April 17, 2013 by admin ·
More groups are coming out in support for the provisions contained in H.R. 892, the S Corporation Modernization Act of 2013, sponsored by S-Corp champions Representatives Reichert (R-WA) and Kind (D-WI).
As you recall, S Corporation Modernization made up a significant part of Option One of the Ways & Means Pass-Through Discussion Draft. Now, a group of 19 business groups, including the National Federation of Independent Business, the National Restaurant Association, the National Roofing Contractors, the Printing Industries of America, and the S Corporation Association sent a letter to Congress expressing their strong support for the modernization of outdated S corporation rules. As the letter states:
Main Street businesses are the growth engine of America’s economy and S corporations are the cornerstone of the business community. There are more than 4.5 million S corporations nationwide. They are in every community and every industry and they employ one out of every four private sector workers.
Yet many of the rules that govern the day-to-day management of S corporations date back more than half a century. These outdated rules hurt the ability of S corporations to grow and create jobs. Many family-owned businesses would like to become S corporations, but the rules prevent them from doing so. Other S corporations are starved for capital, but find the rules limit their ability to attract investors or even utilize the value of their own appreciated property.
Next, the American Bar Association Section on Taxation also submitted comments supporting reform to the S corporation rules. Under the heading of “Options for Tax Reform in Subchapter S” the authors list out a number of reforms to the rules governing S corporations that are consistent with many of the provisions included in H.R. 892, including Sting Tax Relief. According to the authors:
Without a clear rationale for continuing the tax on excess net passive income, we believe that its repeal simplifies Subchapter S, eliminates traps for the unwary, reduces the administrative and recordkeeping requirements for S corporations, and promotes use of Subchapter S and the economic growth of small business corporations, without an appreciable loss of revenue.
Finally, an independent group of former and present chairs of the S Corporation Committee of the American Bar Association Tax Section submitted independent comments to the Pass-Through Working Group in support of reforming the rules governing S corporations. As their letter states:
… we support permanently reducing to five years (from ten years) the built-in gains recognition period – the period following a C corporation’s conversion to S corporation status during which it must pay a corporate-level tax on certain net realized built-in gains…. The impact of the built-in gains tax may be quite significant when coupled with the individual-level tax imposed on the built-in gain passed through to the shareholders. As a consequence, S corporations may avoid or delay restructurings or dispositions of assets no longer required or needed in the operation of the business, which can have an adverse effect on the business, and, in turn, can adversely affect the economy at large. We believe that, once a reasonable period has passed to accomplish the purposes behind the built-in gains tax, the tax laws should no longer discourage sales of assets that no longer serve a productive purpose in the operation of a closely held business. We further believe that a five-year period is sufficient to accomplish the purposes of the built-in gains tax, and that a longer period might well be counterproductive.
Regarding other provisions included in the S Corp Modernization Act (as well as Option One of the Pass-Through Discussion Draft), the S corporation experts support many of those as well:
We also support the proposals with respect to charitable contributions, specifically modifying the shareholder basis adjustment rules for S corporations making charitable contributions and allowing a U.S. electing small business trust (an “ESBT”) to deduct charitable contributions made by the S corporation subject to the contribution limits and carryover rules applicable to individual donors. We also support the proposal permitting non-resident aliens to be S corporation shareholders through an ESBT. Because an ESBT is separately taxed on income earned from the S corporation, non-resident aliens will be subject to U.S. tax on their interests in S corporation income.
The S Corporation Association, with the help of its allies on and off the Hill, has been successful in its work to enact several of the S Corporation Modernization provisions over the years. With strong support like that expressed above, we are hopeful we can repeat that success in the future.
April 11, 2013 by admin ·
The President’s budget is out, and for the second year in a row it seeks to redefine tax reform to fit its own purposes.
The vast majority of policymakers view tax reform as embracing two fundamental goals:
- Increased simplicity for both taxpayers and the IRS; and
- Lower marginal tax rates imposed on a broader base of income.
The President’s budget , however, would take us in exactly the opposite direction. Rather than simplify the tax code, it would make it more complicated, and rather than move towards lower rates and a broader base of income, it would selectively lower and/or raise rates based on priorities that have little to do with simplicity or overall economic growth.
Corporate-Only Tax Reform: The business community is united behind the premise that tax reform should be comprehensive and address the tax treatment of individuals, pass-through businesses and corporations. Nonetheless, the Obama Administration continues to push Congress to consider budget-neutral, “corporate only” tax reform instead.
