The President’s fiscal year 2009 budget was released this morning together with the “Blue Book” describing his proposed tax policies. Here are a couple thoughts as Congress begins the process of putting together its tax and spending bills for the coming year.
First, the whole process of the President’s budget has a strong element of unfairness to it. For the past three decades, every President has put together a comprehensive annual budget and sent it up to the Hill. And every February, whoever runs the Congress immediately labels it DOA, or “Dead on Arrival.”
The unfairness is that Congress mandates that the President put together a budget each year—it’s required under the 1974 Budget Act. So Congress demands the President produce a budget and then promptly ignores it for the rest of the legislative session. Such is the life of the staff over at the Office of Budget and Management.
This routine is too bad for S corporations—this particular budget is decidedly pro-small business. It calls for extending tax relief, including the lower rates and estate tax repeal. It asks Congress to increase the Section 179 small business expensing limits. And it would extend the relief from the Alternative Minimum Tax that many S corporation shareholders pay for another year.
On the other hand, the new budget reveals a couple more macro trends that will be hard for Congress to ignore. First, the deficit picture has gotten decidedly bleaker. In recent years, the deficit peaked in 2004 at $412 billion dollars and declined in each of the succeeding years, falling to $162 billion in 2007. The weakening economy and lower corporate tax collections are expected to reverse that positive trend in 2008, resulting in a predicted $410 billion deficit.
Second, the cost of making the President’s tax relief permanent is growing. According to the budget, simply extending the lower tax rates on wages and investment will reduce revenues by over $1.3 trillion. Extending all the tax relief, including the repeal of the estate tax, would reduce revenues by nearly $2.2 trillion over the 10-year budget window.
For S corporations, neither is particularly good news. The rate relief is very much in the interest of our members, since all 3.8 million S corporations pay their taxes according to the individual, rather than corporate, tax rate schedules. As the cost of extending the lower rates rises, the likelihood that they expire or are pared back increases as well.
Second, rising deficits mean more focus on the so-called “tax gap” and those policies that promise to close it. Where is the Administration and Congress going to look? Of the $36 billion of proposals to “Improve Tax Compliance” in the President’s budget, nearly all are directed at individuals, small businesses, and independent contractors.
So, once again, the challenge for S corporations in 2008 will be to preserve our victories over the past decade and seek to improve the rules under which we operate, all while fighting off unfair tax increases put forward under the guise of closing the “tax gap.”
Stimulus Package and Other Tax Priorities The Senate will hold a series of votes on the stimulus package on Wednesday. While the ultimate outcome of those votes is unclear, we do expect the House and the Senate to agree to a stimulus package in short order—in the next week or so—and send something to the President that he will be willing to sign. The core components of a likely deal remain the same—checks to families, increased but temporary write-offs for businesses, and loosened restrictions for qualifying mortgages.
Once that bill is completed, congressional tax writers will need to turn their focus to a list of “must-do” items that will look eerily familiar to those of us who followed last year’s tortured process—tax extenders (including those like the R&E tax credit that expired last year), another AMT patch, and new and existing renewable energy tax provisions.
For the AMT and regular extenders, the outlook is as clear as mud. The same challenges that faced Congress last year remain. First, should Congress offset the revenue impact of extending these tax provisions and, second, if they do choose to offset them, where will the tax writers come up with $100 billion or so in tax increases that the House, the Senate, and the President (considering his State of the Union threat to veto all tax increases) can all agree to? Given the stalemate that confronted this question last year, another lame duck session to resolve this issue is looking increasingly likely.
On the energy front, the decision by the Senate Finance Committee to include the non-farm renewable energy tax provisions in the stimulus package indicates that they intend to include the farm-related tax provisions on the farm bill. These provisions—including the ethanol and biodiesel tax incentives—are being used as leverage to get the complicated agriculture bill out of conference and on to the President’s desk.
The challenge with that bill, as with so many legislative items, is the desire by congressional leadership to offset the cost of increasing farm payments by raising taxes. The current farm program’s authorization expires March 15th, so some sort of resolution to this issue will have to be attempted in the next six weeks. Otherwise, expect another short-term extension of existing farm programs.
In a bit of potential good news for small businesses, the Senate Finance Committee today adopted by voice vote an $8 billion package of small business tax incentives to accompany a planned increase in the minimum wage. Included in the package is a one year extension of the current Section 179 small business expensing limits, an extension of the Work Opportunity Tax Credit through 2012, and an extension of the shorter, 15-year depreciation lives for certain owner-occupied buildings. For S Corps, the package includes an entire title of big and small changes to the rules governing how S corporations operate, including:
- Easing the rules regarding passive investment income under the “Sting Tax”;
- Addressing concerns of S corporation banks; and
- Expanding qualifying beneficiaries of an Electing Small Business Trust
This title reflects lots of advocacy work on the part of the S-Corp Association and other interested groups in town. As S-Corp readers know, two top priorities of the Association are to eliminate the dreaded Sting Tax while allowing non-resident aliens to become S corporation shareholders. With a couple technical challenges, the Finance-passed provisions represent a significant step forward for achieving our goal of parity with LLCs. As our Chairman wrote to Senator Max Baucus today:
Provisions to reduce the impact of the so-called “sting tax” and to expand the eligible population of S corporation shareholders are two priorities for our group and they represent positive steps in the long road towards establishing parity between S corporations and LLC’s. We appreciate your work in including these priorities, and look forward to working with you in the future to address our Association’s other important challenges.
In addition to providing these much needed improvements to the S corporation rules, I would strongly encourage you to establish a uniform effective date for the S corporation provisions — beginning after December 31, 2006 — to ensure that this relief reaches our members in the same year as the minimum wage is increased.
