During the past year, several tax law and administrative changes have affected S corporations and their shareholders. According to a report published by Stewart Karlinsky and Hughlene Burton (October 1, 2011), these changes include:

• The IRS’s Fast Track Settlement Program was extended to SB/SE taxpayers in certain locations, including S corporations.
• A number of the various tax legislation packages that passed Congress during the past year will have a direct or indirect effect on S corporations and S corporation shareholders.
• S corporations currently will not be required to report uncertain tax positions on new Schedule UTP, Uncertain Tax Position Statement.
• Several courts issued opinions in cases involving shareholder basis in loans to an S corporation and the Sec. 1366(d) basis loss limitation rules.
• The potential zero capital gain rate (available since 2008) was extended through 2011 and 2012 and continues to be an attractive tax planning tool that may affect S corporations and their shareholders’ behavior.

A summary of select report findings are below. The report is available at http://www.aicpa.org/publications/taxadviser/2011/october/pages/karlinsky_oct2011.aspx – fn_.

Fewer S corporation returns are examined than those of individuals

For individual tax returns filed in 2009 and audited in fiscal year 2010, the IRS audited 1.1% of filed Forms 1040, with 30% of those audited including an earned income credit. Of individual returns examined in 2010, 78% were correspondence audits.  The IRS audited individual taxpayers with total positive income of greater than $1 million at a rate of 8.4%.

Fast Track Settlement Program Extended to SB/SE Taxpayers

Many S corporations are clients of the IRS’s Small Business/Self-Employed (SB/SE) Division (i.e., they have less than $10 million in gross assets). The IRS expanded this program to include SB/SE taxpayers at IRS offices in eight locations: Chicago, Houston, St. Paul, Philadelphia, central New Jersey, and three California cities: San Diego, Laguna Niguel, and Riverside. This program is intended to facilitate efforts by certain taxpayers and the IRS to settle issues in open tax years under exam, with an auditor and Appeals together in the same room. The expansion was effective December 1, 2010.

Capital Structure Reporting

Another important administrative change was the January 1, 2011, effective date of Sec. 6045B, which requires any change in the capital structure of a corporation (including S corporations) to be reported within 45 days to the government and by January 15 of the following year to each holder of stock, bonds, or notes or their nominees. These rules cover corporate spin-offs and reorganizations.

The government recently revised Form W-9, Request for Taxpayer Identification Number and Certification, to better distinguish S corporations from C corporations. This was done because beginning in 2012, under the Sec. 6045 disclosure rules, if a “covered security” (including specified securities acquired through a transaction in the account in which such security is held) is acquired by an S corporation, adjusted basis reporting is required.

Increase in Penalties for Nontimely Filing of Form 1120S or Missing Information

For tax years beginning after December 31, 2009, the Worker, Homeownership, and Business Assistance Act of 2009 more than doubled the Sec. 6699 penalty, from $89 to $. This penalty applies per shareholder per month (not to exceed 12 months) if the S corporation does not timely file its Form 1120S, U.S. Income Tax Return for an S Corporation, or fails to provide information required on the return.

Uncertain Tax Position Disclosures

Beginning with the 2010 tax year, entities with more than $10 million in gross assets were required to disclose on their tax returns FIN 48 uncertain tax position information. The IRS subsequently increased the initial gross asset threshold for reporting to $100 million, with a phased-in reduction to $50 million starting with 2012 tax years and $10 million starting with 2014 tax years. The final instructions to the new Schedule UTP, Uncertain Tax Position Statement, do not require S corporations to file the schedule.

Controlled Groups

T.D. 9522 was finalized on April 8, 2011, and became effective on April 11, 2011. It distinguishes a controlled group under Sec. 1563 from the affiliated group rules of Sec. 1561 and has an important impact on S corporations. Many practitioners believed that because S corporations were defined as “excluded corporations,” two controlled S corporations could each take a maximum Sec. 179 deduction and pass those through to their shareholders. The new final regulations state that S corporations are excluded corporations for Sec. 1561 purposes, such as Sec. 11 tax rates or accumulated earnings tax and the alternative minimum tax (AMT) exemption (which would not apply anyway). S corporations are members of a controlled group for Sec. 1563 purposes (see Regs. Sec. 1.1563-1(b)(4), Example (4)), which would also cover Sec. 179, Sec. 41, and other areas of the tax law. To be a controlled group under these provisions, a company must meet the test of having five or fewer shareholders that own 80% of the stock or its voting power, as well as the 50% identical ownership test.

Due Dates of Flowthrough Entity Tax Returns

IRS issued changed the extension due date of calendar-year partnership, trust, and estate income tax returns to September 15. However, the change does not apply to the original due date, nor does it apply to S corporations.

