With the Senate back in town this week, here’s a quick recap on the status of the S Corp reform tax title we’ve been advocating in Congress:
- First, on January 10th, the House passed a clean minimum wage increase and sent the legislation to the Senate.
- Second, on January 31st, the Senate added by voice vote $8 billion worth of small business tax provisions to the House wage increase, including an S Corporation Reform tax title incorporating several S Corp priorities.
- Third, on February 16th, the House adopted its own $1 billion small business tax relief alternative to the Senate package. This package failed to include any S Corporation provisions.
- Fourth, Senate Republicans insisted that the House meet them to “pre-conference” the differences between the Senate and House small business tax packages before they would allow the two bills to go to a conference committee for negotiation.
- Fifth, on March 23rd, the House added its $1 billion small business tax package to the Iraq War supplemental spending bill, despite the fact that a veto threat currently hangs over that bill’s future.
- Sixth, on March 27th, the Senate added its own, larger $12 billion small business package, including the S Corporation Reform tax title, to its version of the Iraq War supplemental spending bill.
- Seventh, on March 29th, Senate Majority Leader Harry Reid appointed members of the Appropriations Committee to the House/Senate conference and did NOT appoint Senate Finance Committee Chairman Max Baucus signaling the potential for conference negotiators to drop the tax bill from the supplemental bill to deal with it separately, at a later date.
And that’s where things stand, awaiting the return of the House from recess next week and the appointment of House conferees to work out the differences between the House and the Senate on these bills.
It almost goes without saying that the S Corporation Association is continuing to press our friends on the Hill to end this stalemate and pass these much needed reforms to the rules governing S corporations. We remain confident that these provisions will be enacted, it’s just a question of how long the process will take.
S Corp Gets Some Ink in INC.
S Corp President Stephanie Silverman is quoted this month in INC. Magazine as part of a story on the new congressional leadership, “Learning to Love Nancy Pelosi.” As the story notes, business groups like the S Corporation Association are having to reconfigure their approach and expectations to reflect the new Democratically-controlled Congress. Here’s Stephanie:
- In the last Congress, there was a serious effort to abolish the estate tax. Today, Congress is considering bolstering the Internal Revenue Service’s budget for business audits and levying new payroll taxes on S corps. Stephanie Silverman, the president of the… S Corporation Association, says the group’s members are nervous about the payroll tax idea. The group is currently scheduling meetings with members of the House Ways and Means Committee to discuss the plan. “We’re trying to make them aware of how many S corporations there are in their states,” Silverman adds.
The President is expected to sign the fiscal stimulus package on Wednesday. After two weeks of hand ringing and posturing, the Senate finally adopted a slightly modified version of the bill the House and the President originally had negotiated.
As sent to the President, the package would:
- Send checks of $600 per filer and $300 per child to families with joint incomes of less than $150,000. Actual amounts will be calculated based on income tax filings for 2007, so expect the actual checks to be in the mail by late spring and early summer.
- Encourage new business investment by increasing the limit on small business expensing from $100,000 to $250,000 as well as allow for 50-percent bonus depreciation. Both of these tax breaks are available for equipment placed in service in 2008 only.
- Allow for a temporary, 2-year increase, from $417,000 to $729,750, in the so-called conforming loan limit and limit on FHA-guaranteed loans.
Whether this package benefits the economy will have to be seen. Certainly the speed with which Congress and the Administration came together, even with the delay in the Senate, was impressive and should send a positive signal to families and businesses. The size of the package is significant as well. The short term cost of the family checks and increased expensing—not counting the mortgage relief—is about $150 billion in 2008, or slightly more than 1 percent of the economy.
The challenge, as always for fiscal stimulus, is how to get it done quickly enough to be effective. Under the current time frame, both the rebate checks and the mortgage relief will not be felt until well into the third and fourth quarter of 2008. The remaining question is whether the economy will still be in its mid-cycle slowdown or will be in a recession at that time.
