Baucus III
The tax community is still waiting for the third version of the Baucus substitute to be released. A “trial balloon” draft circulated yesterday made certain changes, but failed to address many of the sticking points holding up the overall bill.
Meanwhile, Senators Baucus and Reid spent most of yesterday negotiating with swing Republican votes — at this point, just Maine Republican Senators Olympia Snowe and Susan Collins — to identify what changes are necessary in order to gain the 59th and 60th votes needed. As CongressDaily reports:
The chief target appears to be $24 billion to extend higher Medicaid matching funds for six months, first authorized in the stimulus last year. Options floated Tuesday included phasing down the percentage boost and using untapped funds elsewhere in the Recovery Act for offsets. Snowe and Collins were noncommittal, having not seen details. Senior Democrats appeared resigned that the net cost of the Medicaid assistance would be scaled back. “They’re having to cut it back to try to get Republican votes, and it affects my state; it really affects Harry Reid’s state,” said Sen. John (Jay) Rockefeller, D-W.Va., who with Reid was an original lead Senate sponsor of the six-month Medicaid boost. “But it looks like the best we can get.”
The challenge for Senator Baucus is that the deficit spending in the package represents only half the opposition. There is a lot of opposition to the tax increases as well, including the payroll tax hike on S corporations and partnerships. Senator Snowe of Maine has led the fight to strike this provision from the bill. As The Hill notes:
Kyl said he isn’t sure winding down FMAP is the elixir Democrats think it is in garnering Republican support for the bill.“Whether that will satisfy more Republicans remains to be seen,” he said. “There are other issues with the bill as well, including issues related to the tax provisions.”
The current “K Street” rumor is that Chairman Baucus has been given a limited amount of time to round up the 60th vote. If he’s unable to do so, Majority Leader Reid would set the extender package aside and move on to other items. Whether the rumor is true or not (K Street rumors typically run about 50/50 on the accuracy dial), the clock is ticking.
In addition to Senate consideration, this bill would need to return to the House, where its adoption is by no means assured. If the House makes any changes, it would come back to the Senate. And then, since most of the spending and all the tax items expire before the end of 2010, we’d have to do it all over again before January.
We’ve observed previously that getting the entire business community to oppose a bill centered on extending business-friendly tax breaks is fairly remarkable. The current bill before the Senate is anti-business, and would need to be changed significantly before businesses could support it. It appears that several determined senators share those concerns.
Budget’s Impact on Employers
S-Corp allies over at the Manufacturer’s Alliance commissioned a new study on next year’s tax policy and what it means for S corporations and other business forms. Specifically, the study looked at the tax policies in President Obama’s 2011 budget and asked how these policies would impact economic growth and job creation. The verdict?
In terms of macroeconomic effects, the tax proposals in the 2011 budget are forecast to shave an average of 0.2 percent from annual GDP growth through the middle of the decade, resulting in $200 billion of foregone output and a net job loss of almost 500,000 relative to the baseline. Because taxable business revenues are highly concentrated in manufacturing firms, they will account for a disproportionate share of these output and employment gaps.
So despite much of the rhetoric coming from Washington these days, the rules of economics have not been turned on their figurative heads — the tax forecast for next year is higher tax rates imposed on a larger tax base, which means less investment and less job creation over time. Who will get hit the hardest?
The tax provisions of the 2011 budget will affect S corporations and other pass-through manufacturing firms much more heavily than both firms outside of manufacturing and C corporations within manufacturing. Pass-through businesses in the manufacturing sector will see their tax bills increase by an average of 14 percent. Given the growing importance of S corporations and partnerships to economic growth and job creation over the past 25 years, it is important to understand that tax increases intended to help contain deficits will exact a high price in terms of the competitive posture of U.S. manufacturing and the growth of the economy as a whole.
The study’s authors calculate that S corporations and other “pass through” firms will see their aggregate tax burden rise by $177 billion over the next ten years. Ouch.
Latest On Extenders and the Payroll Tax
So the Senate just adopted a stand-alone, six month Doc Fix. Adoption of this provision sends a couple signals for the broader extender package.
This action follows on last night’s failed 56-40 cloture vote on Baucus II. While this vote represented a significant improvement over the 45 votes in support of Baucus I, it still signaled to the Senate (and House for that matter) that the “extenders plus” package was not going to be completed this week. Hence the need for the stand-alone Doc Fix. Moreover, the adoption of this very large — and ultimately offset — spending item suggests that other non-tax parts of the “extender plus” package could get peeled off as well, calling into question the viability of the underlying tax parts.
