Congress to Consider Lame Duck Session Stimulus
What time is it when the market is down, unemployment is up, personal consumption is falling and manufacturing activity is contracting? Time for another economic stimulus package.
Last week, the Ways and Means Committee confirmed it will hold a hearing on the economic stimulus package on October 29th. The specifics have yet to be worked out and several House and Senate Committees are expected to have a hand in crafting the bill. Politico lists the most likely contenders:
It could include a permanent tax cut for lower- and middle-income families, in addition to the expected extension of unemployment benefits, increased money for food stamps and the states and more federal funds for bridges and other transportation projects.
House Speaker Nancy Pelosi and Senate Leader Harry Reid have made clear in recent days that both the House and the Senate will come back for a lame-duck session. The Senate is scheduled to come back for the week of November 17th. Earlier reports from the House indicated they may convene before the elections, but Speaker Pelosi has refused to put a timeline on consideration of a second stimulus package.
Regardless of the timing, Congress is set to consider another stimulus package following the elections and your S-CORP team is committed to ensure our Built-in Gains (BIG) reforms are included. If the business community needs access to capital, BIG reform can help. Here’s some more on Built-in Gains reform:
- Letter from Associations Supporting for BIG Reform
- Letter from S-Corp Chairman Supporting BIG Reform
- Background on “Small Business Growth & Opportunity Act” — H.R. 3874
- Section by section summary of “S-CORP Modernization Act” – S. 3063
Presidential Candidates Revise Economic Plans
In response to the continuing economic crisis, Senators Obama and McCain have put forward new additions to their economic proposals. Here is a quick summary of each of the candidate’s plans.
Obama’s plan would:
- Create a new temporary tax credit for companies that add domestic jobs. Through 2009 and 2010, existing businesses will receive a $3,000 refundable tax credit for each additional full-time employee hired; eliminate all capital gains taxes on investments made in small businesses and start-ups;
- Create a $25 billion Jobs and Growth Fund for infrastructure projects and schools; $25 billion in aid to states, and $25 billion in loan guarantees for auto companies to retool their plants;
- Instruct the Treasury Department to allow those 70 and ½ and older to delay required withdrawals from their 401(k)s and IRAs and allow others penalty free withdrawals of 15% up to $10,000 from IRAs and 401(k)s (although subject to the normal taxes);
- Direct the Secretaries of Treasury and Housing and Urban Development to aggressively modify mortgages; 10% refundable tax credit on mortgage interest for those who don’t itemize their taxes; Reform bankruptcy code to allow for broader mortgage restructuring; Put in place a 90 day foreclosure moratorium for homeowners who are trying to pay mortgages; and
- Extend Treasury’s authority to purchase assets aside from mortgage backed securities to unfreeze other markets for student loans, car loans and other types of loans.
McCain’s plan would:
- Increase the amount of capital losses which can be used in tax years 2008 and 2009 to offset ordinary income from $3,000 to $15,000;
- Reduce the maximum tax rate on long term capital gains to 7.5 percent in 2009 and 2010;
- Allow up to $50,000 to be withdrawn from IRAs and 401(k)s at a tax rate of 10% through 2008 and 2009; Suspend required withdrawals from IRAs and 401(k)s for seniors over 70 ½;
- Purchase mortgages directly from homeowners and mortgage servicers and replace them with an FHA-guaranteed fixed-rate mortgage.
Whichever plan moves forward – Congressional, Obama, or McCain – will add to the deficit in fiscal year 2009 and put additional pressure on Congress to raise overall tax revenues. As the Washington Post reported Saturday (about two weeks after your intrepid S-Corp team alerted its readers), the federal budget deficit is currently projected at $650 billion in 2009, and is likely to go up from there — to $1 trillion or more.
Obama and S Corporations
The Texas and Ohio presidential primaries are dominating the news today, so we thought we’d take a look at the candidates’ tax policies and see how they would affect S corporations. We’ll start with Illinois Senator Barack Obama.
So would an Obama presidency be good for S Corps? Here’s a quick summary of his positions and how they might affect Main Street.
Income Tax Rates: Obama supports letting the top tax rates revert to their pre-2001 levels. In other words, the top tax rate would rise from 35 back to 39.6 percent, the 33 percent bracket would rise to 36 percent, and the 28 percent bracket would likely rise to 31 percent.