Energy Tax Provisions Move Forward—Again
As expected, the introduction of the President’s budget for fiscal year 2009 fell flat last week, with few, if any, of its proposals getting serious attention.
A week later, in a bit of irony, the House is planning to take up a package of renewable energy tax provisions that were dropped from the President’s budget this year. Given the price of oil, why the Administration would pick this year to end its call for extending renewable energy tax incentives is slightly inexplicable.
The House action is curious as well, given the repeated failure of Congress and the Administration to agree how to pay for the extension of these and other tax items in 2007. Staff involved in the drafting expect the bill to look very similar to the House energy tax package from last year, despite the failure of that package to get past the Senate. As BNA noted this morning:
Democrats in both chambers produced energy tax packages in 2007 that were designed to encourage the use of alternative and clean energy at the expense of oil and gas producers. But resistance from Senate Republicans–and a firm stance by President Bush that he will not sign into law any bill that would raise taxes–killed Democratic efforts.
Absent the emergence of a new, non-controversial offset, the fate of this effort is likely to be similar to the energy tax packages considered late last year.
For S corporations, the lesson should be clear. The consensus that brought Congress and the President together on the stimulus package has vanished.
Tax extenders like the energy tax credits, AMT patch, and the R&E tax credit are considered to be “must-pass” items. To get them done, however, congressional leadership will need to bridge the competing interests of “pay-as-you-go” budgeting with the concerns of the President and others who oppose seeing the overall tax burden increase under their watch.
Moving the same energy tax package that failed previously suggests congressional leaders haven’t worked that out yet, and all the positive tax policy initiatives that benefit S corporations and other actors in the economy will have to wait until they do.
Congress returns this week following its Memorial Day recess. As expected, the Small Business tax package was signed into law along with the Iraqi War funding just before they left. This package included a number of S corporation reforms that we have been working on for years, and represents a significant improvement to the rules governing how S corporations operate.
Key reforms included relief from the dreaded “sting tax” as well as allowing trusts that hold S corporation stock to deduct their interest expenses, something other trusts have long been allowed to do. And while we did not get everything we sought in the bill, these new provisions are extremely welcome and we appreciate the members and staff who worked to make them happen.
Tax Bills on the Horizon
With the Small Business tax package behind us, it’s time to focus on what comes next. As we have observed, there are lots of actual and potential tax bills on the agenda for this Congress, and keeping track of them is becoming a full time job. Fortunately for S Corp members, that’s what we do. Here’s a list of tax bills to watch:
AMT Reform: Ways and Mean Chairman Rangel previously announced his plans to introduce a permanent fix to the growth of the Alternative Minimum Tax sometime this month. As we’ve written in past Wires, the threat to S corporations is the potential pairing of AMT relief with an increase in individual tax rates, a reduction in the thresholds at which those rates apply, and the change in the tax treatment of capital gains and dividends.
Energy Tax Incentives: Ways and Means is planning to take up tax legislation next week to provide new and expanded incentives for renewable energy sources. Offsets reportedly include denying the manufacturing income tax deduction to oil and gas producers as well as lengthening certain energy depreciation lives. Significantly, the offsets do not appear to include changes to the LIFO inventory accounting method for oil companies or others, at least in the House version.
Extending Family Tax Relief: The budget adopted last month allows part of the tax relief enacted in 2001 and 2003 to be extended past its current December 31, 2010 sunset. Whether Congress actually acts on this issue prior to the 2008 elections is very much up in the air, but the budget gives Congress the ability to move legislation to retain the 10 percent tax bracket, the $1000 child credit, the higher standard deduction and income tax rate thresholds designed to reduce the marriage penalty, and some sort of permanent fix to the estate tax rules. The budget does not make room for extending the lower rates on capital gains and dividends, nor the reduced rates on income taxes above the 15 percent bracket.
SCHIP: The Finance Committee will also consider legislation to expand the Children’s Health Insurance Program. The Senate has already voted to offset the cost of this increase through a tobacco excise tax during debate over the budget resolution.