As long as the majority insists on offsetting temporary extensions of current law with permanent, new tax hikes, this is going to be a problem and ultimately result in a much more burdensome tax code. Has anybody done a Net Present Value analysis of the relative values of the extenders and the tax hikes that offset them? Only in DC budget parlance are they at all equal.
Which brings us to the S corporation payroll tax hike envisioned by the Finance Committee. As we’ve mentioned, Baucus II is better than Baucus I, but it still fails the very basic test of being better targeted, less complicated and easier to enforce than current law.
Talks continue between the Finance Committee staff and those Senators concerned about raising taxes on small businesses in the middle of a recession — including S-Corp champions Snowe and Enzi. The trick is how to get at the tax avoiders without punishing compliant S corporations, because every dollar this provision takes from taxpayers already complying with the law is one less dollar they have to invest in their employees and businesses.
This debate will now spill into next week. We hope it gets resolved soon, because it’s almost time to take up the extension of the very tax provisions under consideration — they expire in six short months, after all.
Single Class of Stock and Payroll Tax Avoidance
Part of the frustration experienced by the S corporation community on the payroll tax issue is the lack of understanding of how S corporation rules effectively block payroll tax avoidance in multiple shareholder firms. It is extremely difficult if not impossible to effectively avoid payroll taxes year after year in an S corporation where no one shareholder controls the firm. Consider the following example:
A fictional John Edwards and his brother lawyer are both partners in a larger law practice. They agree to form an S corporation where each has a 50 percent share in the business and designate the S corporation as the partner in the law firm. John and his brother agree to pay themselves a nominal wage and take the rest as income on their K-1.
In year one, both John and his brother earn $1 million in legal fees. As the partner in the law firm, this money is paid to the S corporation. As agreed, they both pay themselves $200,000 in wages and take the rest as a distribution from the S corporation. By doing this, they successfully avoid HI payroll taxes on $1.6 million, or $46,400. [Editors Note: Here the IRS steps in, audits the brothers, applies a reasonable compensation test, and dings both of them for unpaid taxes and penalties.]
In year two, John wins a big case and has fees of $5 million, while his brother has legal fees of $1 million. Under their agreement, they would pay themselves $200,000 each and then distribute the rest as S corporation income. But S corporations can only have one class of stock, so any S corporation income would have to be divided up according to their ownership interest, or 50/50. This means John will have to share his $5 million legal fee with his brother. Both brothers would get $2.8 million in S corporation income, or total compensation of $3 million each, and avoid paying $81,200 in HI payroll taxes each.
So John Edwards’ clever scheme to avoid paying $81,200 in HI payroll taxes costs him $2 million in income.
Obviously, a real person would never enter into such an arrangement. And while the brothers could adjust their wages to get around the “single class of stock” limitation, those wages would be subject to payroll taxes and defeat the purpose of creating the S corporation in the first place.
This is an extreme example, but it makes clear the challenge of attempting to avoid payroll taxes in an S corporation with no one controlling shareholder. The HI tax is 2.9 percent, after all, so any effort by taxpayers to avoid this tax is going to be tempered by the cost of doing so. The simple rule is that, unless the earnings potential of all the active shareholders in the S corporation are remarkably stable over a number of years, it is next to impossible to structure an ownership agreement that can last.
Small Business Tax Package Recap
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.
S Corp Champions Push BIG Relief
As Congress moves forward on the stimulus bill, the S Corporation Association continues to push Built-In Gains tax relief as a vital part of the package. If the economy is suffering from a lack of capital, BIG relief can help S corporations access capital currently locked-in by punitive tax rates.
As part of that effort, S-Corp allies Senators Lincoln (D-AR), Hatch (R-UT), Cardin (D-MD), and Snowe (R-ME) sent Senate leadership a letter today advocating for including BIG relief in the stimulus package. Their letter states:
Our proposal, as included in the S Corporation Modernization Act of 2008 (S. 3063), would provide timely relief for many businesses that have converted to S corporation tax status by reducing the BIG tax holding period from 10 to 7 years. This modest reduction preserves the original policy intent of the holding period, while allowing many businesses that have long been S corporations to immediately access their own capital without penalty.