Tax Relief Act Implications

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Tax Relief Act) was signed into law on December 17, 2010. It extended the capital gain and dividend 15% tax rates for 2011 and 2012 and extended the AMT patch for 2010 and 2011 ($47,450 for single filers and $72,450 for married filing jointly for 2010). It reduced the Social Security rate for employees and the self-employed for 2011 and extended the suspension of the itemized deduction and personal exemption phaseout for 2011 and 2012. Notably, for assets acquired and placed in service on or after September 9, 2010, and before January 1, 2012, it allows Sec. 168(k) bonus depreciation at 100% instead of the previous 50%.

Zero Capital Gain Rate

Besides extending the 15% capital gain rate, the Tax Relief Act also extended the zero rate for individual taxpayers in the lower two tax brackets. Consequently, taxpayers should consider gifting appreciated S corporation stock to their children, grandchildren, or parents.

Small Business Jobs Act

The Small Business Jobs Act of 2010 expanded the dollar amount of new or used tangible personal property that a taxpayer may expense in the year placed in service under Sec. 179 to $500,000 for 2010 and 2011. The deduction phases out between $2 million and $2.5 million in property acquired in the tax year. Tax professionals should note that the requirement of sufficient positive business income still applies. If the income (including salary) is not sufficient, a carryforward is permitted. In an expansion of the provision, $250,000 of the $500,000 property acquired can apply to qualified leasehold, retail, and restaurant improvements. This category of assets has a 15-year life, so taxpayers will probably choose to apply Sec. 179 to these assets first. If the income limitation is applied for 2010, this category of asset carryover may be used in 2011, but unless the provision is extended, the carryover may not be used beyond 2011.

Another major change enacted by the Small Business Jobs Act is the ability to carry back eligible small business general business credits, such as research and development or rehabilitation credits created in 2010, for five years instead of the normal one, and they may offset AMT liabilities. An eligible small business includes non–publicly traded corporations (including S corporations), partnerships, and sole proprietorships with less than $50 million in gross receipts in the three years prior to 2010. However, S corporation shareholders and partners of a partnership must meet the gross receipts test as well.

HIRE Act

The Hiring Incentives to Restore Employment Act of 2010 (the HIRE Act) provided a payroll tax holiday from March 19, 2010, to December 31, 2010, for employers for each new nonrelated hire between February 4 and December 31, 2010, that had not been employed more than 40 hours during the previous 60 days or longer. As an additional incentive, if the employee continues to be employed for 52 weeks, the employer receives a credit of the lesser of 6.2% of the wages paid to the retained employee during the 52-week period or $1,000. Because the credit is taken in the first tax year that the 52-week requirement is met, calendar-year taxpayers will take the credit in 2011.

BIG Tax Holiday

The Small Business Jobs Act also modified Sec. 1374 for 2011. If 2010 was the fifth tax year in the recognition period, no tax would be imposed on recognized BIGs for 2011. For 2009 and 2010, the American Recovery and Reinvestment Act of 2009 enacted Sec. 1374(d)(7), which also somewhat reduced the stress and impact of Sec. 1374. This provision exempted Sec. 1374’s BIG tax from being imposed in the tax year that was preceded by the S corporation’s seventh year of the recognition period.

Banks and Sec. 291(a)(3)

When a corporation converts from C to S status, it needs to be aware of the impact of Sec. 291. This tax provision is a vestigial organ of the pre-1986 corporate add-on minimum tax, but it still applies today.

IC-DISC Tax Rate Arbitrage

Most practitioners are aware that when investment interest expense is less than net investment income, a tax planning opportunity can be exploited by increasing investment interest expense and investing in dividend-paying stocks to play the tax rate differential. Less well known is using an interest charge domestic international sales corporation (IC-DISC) to net the same results for companies that produce products in the United States that they sell overseas.

For questions regarding business entity issues, please contact Meredith Theiss at 720-227-0064 or mtheiss@taxops.com.

Congress’ failure to act by Thanksgiving leaves many major tax-code issues unaddressed for year-end. Income-tax rates, capital-gains rates, estate-tax exemptions and rates, and the alternative minimum tax issues have been deferred to 2012.

According to the Wall Street Journal (Weekend Investor, 11/26-11/27), absent Congressional action, a number of significant tax changes will expire at the end of 2011.

• Social Security 2% payroll-tax cut for employees.
• Alternative-minimum tax waiver that otherwise would have imposed an AMT at a 26% or 28% rate on taxpayers with high deductions for state and local taxes, miscellaneous deductions, personal exemptions and incentive stock options. Without action, the AMT will be expanded to millions more taxpayers in 2012.
• Charitable contribution up to $100,000 of IRA assets for people older than 70 ½. Gifts are excluded from income.
• Special depreciation benefits. Sole proprietors and other businesses reporting on Schedule C of a personal return should check expanded write-offs that become less generous at the end of 2011. Bonus depreciation is also changing according to IRS Publication 946.
• State sales-tax deduction in lieu of income tax deduction.
• Mortgage-insurance premium deduction.
• $4,000 higher-education deduction.
• Schoolteacher-expenses deduction up to $250.