Capital Gains and Dividends: While the Senator initially indicated he would like to see the tax rates on investment income rolled back all the way to their pre-2003 levels, some campaign advisors are now suggesting that he would support some middle ground rates of around 25 percent for both dividends and capital gains. Either way, he supports increasing rates on investment from current levels.
Estate Tax: Obama has called for a $3.5 million exemption per spouse, and while he has been quiet on what rate would be applied to the remainder, the impression we have is that the law as it exists for 2009 — a $3.5 million exemption coupled with a 45 percent top rate — is probably close.
Social Security Taxes: The Senator has come out in favor of raising the Social Security earning cap from its current $102,000 to an undisclosed amount to help make Social Security more solvent. Under current law, workers pay Social Security taxes (12.4 percent) on the first $102,000 they earn and Medicare taxes (2.9 percent) on the rest. The Obama plan apparently imposes the full combined tax (15.3 percent) on incomes above a certain level, perhaps $200,000.
Alternative Minimum Tax: We can’t find any indication of what he would do about the growth of the AMT.
S Corp readers know that payroll tax issues are of particular importance to our members. Some in Congress and the IRS would like to have payroll taxes apply to all S corporation income. Combine that desire with an increase in the payroll tax wage cap, and you’re looking at a truly historic tax rate increase on thousands of small and closely-held businesses.
Even without payroll tax convergence, the economic plan outlined above represents a large tax hike on S corporations. Right now, C corporations and S corporations pay a similar top marginal tax rate on their undistributed earnings — 35 percent. Under the Obama plan, the rate for S corporations would rise to nearly 40 percent, while the rate on C corporations would remain the same.
Meanwhile, while public corporations are immune to the estate tax, a family-owned S corporation worth more than a few million dollars would be subject to estate tax rates as high as 45 percent when the business is transferred from one generation to the next.
On the tax cut side, there’s little in the Obama plan to encourage S corporations. Rather than broad policies, he is offering instead a series of small tax credits for low-income workers, tuition expenses, a larger child tax credit, and a small savers tax credit. He would also allow seniors to earn up to $50,000 before they have to pay taxes.
On net, tax policy under a President Obama would mean higher taxes for S Corporations, but not on their larger C corporation competitors.
Alternative Minimum Tax & the Candidates
Senator McCain favors of repealing it. Senator Clinton wants to reform it. And Senator Obama has yet to mention it (as far as we can tell).
What is it? The alternative minimum tax, and together with the expiring Bush tax cuts, it presents Congress with the dominate tax policy challenge of the next three years. This chart from the Tax Policy Center does a better job of outlining the AMT challenge than any words we could write.
Simply put, absent change the AMT will take over the individual income tax, with most of the revenue collected by the federal government coming from the AMT. Taxpayers most likely to get hit by the AMT include those with children and those that live in high tax states like New York and California. Since S corporations pay their business tax as individuals, the growth of the AMT has particular importance to our members.
One interesting aspect of the current presidential run is that all three of the remaining viable candidates are members of the United States Senate and will have the opportunity to vote on many of these critical tax issues over the next few months. Repealing the AMT is a $1.5 trillion challenge, so just how the candidates reconcile their other tax priorities with possible Senate votes to protect taxpayers from the AMT this session will be very telling.
Treasury Conference on Corporate Tax Policy
Your S-Corp Association friends attended the Treasury conference on corporate tax policy last week, rubbing shoulders with the Secretary of the Treasury, Alan Greenspan, and others. As expected, the bulk of the speakers focused on tax issues of most concern to Fortune 500 companies—the corporate rate, the treatment of foreign earnings, etc. There’s growing concern that our corporate tax rate is out of whack with the rest of the developed world and this forum served to highlight the benefits of a corporate tax rate cut.
One of the invited speakers, however, S-Corp ally John Satagaj from the Small Business Legislative Council, focused his comments entirely on the state of flow-through businesses and his concern that they not harm the small business community as they work to fix the corporate code.
Also of note was the very friendly attention flow-through businesses received in the background document Treasury prepared for the conference. Chapter 3 of the report exclusively addresses the role S corporations and other flow-through businesses play in our growing economy and it includes lots of helpful statistics on the state of small businesses structured as S corporations, partnerships, and sole proprietorships. A couple of the more compelling facts:
- “93 percent of all businesses in the United States pay their taxes at the individual income tax rates.”