In the meantime, S Corporation Association Chairman Richard Rodrick submitted a letter to Ways and Means Committee Chairman Rangel (D-NY) advocating for BIG’s inclusion, arguing that the benefits of BIG relief would be significant and widespread:
According to government statistics, hundreds of thousands of S corporations nationwide may be sitting on “locked-up” capital that they cannot access or redeploy due to the prohibitive tax implications of BIG. This “lock-in effect” is widespread and results in these businesses unable to access billions of dollars in assets that could be used to grow the business and hire new employees.
Forcing companies to hold on to appreciated assets for a decade is harmful to their businesses and harmful to the communities in which they operate. Congress is coming back in mid-November. Your S-Corp team will work between now and then to build the case for Built-In Gains relief and get it enacted.
Ways and Means Looks at Another Stimulus
So where is the stimulus in the process? With the elections less than a week away, a large number of House members took a break from campaigning today to consider the struggling economy and a possible fiscal stimulus package.
The House Ways and Means Committee held a hearing this morning (and afternoon — it was a very long hearing) on the need for a new fiscal stimulus package as well as exactly how large and what provisions should be in that plan.
Comments by the Chairman and others suggest the Committee is looking at a $150 billion package made up of extended unemployment insurance benefits, expanded food stamp payments, increased spending on highways and other infrastructure, and select tax provisions.
In the meantime, House Minority Leader John Boehner preemptively put forward an alternative package more focused on tax relief, including doubling the $1000 child tax credit, suspending the capital gains tax, and reducing the corporate tax rate from 35 to 25 percent.
As to the timing of congressional action, it appears the Ways and Means Committee intends to act on a package when Congress returns in mid-November, with the full House taking up the Committee-passed package shortly thereafter.
What happens next is unclear. Whether the Senate can take up and pass something depends very much on the content as well as whether the bill has a chance of getting signed into law. The more spending and less tax relief the package includes, the less likely the President will sign it.
Press Secretary Dana Perino suggested last week that the White House would not propose its own stimulus package and, while it remained open to suggestions by Congress, they were not engaged in discussions and would take a critical view of any package put forward.
We remain open to listening to all good ideas that people want to put forward. What we’ve seen so far in regards to what’s been called a second stimulus package is a series of proposals that actually would not stimulate the economy that are being talked about as something that would assist people — but we actually don’t think it would help the economy.
Another possibility is for the Democratic leadership to wait until the new year and the new president to move a sizeable package through both chambers. A President Obama would be more friendly to many of the spending provisions under consideration than the current President. He would also benefit from the timing of coming into office and immediately signing something into law that is designed to help the economy.
Either way, the content, the size, and the timing of a second stimulus are all on the table right now.
More on Marginal Rates and Small Business
S-Corp allies over at the Tax Foundation have done some more work on the impact raising marginal tax rates will have on America’s small business community. Just to rehash our major points outlined in the past:
- One half of all business income is taxed under the individual rather than corporate tax codes;
- Two thirds of business income subject to the individual tax code is subject to the top two marginal tax rates; and
- 40 percent of all small businesses with between 20 and 250 employees pay the top two rates.
The Tax Foundation paper emphasizes the adverse impact raising marginal tax rates will have on small businesses. As scholar Bob Carroll writes:
The top individual tax rates are particularly important because a disproportionate share of the flow-through income reported by small business owners is taxed at those rates. Among the small share of tax returns that are subject to the top two tax rates, most receive small business income.
Perhaps the most important finding of the new Tax Foundation paper is that of the higher revenues collected by raising the top two individual tax rates, more than one half comes from raising rates on small businesses.
In other words, the core provision in proposals by Senator Obama, Ways and Means Chairman Charlie Rangel, and others is to increase the top two tax rates back to their pre-2001 levels — or even higher — despite the fact that half of that tax increase will be shouldered by small business owners.
Bailout and Extenders Combined
As equity markets continue their wild swings while the credit markets signal distress, Congress will make another run at the financial sector bailout this evening.
This time the Senate will try. The new package retains the core of the bailout — authority for Treasury to purchase hundreds of billions of dollars worth of troubled mortgages and other assets — while adding an increase in FDIC insurance levels from $100,000 to $250,000, hurricane relief, and the Senate-passed tax extender package.
The Senate will take up the package this evening, voting around 8:00 pm Eastern Time. If it passes, the House will take it up tomorrow. Here’s the new package plus the timeline for Senate action.