 By the end of 2012, additional tax changes will occur if Congress does not address important tax issues.

• Top 35% income-tax rate
• Top 15% capital-gains rate
• Current estate- and gift-tax rates and exemption
• American Opportunity Education Credit

 In 2013, a number of tax increases will automatically take effect.

• 3.8% tax on net investment income for joint filers with more than $250,000 adjusted gross income ($200,000 single). The levy applies to taxable interest, dividends, rents, some annuities, royalties and capital gains, including the sale of a house after a $500,000 exclusion ($250,000 for single filers).
• Personal-exemption phaseout
• “Pease” limit on itemized deductions of 3% of itemized deductions – including charitable gifts – for upper-income taxpayers. Current rules allow a deduction up to 50%, 30%, or 20% of adjusted gross income, depending both on the recipient and type of property donated. In general, the 50% limit applies to gifts of cash and the 30% limit to appreciated assets. Gift-givers can avoid capital-gains tax and realize a full deduction for gifts such as shares of stock that appreciate in value.
• Flexible-spending account limit of $2,500 (down from typical $5,000)

On October 26, Ways & Means (W&M) Chair Dave Camp (R-MI) released a draft proposal for international tax reform. Two prominent features of the proposal are reducing the maximum corporate tax rate from 35% to 25%, for tax years beginning after Dec. 31, 2012, and shifting the U.S.’s international tax regime from a worldwide system to a territorial-based system. 

In shifting to a territorial system, the plan would specifically exempt 95% of overseas earnings from U.S. tax when profits are brought back to the U.S., by implementing a 95% deduction for the foreign-source portion of dividends received from controlled foreign corporations (CFCs) by domestic corporations that are 10% U.S. shareholders and that have held the underlying stock for at least one year. It would also allow existing overseas profits to be brought back to the U.S. at a 5.25% rate, which is in line with current repatriation proposals. According to Rep. Camp, this would encourage companies to reinvest their profits in the U.S. and make American companies more competitive. 

Additionally, the plan would treat foreign branches of U.S. parent companies as CFCs for which the 95% dividends-received deduction is available, tax royalties paid by a CFC to the U.S. parent at a maximum 15% rate, and treat certain types of passive and highly mobile income as currently included in the U.S. parent’s taxable income, whether or not repatriated, and allow FTCs for them. 

A number of issues, including dual consolidated losses and tax treaty implications, were not addressed in the draft and may require resolution before any of the proposals are finalized. Among the issues to be worked out are:

• how to best protect the U.S. tax base while minimizing the effect on the competitiveness of American businesses;
• the pros and cons of treating foreign branches as CFCs, as opposed to disregarded entities; and
• how to treat foreign partnerships with U.S. corporate partners owning at least 10% interests.

Carried interest changes were a strong point of contention when last proposed. They are back on the table today as a result of the proposed American Jobs Act.  Although wholesale passage of the Jobs Act has been blocked in the Senate, individual pieces may still have life as separate bills, including carried interest taxation.     

The Administration’s $447 billion job creation plan included a proposal to tax carried interests as ordinary income rather than capital gains. Although this tax treatment has been proposed multiple times before, the Administration’s support is the latest in a long line of attempts to change the tax treatment of carried interest.               

In general, the legislation characterized carried interest income and gain as ordinary income, and would apply to interests in traditional hedge funds, private equity funds, venture capital funds, and real estate funds. It would also continue to treat gain on the sale of such interests as ordinary income. The specified asset definition has not changed significantly, and includes securities, real estate held for rental or investment, interests in partnerships, commodities, cash or cash equivalents, as well as options or derivative contracts with respect to those assets. 

A “carried interest” is a financial interest in the long-term capital gain of an asset given to a general partner (GP) by the limited partners (LPs), or investors in the partnership. It is paid if the asset is sold at a profit that exceeds the agreed upon returns to the investors. This serves to align the interests of the GP with the investors by allowing the GP to share in the “upside” of the asset, and to compensate the GP for the substantial risks taken during asset development and during the period prior to sale of the asset. Carried interest has traditionally been treated as capital gains income taxed at favorable capital gains rates. 