Technical Corrections: As S Corp readers know, last year’s technical corrections package did not move forward based, in part, on concerns raised about increasing tax rates on exporters who have an IC-DISC. Ways and Means is working on another version, and the most recent word is the IC-DISC provision is still in the package. No word on timing of this package just yet.
Education Incentives: The Senate Finance Committee has been working on legislation to increase and reform the tax incentives for education. A proposed markup on legislation prior to Memorial Day was postponed, but this is a priority for Chairman Baucus, so expect something soon. On the House side, Chairman Rangel joined other Ways and Means members to introduce legislation to fund public school construction and rehabilitation with tax-free bonds. And several House members introduced legislation to increase tax benefits tied to the Hope Scholarship and the Lifetime Learning Credit.
International Tax Reforms: Earlier this year, Congressman Richard Neal (D-MA) introduced legislation (H.R. 1672) to change the tax treatment of dividends for certain hybrid foreign stocks. In May, the Senate Finance Committee held hearings on offshore tax evasion. And this week the Finance Committee will hold hearings on the impact globalization has on the American workforce, with a particular focus on the tax incentives that make up part of our Trade Adjustment Assistance programs. We expect these mutual concerns to coalesce into a package of international tax provisions — mostly revenue raisers — to accompany other tax legislation.
Housing: The implosion of the sub-prime lending market and the general rise in housing and land prices suggest that a housing tax bill or tax title could be considered by this Congress. The House Revenue Measures subcommittee held hearings last month that focused on the Low Income Housing Tax Credit, private activity tax-exempt bonds, and the historic rehabilitation tax credit.
Bottom Line: The combination of lots of tax bills together with the desire to offset any tax decreases with tax increases should make all taxpayers wary, especially those that, like S corporations, have been the target of unwarranted criticism in the past couple years.
House Leadership has indicated that it will attach the $4.8 billion Small Business tax package to the second Iraq supplemental spending bill to be considered by the House this week. The tax package will likely remain the same, while the underlying spending bill will fund operations in Iraq for just three months. This approach will likely pass the House, but it appears to have significant challenges in the Senate and at the other end of Pennsylvania Avenue. As CongressDaily reported yesterday morning:
“McConnell labeled as a “uniquely bad idea” the House proposal backed by Appropriations Committee Chairman Obey to send Bush a compromise supplemental guaranteeing funding for combat operations only through July and then tie additional installments of money to the performance of the Iraqi government.”
White House spokesman Tony Snow has made similar comments.
Which all means that the ultimate fate of the Small Business tax package is an unknown; it could get enacted as part of a broader Iraq funding package that gets signed by the President, it could move separately as a stand-alone minimum wage/Small Business tax package bill, or it could get attached to an as-yet-unknown tax bill to come later.
A S-CORP readers know, we strongly support enactment of this package — especially the S Corporation reform title it contains — and have worked to ensure the final package includes S-CORP priorities of a uniform 2007 effective date and language (currently excluded from the package) to allow foreign investment in S corporations. As this legislative dance continues, we’ll look for opportunities to get these priorities included.
S Corporations and Foreign Investment
As the Small Business tax package is considered, one of the concerns we have heard is that allowing foreign investment in S corporations through a small business trust is somehow a limited or targeted tax benefit.
That’s not our experience. There are 3.8 million S corporations after all, and the idea that only a handful of these businesses feel the pinch of the nonresident alien limitation is simply not possible. Businesses residing on the border, those that serve ethnic communities, and mature family-owned S corporations as they approach their third and even fourth generation of ownership appear to be the most susceptible to running into this unnecessary ownership brick wall.
An indication of the true size of the problem may come from the IRS, which estimated that there were approximately 40,749 foreign partners of domestic partnerships in 1993 (the last numbers available), or about .3 percent of all partners in that year. With 3.8 million S corporations, a similar level of foreign investment in S corporations suggests the nonresident alien ESBT provision will benefit thousands of businesses across the country.