Under this approach, Congress would eliminate business “tax expenditures” and use the new revenue to offset lower rates on C corporations. A 2011 Ernst & Young study made clear the challenge corporate-only tax reform presents to pass-through businesses. According to E&Y, a broad policy of eliminating business tax expenditures while cutting only corporate rates would raise the tax burden on pass-through businesses by approximately $27 billion per year – and that doesn’t include the additional hit to pass-throughs from their increased marginal tax rates beginning as of January 2013. The most affected industries include agriculture and mining, followed by construction, retail trade, and manufacturing.
This shift in the tax burden happens because pass-through businesses use the same business deductions as their C corporation counterparts. So, if a simple reform package eliminated the Section 199 manufacturing deduction in order to offset a reduction in corporate tax rates, a manufacturer organized as a C corporation would lose the use of that deduction, but they would get a lower corporate rate in return. It is a mixed bag.
For the S corporation manufacturer down the street, however, there is nothing but downside. They too would lose the use of Section 199, but unlike their C corporation competitor, the resulting higher tax base is not offset by lower tax rates. Instead, tax rates on the pass-through manufacturer just went up. Corporate-only tax reform represents a double whammy on pass-through businesses – higher tax rates imposed on a broader base of income.
To address this challenge, some advocates have suggested allowing pass-through businesses a deduction on their income, or even separating pass-through business income from individual income and taxing it at different rates. While these options might mitigate the adverse impact of corporate-only tax reform on pass-through businesses, it also inflicts serious damage to the tax reform effort in general.
Prior to the 1986 Tax Reform Act, the tax rates on individuals and pass-through businesses were significantly higher than the tax rate imposed on C corporation income. Here is how tax attorney Tom Nichols described the situation during his testimony before the Ways and Means Committee last year:
This tax dynamic set up a cat and mouse game between Congress, the Department of the Treasury and the Internal Revenue Service (the “Service”) on the one hand and taxpayers and their advisors on the other, whereby C corporation shareholders sought to pull money out of their corporations in transactions that would subject them to the more favorable capital gains rates that were prevalent during this period or to accumulate wealth inside the corporations. Congress reacted by enacting numerous provisions that were intended to force C corporation shareholders to pay the full double tax, efforts that were only partially successful. These provisions included Internal Revenue Code (the “Code”) Sections 302 (treating certain redemptions of corporate stock as “dividends”) and 304 (treating the purchase of stock in related corporations as “dividends”), as well as Code Sections 531 (imposing a tax on earnings retained inside the corporation other than “for the reasonable needs of the business”) and 541 (imposing a tax on the undistributed income of “personal holdings companies” deriving most of their gross income from investments).
In other words, business owners began making decisions based on the tax code and not on the needs of their business. The 1986 Tax Reform Act ended this dynamic. Corporate-only tax reform would restore it. It is literally “anti-tax reform.”
Buffett Tax: The Buffett Tax is again included in the President’s budget submission as a means of raising revenue while ensuring that the tax code is more progressive and fair. Despite the frequency with which the President and others talk about the need for the Buffett Tax, the arguments in favor of the tax are uniformly weak.
Congressional Budget Office (CBO) analysis makes clear that the federal tax code is already strongly progressive. According to the CBO, the top 1 percent of taxpayers in 2009 paid an effective tax rate of 29 percent, or nearly three times the effective tax rate paid by moderate income taxpayers (11 percent).
Moreover, we already have three tax codes for individual income, not counting the payroll tax system used to finance Social Security and Medicare. That is, we already impose three distinct tax rate structures on three distinct definitions of income earned by individuals and pass-through business owners:
- The Individual Income tax
- The Alternative Minimum Tax (AMT)
- The Affordable Care Act Investment Tax
By any reasonable standard, tax reform should seek to reduce rather than to increase the number of tax codes we impose on families. Yet proponents of the Buffett Tax would impose yet a fourth tax code, this time on families and pass-through businesses earning in excess of $1 million dollars.
Under the Buffett Tax, families and business owners earning that much in income would need to calculate their taxes four different ways! First, they would calculate their taxes under the Individual Income tax, then under the new Investment Surtax, then under the AMT, and then, after adding all those taxes together, they would need to calculate their overall Buffett Tax liability and see if it is higher.
On this basis alone, Congress should reject the Buffett Tax concept.
For S corporations and other pass-through businesses, however, there are other reasons for rejecting the Buffett Tax. As discussed above, S corporations must make quarterly distributions sufficient for their shareholders to pay taxes on the business’ income. The Buffett Rule would exacerbate this challenge by forcing an S corporation to calculate and distribute additional earnings, even if only one of its shareholders has (or might have) income subject to the Buffett Tax. The result would be to drain additional capital and resources from S corporations seeking to build up their equity and working capital.