The goal is for the Senate to pass this package with a strong vote and put new pressure on House members of both parties to support the bailout. The House needs at least 12 members to change their vote and support the package.
We are hearing that a significant number of House Republicans are prepared to support the bailout this time around. Those votes will be needed. The Senate extender package that passed the Senate 93-2 has focused opposition on the House side, including the caucus of moderate Democrats known as the “Blue Dog” coalition.
Blue Dogs oppose passing tax provisions without offsets, but they voted 26-21 for the failed bailout on Monday. How many of those 26 will switch and vote against this expanded package? Will increased Republican support be sufficient to offset Blue Dog defections?
House Leadership thinks it will, but then, House Leadership thought they had the votes on Monday too.
Effective Tax Rates
The Tax Policy Center has a new study comparing the effective tax rates under the Obama and McCain tax plans. According to the Center, the effective tax rate for taxpayers making more than $1 million stays the same under McCain (34 percent) but rises dramatically under Obama (45 percent if you include his payroll tax proposal).
We have pointed out in the past that fully one-third of all business income in this country is subject to the top two individual tax rates. Raising the effective tax rate on that income from 34 to 45 percent is going to harm small business creation and growth.
As Economist Greg Mankiw points out in his blog, higher tax rates also mean more dead weight loss to the economy, even if lower income taxpayers see their effective tax burden decline.
The deadweight loss of taxation rises roughly with the square of the tax rate. As a result, if one person sees the marginal tax rate fall from 20 to 15, while another sees it rise from 30 to 35, the average marginal tax rate is unchanged, but the deadweight loss increases.
In non-economist speak, that means a revenue neutral plan to balance tax cuts and higher government payments for low-income families with rate hikes on upper income families will result in less economic activity overall. That means less capital for investment and fewer jobs for workers.
Signs of recession are every where right now. The last thing Congress should consider is a hike in tax rates.
Bailout Votes This Week
The House is scheduled to vote on the financial sector bailout package later today. If it passes, the Senate will take it up on Wednesday.
The package itself retains the core Paulson proposal to give Treasury the authority to purchase $700 billion in problem mortgages held by banks and other financial institutions. The goal of the plan is to restore confidence in these institutions by eliminating this source of fear and uncertainty for the next two years. The ultimate cost of this plan to taxpayers will depend on how much further home prices fall. Some observers believe the taxpayer will be made whole when Treasury resells the securities.
In the past few months, we have seen the entire American investment banking industry disappear, the world’s largest insurance company fail, the largest failure of a bank in history, and Wachovia sold at a fire sale. Meanwhile, banks overseas are experiencing runs as well. Belgian giant Fortis was bailed out by European authorities this morning.
Opposition to the plan is now focused on questioning whether this plan will address the underlying problem — the lack of capital for our lending institutions and the pending run on our banks. One challenge for the plan as negotiated is it will take time for Treasury to begin buying these assets. Getting these assets off the banks’ books may help, but will it arrive in time?
Here’s some background material for those interested.
- Text of Plan
- Section-by-Section
- Side by Side of Plans
- OMB and the CBO Scoring Methodology
Observers expect the plan to pass both bodies, but it is going to be close. In the meantime, the world’s credit markets are watching very closely.
Extenders on Hold
At the beginning of the year, we would have bet money — serious money — that there is no way Congress would leave for the year without addressing the expiration of tax provisions like the AMT patch, R&E tax credits, and a long list of credits and deductions designed to encourage renewable energies.
The House is scheduled to take up yet another version of the energy extenders later today, and expects to adjourn for the elections shortly thereafter. The pending House action marks the six or seventh time this year that body has considered extender packages that include offsetting tax increases to cover the revenue loss.
The Senate has demonstrated repeatedly that it does not have the votes to adopt fully-offset extender packages, so why the House is taking yet another vote on this issue is unclear. Last week, the Senate passed a $150 billion package of extenders that included $25 billion in offsets. Both the Senate Leadership and the White House have communicated to the House that $25 billion is as high as they are willing or able to go.
The House action today suggests that if there is going to be an extension of these tax provisions before the end of the year, it’ll have to take place in a lame duck session. Now the question becomes, is there going to be a lame duck?
Congressional Overview
We are nearing the finish line for the 110th Congress with more on the table than when we started nearly two years ago.