- “The share of S corporation returns as a percentage of all business returns grew from 4 percent in 1980 to 12 percent in 2004.”
- “The number of taxpayers who receive more than half their income from their business was 11.9 million in 2006. Of those, more than a million were subject to the top two income tax rates.”
As the report notes, flow-through businesses are an increasingly important sector of the U.S. economy. Let’s hope the policies coming out of Washington in the next few years reflect that.
Tax Outlook Summary
With the August break upon us, here’s another quick look at all the tax activity on the legislative calendar. We have updated our tax chart, here.
Perhaps the most significant event in recent days was to see how quickly the farm bill managed to turn into a tax bill with the addition of a $4 billion offset for some food stamp additions — no hearings, no warning, and suddenly there’s a $4 billion tax increase on the House floor. Something to keep in mind as the session continues. Here are the current tax highlights:
AMT Reform: This broad, $500-750 billion package is now being discussed as a fall or winter bill in the House. In the Senate, the tax writers are increasingly making it clear they have little or no intention of doing anything permanent on the AMT this year. Smart observers are expecting that another so-called AMT patch—a temporary increase in the AMT exemption levels to restrain the growth in the number of AMT taxpayers—will be adopted late this session, likely just before everybody goes home for Christmas.
Energy Tax Incentives: The House plans to take up the energy bill this Friday, with a $15 billion energy tax package of renewable and conservation incentives included. Offsets to the incentives are targeted at the oil and natural gas industries. Oil Patch Democrats have insisted that the tax provisions be voted on separately, however, so they can support the broader energy bill while opposing the tax package. The total package is expected to pass, but similar concerns in the Senate derailed the Senate energy tax package.
SCHIP: The House and Senate are considering the bill right now. While the bill might succeed in passing the House and Senate, the President has promised a veto. Odds that the current proposal—including the $50 billion tax increase on tobacco—can survive a veto and becomes law are slim to none.
Technical Corrections: Look for this package to be introduced and open to comment in the fall. Last year’s technical corrections package included an IC-DISC provision that would have raised taxes on small and closely held exporters. This provision is likely to be part of the initial bill, but we’re working to keep it out.
S-CORP OPPOSES EXPORTER TAX INCREASE
Chairman Submits Comments to Tax Writers
S-CORP Chairman Tom McMahon today submitted comments (click here for full text) to the House Ways and Means and Senate Finance Committees opposing a proposed tax increase on small and closely-held exporters. Chairman McMahon observes in his comments:
“I would like to raise serious concerns regarding Section 7 of the Act which, if enacted, would significantly increase taxes on small and closely-held U.S. manufacturing exporters.”
As you’ll recall, the Senate Finance and House Ways and Means Committees introduced companion “tax technical corrections” bills (H.R. 6264 & S. 4026) just before breaking for the elections, requesting that interested parties submit comments regarding the proposed changes prior to October 31st. The plan is to create a technical and non-controversial tax title that would eventually be sent to the President during the final weeks of this Congress.
As we’ve previously pointed out, Section 7 of the bill is neither technical nor non-controversial. It would increase from 15 percent to 35 percent the tax rate on qualified export income for small and closely-held business exporters! As our Chairman observes, “Given the current size of the U.S. trade deficit, it makes little sense for Congress to act unilaterally to harm small and closely-held manufacturers and other exporters.”
As always, the S Corporation Association is working with other affected groups such as the National Association of Manufacturers and the Small Business Exporters Association to ensure that this substantive and controversial amendment does not pass. If you or your clients benefit from IC-DISC, you can send comments directly to the Finance and Ways and Means Committees at the following email addresses:
techcorrections@finance-rep.senate.gov
S-CORP PAYROLL TAX INCREASE BACK IN NEWS
On another front, the Wall Street Journal yesterday reported on the recently published “tax gap” report from Congress’ Joint Committee on Taxation and its potential impact on taxpayers. As S-CORP readers know, this report includes a proposal to apply payroll taxes to all the income of certain S corporations. This proposal is significantly reduced from previous versions – it applies only to personal services bus inesses like law firms and consultants, not manufacturers – that S-CORP opposed. The WSJ summarizes the current proposal like this:
“The report proposes a significant tax -law change for law firms and family-owned personal-service firms, which may face new self -employment tax obligations. Typically, an executive in a “subchapter S corporation,” used by many family businesses, takes a salary and distributes the remaining profit in a dividend that isn’t subject to self-employment taxes, Mr. Smith says. The report suggests a new uniform rule to have these entities covered by the same self-employment tax regime as partnerships or sole proprietors. Not having a uniform rule is a sizable problem: $39 billion of the tax gap was attributable to the self -employment tax and an estimated $15 billion of the tax gap attributable to unemployment taxes. Yet Mr. Smith says in his experience, most people using an S corporation don’t pay themselves “ridiculously low” salaries and take the rest in a tax -advantaged dividend distribution.”