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Late Friday evening, House and Senate tax writers announced they had come to an agreement on the Small Business Tax Package to accompany an increase in the minimum wage. While this package is destined to join the current Iraq Supplemental and get vetoed by the President, the expectation is that the package will then be included in the subsequent supplement spending bill that should get signed into law. As BNA reports:
The package, the culmination of several weeks of impasse in reconciling vastly different House and Senate packages followed by a short spurt of negotiations, will be included in the supplemental spending bill (H.R. 1591) conference report. Conferees are slated to meet the evening of April 23 and the conference report is expected to be on the House and Senate floors later that week. The conference report is expected to be vetoed by the president, though a modified supplemental will follow quickly.
The package itself was whittled down from the Senate-passed $12 billion version to just under $5 billion over ten years. This small package is not popular in some circles. Senator Grassley, ranking member of the Finance Committee, issued a statement Friday evening criticizing the size of the agreement and the failure of the agreement to include several revenue offsets he championed. According to the Grassley statement:
“The point of this package was to give tax relief to small businesses to counteract the effects of the minimum wage increase and otherwise boost the economy. The relief was supposed to be contemporaneous with the wage increase so small businesses wouldn’t cut jobs. The Senate package was barely adequate. I called it peanuts. The House package was puny. I called it a peanut shell. Now we have a single shriveled peanut. This package is stripped of a lot of meaningful tax relief.”
Meanwhile, a number of the S corporation provisions did survive the negotiations, including the passive investment provision and provisions affecting banks and qualified subchapter S subsidiaries. The negotiators chose to exclude the nonresident alien provision and did not harmonize the effective dates of these provisions to begin this year. So while we support any and all improvements to the S corporation rules, we’ll continue to push for those priorities until the ink on the signed bill is dry.
Here’s a summary of the agreement reached on Friday.
It’s getting so you can’t tell the tax bills without a program. The Small Business Tax package that includes the S Corporation Reform tax title has been adopted by the Senate for the second time, this time as a Baucus/Grassley amendment to the Iraqi War supplemental.
An earlier version of this package was adopted as part of the effort to raise the minimum wage. Differences between the House and the Senate stalled that bill, and the House attached its version to the supplemental as a means of breaking the stalemate. What happens now is unclear. The supplemental is likely to be vetoed in its current form, while the minimum wage package is being held up in the Senate pending Senate Republicans demand of a pre-negotiated agreement over what the final bill will contain.
The S Corporation Association has weighed in strong support of these improvements to the rules under which S corporations operate. Our Chairman has written a letter of support to the tax writers, we have organized a coalition of business groups to support the provisions, our champions in the Senate have weighed in with their leadership, and our S corporation members have met with their Senators and Representatives to build support for these helpful reforms, including S Corp priorities of reducing the impact of the Sting Tax and expanding the ownership pool for S corporations.
In addition to the Baucus/Grassley amendment, S Corp Champions Senators Smith and Coleman have filed an amendment to harmonize all the effective dates for the S corporation provisions to January 1st, 2007. If our members are going to pay higher labor costs in 2007, it makes sense for all of the offsetting tax relief to begin this year as well.
Despite the current logjam, your S Corp team is confident that these reforms will wind up on the President’s desk this year, in a form that he can sign into law. In the meantime, we’ll keep advocating for these and more. Your advocacy is welcome as always.
Cato on Tax Gap
Cato’s Dan Mitchell has written an excellent summary of the tax gap issue, noting among other things that the U.S. enjoys the smallest shadow economy of any of our major competitors. As Dan writes:
“By global standards, the United States has very little tax evasion. According to the world’s leading expert, Friedrich Schneider of Austria’s Johannes Kepler University, the U.S. shadow economy accounts for just 8 percent of gross domestic product, which compares to an average of 16 percent for 21 major industrial countries he examined. Indeed, Schneider finds that the United States has the smallest shadow economy of 145 nations analyzed.
