S corporation allies a better chance to make the package more small business friendly, especially with regard to built-in gains reform. We expect the Ways and Means Committee to also hold a mark-up as early as the week of the inauguration. S-CORP In the News
Speaking of small business tax relief, the Baltimore Sun published an op-ed by S-CORP Executive Director Brian Reardon highlighting the history of the small business corporation and outlining how Congress can best help ensure the small business community is adequately armed to respond to the on-going economic recession:
What should Congress do? First, follow President-elect Obama’s lead and make small business tax relief the center of any economic stimulus plan. Relief that increases small business’ access to capital would be especially timely. For S corporations, the tax code forces many of them to sit on appreciated assets rather than sell them and put the money to better use. Another rule prohibits them from accepting direct foreign investment. Changing these out-of-date rules would free up capital and encourage new business formation.
Second, keep the rates on small business income low – certainly no higher than what large corporations pay. Actions like these would signal to millions of small businesses that they will not be punished to pay for the excesses of Wall Street, which should make it easier for them to grow their businesses and create jobs.
New Members on Ways and Means
The House Ways and Means Committee for the 111th Congress is now complete, with both Democrats and Republicans announcing their final additions to the committee. House Republicans had six seats to fill and announced their selections yesterday. New members include:
Rep. Charles Boustany (LA-07)
Rep. Ginny Brown-Waite (FL-05)
Rep. Geoff Davis (KY-04)
Rep. Dean Heller (NV-02)
Rep. David Reichert (WA-08)
Rep. Pete Roskam (IL-06)
Earlier this week House Democrats filled their one remaining spot on the Ways and Means Committee with the selection of Linda Sanchez (D-CA), after Representative Raul Grijalva (D-AZ) turned down the position in December. Combined with the Democrats’ earlier additions, that’s a total of 11 new members for the tax-writing Committee.
You can bet your S-CORP team will be reaching out to new and old members alike in coming weeks. Small business tax relief is on the table, and we need to get the message out.
Bailout Watch
The ongoing soap opera of the auto bailout continues, with Congress failing to find a means of balancing the needs of Detroit with the concerns of taxpayers and Senate Republicans. As a result, the bailout stalled in the Senate last week and the Administration appears poised to step in and use whatever authority it has — TARP, Treasury, Fed — to provide the companies with the liquidity necessary to survive into the New Year and the next Administration. A nice little Christmas present for the Obama economic team, indeed.
Whatever happens, what is clear is that the plight of Detroit will continue into next year and will provide yet another catalyst for a major stimulus package early next Congress. Just how early may surprise folks.
The Senate Finance Committee reportedly plans to begin formal consideration of a stimulus package January 8th, twelve days before President-elect Obama is sworn in. According to our friends at Dow Jones:
The package is expected to include between $600 billion and $700 billion to jump-start the economy, and congressional leaders say they want to pass it before President-elect Barack Obama takes office Jan. 20.
For those of us focused on the tax code, that means the next vehicle for tax provisions will be drafted over the next couple weeks. How much of the package will be devoted to tax relief?
The panel’s chairman, Sen. Max Baucus, D-Mont., said in a news conference last week that tax cuts for businesses and individuals could comprise as much as half of the package. U.S. House Speaker Nancy Pelosi on Monday estimated the tax portion of the package at closer to one-third.
With that time table in mind and with tax policies on the table, we’re working with our allies on the Hill to ensure that S corporation changes to the built-in gains rules are considered as part of this package. If the economy needs capital, S corporations are sitting on lots of it, and BIG relief would help put it to work. Our Hill champions are working the issue, armed with a letter from our association allies as well as a statement of support from four Senators to their leadership.
New Taxwriters Selected
The combination of Democratic gains and lots of retirees means the Ways and Means Committee will be welcoming at least eleven new faces when it reconvenes for the 111th Congress. Democratic gains shifted the ratio of the overall House close to two-thirds/one third, so Democrats last week set the new ratio of Members on the Committee at 26 Democrats to 15 Republicans — up from 24-17 in the 110th Congress — and selected four of the five new members necessary to fill the seats. New Democratic Members include:
Rep. Danny Davis (IL)
Rep. Bob Etheridge (NC)
Rep. John Yarmuth (KY)
Rep. Brian Higgins (NY)
Note: One of the seats was offered to Rep. Raul Grijalva (AZ) but apparently he turned it down, so an additional name will have to be selected. On the Republican side, Representative Dave Camp (R-MI) was selected Ranking Member following the retirement of current Ranking Member Jim McCrery (R-LA). Republicans did not make any other committee membership decisions but rather put off the appointment of six new members to fill the vacancies when Congress returns in January.
On the Senate side, the report is the same as just after the election, with leadership waiting to see how the election in Minnesota goes before setting committee ratios and picking new members. One new development is President Obama’s selection of Senator Ken Salazar (D-CO) to be Secretary of Interior. His departure from the Finance Committee means Democrats will likely have two new members on the committee next year rather than just one.
Estate Tax Update
We’ve forecast that one of the few tax challenges likely to get addressed in 2009 will be some sort of deal on the estate tax. As readers know, the estate tax is scheduled to go out of existence in 2010 only to return from the grave the following year, looking very much like the youthful and hungry estate tax of the year 2000. This repeal and restoration routine gives both sides a strong incentive to come to a compromise — estate tax apologists don’t want to face its repeal in 2010 and estate tax critics don’t want to see its resurrection in 2011.
We noticed that Len Burman over at the left-leaning Tax Policy Center agrees. In an open letter to President-elect Obama, he raises the red flag over the pending estate tax repeal from the pro-estate tax perspective:
One more thing. You probably want to fix the estate tax before the end of 2009. Otherwise, the tax disappears for only a year in 2010, returning in full force in 2011. We just don’t want to see how greedy potential heirs would respond to the incentives created by a one-year “death tax” holiday…
Yeah, Len just wants to make the world safe from greedy heirs. Thanks. Setting aside the obvious question of who’s greedier — individuals with money or policy makers who want to take it from them — his point just reinforces our notion that the estate tax is going to be front and center of policymakers come next summer.
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