Finally, perhaps the most dramatic and unfair consequence of the Buffett Tax for closely-held business owners would occur in the context of a sale of the business. The current federal tax rate for sale transactions is 20 percent (before taking into account the 3.8 percent additional tax on net investment income). The Buffett Tax would increase this tax rate for taxpayers making more than $1 million, even if that higher income was triggered by a “once in a lifetime” transaction involving the sale of a business built up over decades, effectively punishing entrepreneurs for starting and building a successful business.
By definition, both corporate-only tax reform and the Buffett Tax would make the tax code more, not less, complex. They are anti-tax reform and should be rejected by Congress.
March 20, 2013 by admin ·
A coalition of more than forty Main Street business groups, including the S Corporation Association, the National Federation of Independent Business, the National Farm Bureau, the Restaurant Association, and the National Wholesalers Association, released a letter today calling on Congress to resist pressure to consider corporate-only tax reform.
As the letter states:
Every day, nearly 70 million Americans go to work at a firm organized as something other than a C corporation. These “flow-through” businesses, structured as S corporations, partnerships, LLCs, or sole proprietorships, represent 95 percent of all businesses and they contribute more to our national income and our job base than all the C corporations combined.
Despite these contributions, recent press reports suggest that the Administration and some Members of Congress support budget-neutral legislation that would reform the tax code for C corporations only. The proposal would be to reduce the tax rate on C corporations and offset those lower rates by eliminating or reducing tax deductions and credits used by all businesses.
That approach means the same firms that just saw their tax rates go up on January 1st will be subject to yet another tax hike, this time in the form of fewer business deductions and a broader base of taxable income.
If these arguments sound familiar, they should. The S Corporation Association and its allies have been warning Congress about the perils of “corporate-only” tax reform since the idea was first floated by the Treasury Department two years ago. It was those warnings that caused us to ask Ernst & Young to study exactly what budget-neutral, corporate-only tax reform would mean to Main Street businesses. The answer: $27 billion a year in higher taxes.
And that was before tax rates on Main Street business went up in January. The hit today would be much higher.
As before, the S Corporation Association supports reforming the corporate tax code. Rates on public corporations are too high. But every argument in support of reducing the corporate rate also applies to the tax rate imposed on pass-through businesses like S Corporations.
Ways & Means Chairman Dave Camp recognizes this key fact and is committed to comprehensive tax reform that addresses the individual, pass-through, and corporate tax codes. We look forward to working with the Chairman and other policymakers to ensure that tax reform is broad and benefits all employers, including those located on Main Street.
Two Budgets – Two Visions
The House and Senate will consider their respective budgets this week. You can find the pertinent documents at the following sites:
There is a lot of commentary flying around about which budget embraces the better vision for America, but we think the analysis by our friend Charles Blahous is the most straightforward. Rather than getting bogged down in opaque world of baselines and savings figures, Charles focuses on the top line numbers instead – how much does the budget spend, how much does it tax, and what happens to the deficit and debt. Here’s his chart for the spending:
As you can see, the there’s a significant difference in the projected size of government between the two budgets. Spending currently is at inflated levels, and the Senate budget would continue those high levels with the prospect of even higher spending in the out years. Meanwhile, the House budget would return spending to around its post-WWII average.
What happens to revenues?
Again, the Senate budget embraces higher-than-average tax collections for the next ten years, calling for an additional $1 trillion in taxes over current policy, while the House would lock in current revenue estimates and calls for revenue-neutral comprehensive tax reform.
So where does that leave the deficits and debt?
The House budget projects balance by the end of the ten-year budget window, whereas the Senate budget would result in steady-state deficits of between two and three percent of GDP for the next decade. Moreover, because the Senate budget fails to tackle entitlement reform, it’s likely those deficits and debt levels would quickly rise in the following decade, placing increased pressure on Congress to raise taxes beyond the $1 trillion tax increase already called for in the Senate budget resolution.
It is this latter concern that has united the business community around the need for entitlement reform. In recent months, the Chamber of Commerce and our Main Street Business coalition have issued broad statements signed by hundreds of business organizations calling on Congress and the Administration to reform our entitlement programs.
This unity of purpose is unprecedented in our experience and should act as a signal of the enormity of the challenge. Unless we reform our entitlement programs, even the most successful tax reform bill enacted today will short lived and have to be revisited by a future Congress.
March 12, 2013 by admin ·
The Ways & Means Committee today released another in a series of “discussion drafts” outlining their plans for tax reform. This latest draft focuses on how to tax pass-through businesses — those businesses organized as S corporations, partnerships, and sole proprietorships — under a reformed code. In response to the draft, the S Corporation Association today released the following statement:
“The S Corporation Association strongly applauds Chairman Camp and the Committee for their efforts.