None of the 12 bills to fund the government have been adopted. Tax provisions that expired at the end of 2007 remain to be extended. And the collapse of the subprime mortgage market that began a year ago with the failure of several hedge funds has grown into a full fledged credit crisis that, according to the Administration, threatens to harm the entire economy.
It appears Congress will stay in through next week and will have to address the following major items:
- A Continuing Resolution to fund the entire government through next March;
- A tax bill to extend expired and expiring provisions through 2009 and beyond; and
- Some form of relief to the credit markets, perhaps along the lines of what Secretary Paulson proposed last week.
Nothing like waiting until the last moment to start that really big term paper.
Extenders
Some people believe you are not a real player in Washington tax circles until you have your own tax extender to worry over. If that’s the case, then your S Corporation Association has hit the big-time.
The S-Corp extender would extend for one year a provision that allows shareholders to deduct the full value of S corporation property they donate to charity. This provision, like all the other extenders, is caught in a battle of wills, with the House Democrats on one side and everybody else on the other.
Earlier this week, the Senate adopted a $150 billion package that included extensions of the AMT patch, the R&E tax credit, and the assorted energy tax provisions designed to encourage renewable energy. Over the last couple days, the House responded by passing separate bills to do the same thing.
The biggest difference in the two approaches is that the Senate package is offset with $25 billion in tax increases, while the House bills are offset by a total of $60 billion in tax increases. The horse traders in the room are probably thinking, “The Senate is at 25, the House is at 60. Let’s split the difference, pass the bill, and go home.”
But our intelligence is that both the Senate Republicans and the White House have made it clear that $25 billion in revenue raisers is as high as they are willing to go in this process — they would have preferred zero — and the House will have to take the Senate-passed bill or there will be no bill.
The Administration issued a veto threat against the House energy package, suggesting the House take up and pass the Senate bill instead. Whether House Democrats take the suggestion of a departing President remains to be seen.
Bailout Keeping Congress In D.C.
As we forecasted, the legislative wrangling over the bailout has been about as ugly as it gets. While we still expect a deal to get passed and sent to the President, there are several huge obstacles in the way and, while a deal this weekend is possible, action later next week is more likely.
The core of the plan being drafted in Congress is to give the Treasury the authority to purchase up to $700 billion in distressed assets over the next couple years. These assets are backed by subprime and Alt-A mortgages, are primarily held by banks and other financial institutions, and have undermined the ability of these institutions to continue their lending and other operations. Credit measures like Libor are signaling the threat Paulson outlined last week is becoming increasingly real.
If it works the way Paulson and Fed Chairman Bernanke suggest, the Treasury would purchase these assets at reverse auction for a competitive price, inject liquidity into the financial system while removing a considerable amount of risk and uncertainty, hold the assets until the housing market stabilizes, and then sell them back to the private sector. Observers much smarter than your intrepid S-Corp team — including Bill Gross and Warren Buffett — believe a properly executed plan would return a profit to the taxpayer.
The biggest obstacle to the bailout is the stand-off between Speaker Pelosi and House Republicans. The Speaker has made clear she will not move the bailout package unless a majority of House Republicans support it. But House Republicans — including their leadership and a substantial portion of their conference — have made it clear they oppose the current plan.
The solution is either that the plan changes enough to attract more House Republicans, or the Speaker moves the package without them.
- Here’s the latest Democratic draft reflecting the core proposal with numerous additions.
- Here’s the House Republican bailout principles released yesterday.
As you can see, there’s not a whole lot of common ground here. Republican Leader John Boehner just appointed the Republican Whip, Roy Blunt from , to represent House Republicans in future discussions, so talks will resume this afternoon and go into the weekend.
The question for S corporations is whether the dire predictions of the credit markets seizing up — affecting lines of credit, payrolls, etc — are realized before these talks result in some type of agreement.
Extenders Advance
Following a series of votes on alternatives, the Senate adopted a $150 billion package of tax extenders yesterday by a vote of 92-5. The key components of the package include:
- A one year extension of the higher exemption amount under the Alternative Minimum Tax. This provision will prevent about 20 million taxpayers from getting sucked into the AMT when they file their taxes this April.
- An extension of expired and expiring personal and business tax provisions, including the state sales tax deduction and R&E tax credit, though 2009.
- Several new provisions, including making the refundable child tax credit more valuable to low-income families and mental health parity provisions.
- Disaster relief for Hurricane Ike.
- A $17 billion package of energy extenders and new provisions, including an extension of the Section 45 production tax credit and a new credit for plug-in hybrid vehicles.