S-CORP is currently polling its members to determine how we should respond to the most recent payroll tax proposal. If you have a view, please let us know.
House Approves $70 Billion Tax Cut Bill
Yesterday, by a vote of 244-185, the House approved the long-delayed tax reconciliation bill (H.R. 4297) following an agreement between House Ways and Means Committee Chairman Bill Thomas (R-CA) and Senate Finance Committee Chairman Chuck Grassley (R-IA) that a follow-up tax extenders bill may be attached to pension reform legislation.
The reconciliation tax bill includes a two-year extension of the reduced tax rate on capital gains and dividends, a one-year extension of alternative minimum tax relief for middle-income tax payer, a two-year extension of increased small-business expensing under section 179, and extension of the subpart F exemption for active financing income.
Fourteen revenue offsets are also included that raise $13 billion over the next 10 years. The Senate is expected to vote on the bill today. It needs a simple majority to pass the Senate, and a few Republican defections are expected, while a few Democrats are expected to vote for the bill.
For the Joint Committee on Taxation Estimated Revenue Effects Of The Conference Agreement For The “Tax
Increase Prevention And Reconciliation Act Of 2005”: http://www.house.gov/jct/x-18-06.pdf
Revenue Offset In Tax Cut Bill Impacts Domestic Manufacturing Deduction for S Corporation Manufacturers
S Corps engaged in production activities should probably take a look at Section 514 of the reconciliation tax bill. This section modifies the wage limitation for the domestic manufacturing deduction enacted in the 2004 American Jobs Creation Act. The Jobs Creation Act allowed manufacturers to take a deduction against qualified production income, but limited that credit to no more than 50% of the wages paid to all employees that year. H.R. 4297 would limit the deduction to workers directly involved with producing the qualified property. This change will definitely be an administrative challenge and could reduce the benefits of the deduction for companies with significant nonproduction wages.
The provision also includes a simplification measure repealing the special limitation on wages treated as allocated to partners or shareholders of pass-through entities. S-CORP Advisory Board Chairman Jim Redpath noted this is a “good simplification move for S corporations.”
S-CORP recently heard from Eric Solomon, newly nominated by the President to head up the Treasury
Department’s Office of Tax Policy, regarding their plans the issue final regs on Section 199. This provision is a big change to Section 199, and observers now expect that schedule to get pushed back.
S-CORP Continues Efforts on “Sting Tax Relief”
Despite the best efforts of S-CORP members and allies, the final reconciliation tax bill left out the Senate-passed provision to provide relief from the “sting tax” on excess passive income held by S corporations. The good news is that the Sting Tax provision continues to be in play, and is being considered for a second bill that is still being negotiated. The second bill is expected to include provisions that were removed from the reconciliation bill to keep that bill’s cost under the $70 billion cap set by the fiscal year 2006 budget resolution. The “trailer package” is expected to an extension of several popular business tax cuts, including the research credit, the work opportunity tax credit, the state and local tax deduction, and the above-the-line deduction for teacher classroom expenses.
S-CORP Board of Directors and Advisory Board Capitol Hill & Administration Visits
Last week S-CORP’s Board of Directors and Advisory Board held their annual Washington, DC meeting. We were privileged to meet with key Administration personnel to update them on our members’ priority issues: preserving the tax status of S corporations, fighting proposed increases on S corporations, and promoting initiatives that will allow S corporations to grow and prosper.
We briefed Members of Congress and their staff on the benefits of H.R. 4421, the S Corporation Reform Act.” We are pleased to announce that S-CORP Chairman Tom McMahon’s (Barker Company in Keosauqua, Iowa)
representative, Congressman Jim Leach (R-IA) quickly signed on as a cosponsor of the bill. We continue our efforts to increase cosponsors for this important legislation.
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