The Chairman is committed to a comprehensive reform of the tax code, and he’s made clear that the Committee intends to conduct this reform in a transparent and interactive process. This means more work for them, but it also promises a better policy outcome for America’s businesses.
The Committee draft released today would improve the rules governing S corporations, making it easier for them to raise capital, manage their businesses, and transfer the business on from one generation to the next.
The S Corporation Association has a long history of supporting many of the provisions included in today’s draft, including making permanent the five-year holding period for built-in gains, expanding the ability of S corporations to have foreign shareholders, and reducing the harmful effects of the ‘sting’ tax. Most recently, these provisions were included in the S Corporation Modernization Act (H.R. 892) introduced by Reps. Dave Reichert (R-WA) and Ron Kind (D-WI) last week.”
While there are many details to work out, the draft presented today is an excellent start and we’re eager to work with the Committee and its Working Groups to construct the best possible framework for America’s small and closely-held businesses.”
Our plan for the next several weeks is to work with the pass-through business community to dive into the details and provide comments to the Committee and the Working Groups. Expect to hear more on this soon.
Small Business Survey Supports Comprehensive Tax Reform
Last week, S-CORP ally NFIB released an impressive survey of small-business owners on the tax and spending issues before Congress. The survey can be found here.
Our main take-away is that the small business community strongly supports tax reform. NFIB found that eight out of ten business owners support comprehensive tax reform while a similar number believe tax reform means lower rates applied to a broader base.
Moreover, business owners are ready to put their money (preferences) where their reform is by identifying specific tax items that should be repealed or paired back. The most popular preferences to reduce or eliminate include the mortgage interest deduction (73 percent), the employer-provided health insurance (57 percent) and tax-exempt bonds (47 percent).
Some other interesting points:
Thirty-four percent of owners have spent money planning for the estate tax while another 15 percent expect to spend money in the future. So much for the old saw that “nobody is affected by the estate tax.” If they’re not affected, why are all these business owners paying somebody to get prepared?
On the budget front, small-business owners are all about cutting spending. More than one-third favor balancing the budget through spending cuts only, while nearly two-thirds believe that spending cuts should make up at least 75 percent of the deficit reduction. This position fits with our recent letter to Congress supporting reforms to our entitlement programs and is consistent with the push for tax reform. Without entitlement reform, pro-growth tax reform is simply not possible.
Oh, and finally, 45 percent of NFIB members are organized as S corporations! No wonder we work so well with them!
Good news! Last week, S-Corp champions and Ways & Means Committee members Dave Reichert (R-WA) and Ron Kind (D-WI) introduced the latest version of the S Corporation Modernization Act of 2013. Designated H.R. 892, the bill seeks to improve the rules governing S corporations by making permanent the five years BIG holding period, allowing non-resident aliens to invest in S corporations through an ESBT, and reducing the sting of the “sting tax”, among other provisions.
Specifically, H.R. 892 would make needed changes to keep S corporations competitive and ensuring continued success of America’s predominant private business model by:
- Increasing the ability of S corporations to access much-needed capital;
- Modernizing the rules that apply to firms that have selected S corporation status; and
- Easing and expanding S corporations’ ability to make charitable donations.
Said Congressman Reichert of the bill in a press release—which also cites our 2011 Ernst & Young study—issued on Thursday:
This tax relief proposal that would make it easier for S corporations to access capital, compete, and hire new workers by modernizing outdated rules that currently stifle their growth. A 2011 independent study revealed tax law dealing with S corporations affects 31 million Americans as S corporations employ one out of four workers in the U.S. private sector.
“S corporations and similar businesses are responsible for more than half of the jobs in Washington State and across America,” Rep. Reichert said. “As our economy continues to struggle to regain sound footing, I’m proud to introduce bipartisan legislation to help these proven job creators access the capital needed to grow, compete, and get Americans back to work. Working with the Ways and Means Committee toward comprehensive tax reform, I am committed to supporting these small businesses by advocating for pro-growth tax policies.”
The Reichert-Kind legislation presents a realistic set of reforms that would improve the ability of 4.5 million S corporations to access much-needed capital and increase their hiring capabilities. These reforms would improve the ability of S corporations to respond to the current business environment and remove impediments that prevent them from competing on a level playing field at home in the United States.
The bill is consistent with legislation introduced in the past, and we’re confident several of these provisions will be seriously considered this Congress. Thank you Mr. Reichert and Mr. Kind!