A comparatively modest tax burden is perhaps the main reason why American taxpayers are less likely to evade taxes than are their foreign counterparts. Table 1 shows that lower-tax nations such as the United States, Singapore, and Switzerland have the least tax evasion. With lower tax burdens, taxpayers have less incentive to hide their money from tax authorities.
However, some U.S. taxes have high marginal rates, which undermines compliance. One study found that a 1 percentage point increase in marginal tax rates is associated with a 1.4 percentage point increase in the underground economy.”
The S Corporation Association (“S-CORP”) today sent a letter to congressional tax writers advocating for the inclusion of S corporation reforms in the final small business tax relief package and for the need to make these provisions effective immediately.
Signed by the S Corporation Association, the Associated General Contractors, the Printing Industries of America, the Independent Community Bankers of America, the Association for Manufacturing Technology, America’s Community Bankers, and the National Roofing Contractors Association, the letter emphasizes the important role S corporations play in the growth of small businesses and the importance of easing the rules under which they operate.
“While the S corporation community has grown, many of the rules governing their operations have remained the same. The Senate-passed package of small business tax relief would address some of these rules, making it easier for S corporations to compete with LLCs and other business forms,” the letter notes. “While these provisions do not address all the challenges faced by S corporations, they are a significant step towards eliminating unnecessary and costly rules that hinder the ability of S corporations to grow and create jobs.”
S-CORP Chairman Tom McMahon observed that several of the provisions included in the Senate package have been long time priorities for the S Corporation Association. “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 LLCs, ” McMahon said.
S-CORP Executive Director Brian Reardon pointed out that both history and the economics support making S corporation reforms part of the minimum wage increase. “S corporation reform was a big part of the tax package that accompanied the last increase in the minimum wage,” Reardon observed. “While S corporations appear to be disproportionately represented in industries that pay the minimum wage, the average S corporation has significantly fewer resources than the average C corporation to pay those increased labor costs.”
The S Corporation Association is the only association that speaks exclusively for the national interests of America’s 3.6 million Subchapter S businesses. S-CORP was founded in 1996.
Good news for S corporations and other closely-held businesses! Ways and Means Chairman Charles Rangel (D-NY) indicated yesterday that he plans to put together a package of small business provisions to be coupled with the minimum wage increase that has already passed both the House and the Senate. This announcement reverses the previous position of the House leadership, who had indicated they wanted to send the President a “clean” minimum wage bill. As BNA reports:
House Ways and Means Committee Chairman Charles Rangel (D-N.Y.) said Feb. 6 that the House would put together its own tax package to be married with minimum wage increase legislation (H.R. 2) in the Senate, but gave no indication of the size of the package or what it would include. Rangel had previously given little indication of his plans for the future of the minimum wage increase. The House passed a minimum wage increase as a stand-alone measure Jan. 10 and the Senate approved an increase with an $8 billion tax package Feb. 1. He told BNA Jan. 30 that the $8 billion Senate package was too expensive and would use up too many revenue raisers.
Your S Corp team has already started discussions with House tax writers on the importance of including S corporation reforms in this package, and of making sure the provisions take effect immediately to offset any increased labor costs from the higher minimum wage. Expectations is that the Ways & Means Committee will mark-up its bill as early as next week. We’ll keep you apprised of any progress.
S Corp Audits Back in the News
Remember the National Research Program over at the IRS? This project is designed to give the IRS better information regarding tax compliance and the “tax gap.” The NPR began by looking closely at high-income individuals. Next, NPR targeted 5000 S corporations for intensive audits to identify better means of ensuring their compliance with the tax laws.
Yesterday, the Treasury Inspector General for Tax Administration (TIGTA) released a progress report on the audits. While the report itself focuses on the technical challenges faced by auditors, there were a couple of interesting points. First, TIGTA observes that, for 2005, there were 3.6 million S corporations, a significant jump from previous years. We’ll have to update our website! Second, 99 percent of the 5000 audits have been initiated, and 17 percent are complete to date.