Just where does the package go from here? The House minimum wage bill does not include any tax provisions, and careful readers of the Constitution understand that revenue bills must originate in the House. Meanwhile, a minimum wage increase without any small business tax relief is unlikely to pass the Senate… so, how do small business advocates get around the Constitution and enact much needed tax relief for America’s employers? As CongressDailye reports earlier today:
But Finance Chairman Baucus said it is now up to House and Senate Democratic leaders to resolve a dispute between the two chambers over whether the small business tax breaks should be linked to the minimum wage. “The Senate has made it clear: There aren’t 60 senators who will vote for the minimum wage [increase] unless it includes small business provisions,” Baucus told reporters after the markup. “But at this point, it’s up to Speaker Pelosi and [Majority Leader] Reid as to how they want to work this out.” The House passed a straight minimum wage bill, and House Ways and Means Chairman Rangel has indicated he intends to enforce the House’s constitutional prerogative to initiate tax legislation. “The Senate as a whole still has the opportunity to pass a clean minimum wage bill,” a Rangel spokesman said today.
One possible solution is for the Senate to wait for the energy tax bill scheduled to be considered by the House this week, attach the Senate minimum wage and tax package, and send it back. Under the rules, a tax bill is a tax bill, and there would be no constitutional challenge to the resulting package.
Congress returns to legislative business this week following a week long Columbus Day recess. With numerous outstanding issues for Congress to consider before adjourning for the year (possibly by Thanksgiving, but December remains a distinct possibility), the small and family owned business community must continue to be vigilant for any misguided efforts to raise payroll taxes on S Corps and other small businesses.
The first priority of the tax writing committees continues to be legislation to encourage the physical restoration of the areas hit by Hurricane Katrina. Both the Senate Finance Committee and the House Ways and Means Committee are expected to take up hurricane legislation this month.
Growing restlessness among conservative Republicans and Democrats to offset Hurricane Katrina recovery costs – either through increased spending cuts or foregone tax relief – raises the possibility that part or all of this hurricane relief will be paid for through spending cuts and tax increases in other parts of the budget.
It also spells difficulty for the $70 billion tax relief reconciliation bill. After Congress delayed the deadlines once, the House pushed back their deadline further to October 28th, just three weeks prior to the Thanksgiving recess and the date congressional leadership had hoped to finish the session Just how much of the $70 billion in tax relief will survive in the post-Katrina session remains to be seen, but Congresses more emphatic emphasis on deficit reduction once again increases the pressure the tax writers will feel to include revenue offsets, like the JCT’s payroll tax increase on S Corps.
Tax Reform Panel Unlikely to Scrap Tax Code
We are continuing to monitor the progress of the President’s Advisory Panel on Federal Tax Reform recommendations have numerous potential repercussions on S corporations.
First, the tax panel’s mandate to recommend “budget neutral” reforms will force them to fully offset any revenue reduction – like their decision to support eliminating the Alternative Minimum Tax – included in their recommendations. Much of last week’s meeting was spent discussing different ways in which the panel could limit the mortgage interest deduction, cap the amount of employee-health care expenses employers may deduct, and change the manner in which charitable contributions are treated.
Given the sensitivity of these possible changes, the S Corp community needs to be on its toes in case the Panel chooses to take on other sensitive topics as well, including recommendations to overhaul and reorganize the corporate tax structure.
The panel is scheduled to meet on October 18th for what should be its last public meeting before issuing its final recommendations to Treasury Secretary Snow by the November 1st deadline. Other significant tax issues likely to be addressed by the panel include: an expansion of savings incentives, increasing the taxpayer base eligible for charitable deductions, allowing businesses full expensing of equipment purchases, reducing the individual tax on interest income while limiting the corporation interest deduction, moving toward a territorial tax system, and extending the 2001 and 2003 Bush tax cuts. That’s lots of moving parts to keep track of, and the panel’s final report should provide the tax community with lots to talk about. Stay tuned.
Built-In Gains Tax Relief
On a positive S Corp note, legislation has been introduced to provide relief to those S Corps that converted from C corporation status in the past decade. Senator Gordon Smith (R-OR) has introduced a bill to reduce from 10 to7 the number of years a converted S Corp is subject to the built-in gains tax and is working to include this relief in the Finance Committee’s Hurricane Katrina tax bill.
At the October 6th Senate Finance Committee hearing to consider tax initiatives and incentives for businesses in the Gulf Coast region, Senator Smith made the following case for built-in gains relief:
“I’d like to highlight, S. 965, which will provide relief to small business that are S corporations to ensure that now, more than ever, they continue to be the driving force of our economy. Currently, small businesses that changed their tax status (from C corp to S corp) cannot sell off assets for ten years without being double taxed (a regular tax plus a built-in gains tax). The double tax leads companies to hold unproductive assets much longer than they otherwise would just so they do not have this double tax. This directly affects their cash flow by locking up their assets.
It is estimated that there are 400,000 small businesses across the country that are stymied by this double tax. Taking away this double tax is not just important for those small businesses in the Gulf Coast region that want to rebuild. Businesses across the country may be looking to site facilities in that area. My proposal would make it easier for these companies to sell off unproductive assets and use that cash to rebuild, newly build, and create jobs in an economically devastated region. We need to help small businesses restart their engines and that is exactly what my proposal would do.”
A number of S Corps saw significant losses to their businesses after Hurricanes Katrina and Rita. These companies in particular have made their case to Senator Smith, Senator Lincoln and other S Corps allies that built-in gains relief is especially valuable to them now, as they identify ways to reallocate assets and rebuild.