The big break-though was the decision by Senate leadership not to insist on offsetting the revenue impact of extending the AMT relief and other expired and expiring provisions. Of the total $150 billion revenue impact, only $42 billion is offset.
The package now moves to negotiations with the House, where its future is uncertain. The House today is expected to take up a smaller, $43 billion package of extenders fully offset with the same tax increases included in the Senate package.
All this action masks the fact that the underlying question remains the same — will House Democrats set aside their demand that all extensions of existing tax provisions be full offset, or will they accept the Senate compromise? With only a few days left before Congress leaves for the elections, we’ll know the answer in a couple of days.
Futures on Tax Rates
In the past, we have discussed how tax policy changes depending on who is the next President. Our assessment is that while there will be marginal differences, the final polices enacted under a McCain or Obama presidency will be more similar than not, with a strong bias for higher rates.
Greg Mankiw, former Chairman of the CEA, takes a more rigorous approach, but comes up with a similar conclusion. As posted on Greg’s blog:
What kind of tax policy will we get if John McCain is elected President? He says he wants to make the Bush tax cuts permanent. But is he likely to deliver that outcome in the face of a presumptively Democratic Congress? We can get some insight into this question using Intrade betting and some basic rules of conditional probability.
First, who knew the Intrade Prediction Markers tracked tax rates? Well they do, and using the current Intrade betting, Greg comes to the following conclusion:
That is, according to the Intrade betting, we are likely to see a significant hike in the top income tax rate even if McCain is elected President.
Bailout Proceeds
Estimating what will happen with the Treasury bailout plan is complicated by all the noise from Members of Congress expressing their opposition, advancing alternatives, and proposing additions like caps on executive compensation and changes to bankruptcy rules.
With a plan this large — and really, there’s nothing larger than giving Treasury $700 billion to save the economy – your S-CORP team prefers to step back and look at the forest.
Is the leadership in Congress willing to tell Treasury Secretary Paulson and Federal Reserve Chairman Bernanke “No” and take the risk — and responsibility — that the economy goes into free-fall? The answer is no, which means Congress will adopt some version of the Treasury plan with the core provisions intact.
The sausage making process will take a few days; it won’t be pretty, and many less than attractive provisions will be added to the legislation, but we believe it will get done.
By the way, Intrade agrees — the odds of Congress passing the package before the end of the month skyrocketed from yesterday’s close of 55 percent, to 80 percent this morning.
House Passes Marginal Tax Increase
Foreshadowing things to come, the House on Thursday adopted legislation to increase Veterans education benefits by raising marginal tax rates on individuals—including S corporation shareholders—making $500,000 a year or more. As Congress Daily reported:
“The House, as one portion of a three-part war funding supplemental spending package, approved a provision that would pay for a four-year college degree at any public university for veterans of the wars in Iraq and Afghanistan for at least three years. To pay for the increase — $52 billion over 10 years — the House Thursday voted to impose a 0.47 percent tax on individuals with a gross income of more than $500,000 and couples with income more than $1 million.”
This tax-and-spend approach is unlikely to be adopted by the Senate, and the President has issued a veto threat based on his opposition to the tax increase:
“In addition, amendment number three to the bill would impose a tax increase on individuals and owners of small businesses, totaling more than $50 billion over ten years. A tax increase would be harmful to jobs and economic growth, and the President has been clear that tax increases are unacceptable. If the bill presented to the President contains a tax increase, he will veto it.”
Nonetheless, the S Corporation Association expects that efforts like this will be the norm in coming years rather than the exception. Increasing education benefits for Veterans is a worthy cause, but there are an infinite number of worthy causes, and a limited number of taxpayers. Raising marginal tax rates on small businesses is bad tax policy that deserves to be defeated.
House Extender Package Likely Veto Target
The common perception is that lame duck Presidents have little or no role in on-going policy debates, but reality is slightly different.
President Clinton late in his tenure effectively used his veto pen to either kill legislation outright or negotiate significant changes. This President is doing the same. By our count, more than half of the Statements of Administration Policy issued this year contain veto threats (21 out of 36).
We expect another veto threat when the House takes up the tax extender package next week. The bill would extend for one year a number of tax provisions that either expired at the end of 2007 or will expire at the end of 2008. As outlined in BNA and other publications, the bill would also include two revenues raisers affecting the level of US taxes paid on income earned overseas.