Finally, BNA’s coverage of the report reflects one of our principle concerns with the audits. The IRS is looking only at S corporations right now. Partnerships are not being studied, even though the LLC community is, by many accounts, growing faster than the S corporation community.
The S corporation research project emanated from a pilot study conducted in 2004 involving about 130 audits of S corporations and partnerships. IRS decided to focus on S corporations for the NRP project to determine how agency auditors could “do a better job” of auditing the flowthrough entities, IRS Research, Analysis, and Statistics Director Mark Mazur said at an August Senate Finance Committee hearing. The NRP project is auditing about 1,200 taxpayers from tax year 2003 and about 3,800 audits from tax year 2004. The audits will focus on taxpayers’ Forms 1120S.
Just a quick update on the status of the $8 billion small business tax package that may accompany the proposed minimum wage increase. The bill is currently the pending business in the Senate. On Monday, Majority Leader Harry Reid filed a petition to close off the debate and pass just the minimum wage increase, without any offsetting small business tax relief. This vote is scheduled to take place momentarily.
The consensus is that Senator Reid doesn’t have the 60 votes necessary to move the minimum wage package without the offsetting business tax relief, and the vote is being characterized as part of the ongoing tug-of-war between the House and Senate over whether the minimum wage should be paired with any small business tax relief at all. As BNA noted, the vote “is expected to demonstrate that a bill without the tax relief cannot succeed in the Senate.”
Once the clean bill fails in the Senate, debate will begin in earnest on the tax title. As S-CORP readers know, there is an entire title of S corp reforms in the Finance Committee bill, so we’ll be actively engaged in the debate.
Another Tax Gap Hearing
Another page was added in the ongoing search for a plan to close the so-called “Tax Gap” yesterday. The issue previously has been raised in the Senate Finance Committee, where Treasury officials and others have been questioned in hopes of discovering the best means of closing the gap between what taxpayers owe and what they pay.
Yesterday the Senate Budget Committee took its turn on the issue. The Committee held a hearing yesterday morning entitled, “The Growing Tax Gap and Strategies for Reducing It” and invited three experts, Robert McIntyre with the “tax happy” Citizens for Tax Justice, Michael Brostek with the Government Accounting Office, and S- CORP ally John Satagaj with the Small Business Legislative Counsel. Perhaps the most revealing moment of the hearing occurred when Mr. McIntyre observed that compliance would increase if the IRS engaged in “… terrorizing people, ah, that’s the wrong word I suppose. Scaring people out of entering shelters is even better than catching them after they do it.”
Such an approach is a far cry from the dominant view just a few years ago that a more communicative, interactive, and technically nimble tax collection policy would be best. As former Vice President Al Gore and Treasury Secretary Robert Rubin penned in 1998, “For the past five years, this Administration has been committed not just to a fairer tax code, including cutting taxes for middle-class families, but also to fairer tax collection. Our philosophy is simple: the taxpayers don’t work for us, we work for them.”
The hearing itself was a sobering discussion of just how difficult it is to accurately collect taxes under our convoluted and arbitrary tax code. Mr. Satagaj neatly condensed S-CORP concerns about the Tax Gap effort into two sentences – “Honest small business taxpayers are especially at risk of being subjected to needless and unwarranted regulatory burdens in an attempt to capture the few “bad actors” that do not fulfill their tax obligations. Small businesses already bear a disproportionate share of the cost of regulation.”
Beyond new regulatory burdens, John also reiterated our concerns about proposals to increase taxes – like the S corporation payroll tax – being promoted under the guise of reducing the tax gap. As John pointed out, “It is important that we reserve the label “Tax Gap” for only those proposals which are truly related to addressing the “Tax Gap.” We fear we will see various revenue offsets labeled as “Tax Gap” closers. In many cases, the revenue offsets alter long time policies upon which compliant taxpayers have fairly and honestly relied.”