Both the White House and the Senate oppose offsetting the extender package in general and do not like these offset in particular, so the long-term tax picture for extenders and AMT remains as unclear as ever.
Tax Reform Hearing in Senate Finance
The Senate Finance Committee held another in a series of hearings on reforming the tax code. As we have indicated in the past, these hearings and those planned in the House Ways and Means Committee are being held to prepare for the major tax reform expected next year.
What caught your S Corp team’s attention was the uniformity of opinion from the witnesses. All four witnesses argued that rates should be flattened and the base broadened. All four argued for lower taxes on capital income. And all four pointed out that taxes applied to businesses are really paid by individuals.
S Corp readers know the expectation for the next Congress is for higher rates on families and businesses. If Congress does nothing, taxes are going up. If Congress acts, taxes are likely to go up. Given that baseline, it was interesting to hear a panel of witnesses uniformly testify against the direction Congress appears ready to go. Maybe we need to rethink our expectations.
Speaking of baselines, S Corp readers know we have a problem with the baseline accounting Congress uses to score expiring tax provisions. Dr. Foster from the Heritage Foundation included a critique of the current rules:
“The issue arises, of course, because the 2001 and 2003 tax cuts are slated to expire at the end of 2010. This leads some to suggest that extending any or all of the tax provisions, provisions that will then have been in the law for eight or 10 years, is somehow a tax cut. Respectfully to those who make this argument, this is utter nonsense Washington style. Extending current law, or better yet, making it permanent, prevents a tax hike.”
Amen to that.
Stimulating S Corporations
S Corporation Association Chairman Richard Roderick weighed in on behalf of S corporations yesterday regarding the second stimulus package being developed in the House. In a letter to Small Business Committee Chairwoman Nydia Velázquez, Roderick argued that any bill moving through Congress should include assistance to S Corporations.
In particular, the letter advocates for relief from the built in gains tax (BIG) that forces so many S corporations to sit on appreciated assets that could be put to better use. As the letter states:
“According to government statistics, hundreds of thousands of S corporations nationwide may be sitting on “locked-up” capital that they cannot access or redeploy due to the prohibitive tax implications of BIG. This “lock-in effect” is widespread and results in these businesses unable to access billions of dollars in assets that could be used to grow the business and hire new employees.”
While the economic news this week has improved, there remains considerable appetite on the Hill for moving a second package of pro-growth provisions. Given the important role S corporations play in economic growth and job creation, it only makes sense that one of our priorities be included.
Tax Gap and Payroll Taxes and S Corporations
Our friends over at TIGTA (the Treasury Inspector General for Tax Administration) have sent another shot across the bow of the S corporation community regarding the payroll taxes we pay.
In a report released yesterday (Additional Actions are Needed to Effectively Address the Tax Gap), the Inspector writes:
“Similarly, there are potential abuses of employment tax laws caused by misclassified workers and single shareholder owners of Subchapter S corporations. In addition, a prior Treasury Inspector General for Tax Administration audit found that a significant number of single shareholder owners of Subchapter S corporations did not pay themselves salaries to avoid paying employment taxes. We estimated that this would cost the Department of the Treasury approximately $60 billion in employment taxes over 5 years. We believe that the combination of increased transparency through expanded information reporting and targeted legislation aimed at tax abuse loopholes would make the strategy for the Reduce Opportunities for Evasion component more robust.”
As a reminder, the issue is whether some S corporation shareholders who actively work at their business pay themselves a less than market salary in order to avoid paying payroll taxes. In recent years, this issue achieved notoriety during a featured exchange in the Vice Presidential debate in 2004 and later picked up as a possible $57 billion revenue raiser by the Joint Committee on Taxation in 2005.
To date we’ve seen four distinct S corporation targets for increased payroll tax levies:
- The original JCT report would have targeted ALL S corporations;
- The second JCT report focused on personal services businesses similar to those defined by Section 448(d)(2);
- The TIGTA has highlighted single shareholder S corporations; and
- The Rangel bill would affect S corporations engaged in services businesses on the portion of their income that derives from service activity.
S Corp expects that this issue, along with so many tax items affecting our members, will be debated in Congress in the next Congress as part of broader tax reform. However, with the resolution of tax provisions expiring at the end of this year unclear, it could come up sooner. We have weighed in with the tax writers before on this issue. With TIGTA keeping the issue front and center, we plan to do so again.
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