Similar carried interest proposals have been passed by the House of Representatives several times over the past several years, but have failed to pass in the Senate. Representative Sander Levin (D-Mich), a senior member of the House Ways and Means Committee and later chairman, introduced legislation in 2008 to change the tax treatment of carried interest from capital gains to ordinary income. Supporters of the legislation described it as eliminating a loophole used by Wall Street private equity and hedge fund managers to avoid taxes. However, the proposed partnership tax law might have more than doubled the tax rate on partnership’s carried interest, from 15 percent to nearly 35 percent. 

In addition to including the tax hike in the Jobs Act, President Obama has also called for the Joint Select Committee on Deficit Reduction to include a carried interest tax increase as a revenue raiser in deficit reduction package it develops. 

There was a concern that earlier versions of the legislation could have applied to interests in certain entities organized as partnerships other than investment funds (e.g., partnership holding companies, boutique investment banks, or other businesses organized as partnerships that are operating businesses). The proposed legislation introduces a concept of an “investment partnership” and a revised definition of “investment services partnership interest” (ISPI) that, while ambiguous in some respects, serve in many cases to narrow the application of the proposed rule change.  

As a result of these changes, the treatment of gain on the sale of an interest in a partnership that serves as an investment manager but also owns a carried interest, fee waiver or other interest in the underlying investment funds it manages is not entirely clear and may depend on the specific facts of the particular transaction. At a minimum, any gain attributable to fee waiver, carried interests or similar interests will be ordinary income. Under the revised proposal, however, sales of interests in many operating businesses structured as passthroughs that might have been caught by prior versions of the legislative language will continue to be eligible for capital gains treatment, to the extent available under existing law. The proposed legislation would generally be effective in 2013.

Individuals with signature authority over foreign financial accounts may have some quick work to do to meet the looming Nov. 1, 2011 reporting deadline.  The IRS extended the deadline to give affected individuals extra time to gather the necessary information to complete and file accurate Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), for 2009 and earlier calendar years.

Filers are certain U.S. persons who have a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts in a foreign country. If the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, these individuals must report that relationship each calendar year by filing TD F 90-22.1 with the Department of the Treasury on or before June 30th of the succeeding year. 

The IRS has developed somewhat of a history in providing extensions for certain FBAR filers. There is, however, no indication that the IRS plans further extensions. FBARs must be received by the Department of the Treasury by Nov. 1, 2011 in order to be considered timely filed. FBARs can be electronically filed to minimize late filing fees (see blog “FBAR can now be filed electronically”).

Two extensions have previously been provided to certain filers to give the U.S. Treasury more time to develop comprehensive FBAR guidance. . The IRS extended the deadline to June 30, 2010, to file a FBAR for years 2008 and earlier, for (i) persons with no financial interest in a foreign financial account but with signature or other authority over that account; and (ii) persons with a financial interest in or signature authority over a foreign financial account in which the assets are held in a commingled fund. In a subsequent extension, the IRS deferred the filing deadline from June 30, 2010, until June 30, 2011 for filers for 2010 and prior calendar years.

On Feb. 24, 2011, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a final rule to amend the Bank Secrecy Act (BSA) regulations regarding FBAR reporting requirements. The rule was made effective as of Mar. 28, 2011 and applies to 2010 reports filed by June 30, 2011, and those for subsequent years. The final rule provided additional guidance and clarification regarding who must file FBARs.

Concerns that filers did not have enough time to collect data for accurate filings prompted yet another extension. The IRS further pushed the deadline back to Nov. 1, 2011 for required filings for 2009 and earlier calendar years. However, the June 30, 2011, deadline for reporting either signature authority over, or financial interest in, foreign financial accounts for the 2010 year remained unchanged. IRS also stressed no change in the requirements to provide information or file FBARs in connection with IRS’s 2009 or 2011 Offshore Voluntary Disclosure Programs.

For additional information on whether you are subject to the Nov. 1, 2011 FBAR deadline, please contact Mike Abramovitz at 720-227-0423 or mabramovitz@taxops.com.

On September 20, Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking member Orrin G. Hatch, R-Utah, made a case for the permanent extension of the federal research and development (R&D) tax credit during a hearing on tax reform and incentives for innovation. The lawmakers called it a necessary incentive for the U.S. industry to remain competitive in the global marketplace. The R&D credit has been temporary for the last 30 years and has sunset numerous times during that period. It is currently scheduled to expire at the end of 2011.

Prior to the hearing, the Senators proposed the Greater Research Opportunities With Tax Help Bill of 2011, which would simplify and make permanent the R&D tax credit. The bill provides for raising the value of the alternative simplified credit (ASC) from 14 percent to 20 percent  (ASC: rate % multiplied by the current year Qualified Research Expenses (QRE) increment amount over half the average of the three previous years’ QREs).  The bill also allows the traditional credit (fixed base percentage) to expire at the end of 2011.

Proponents of a permanent credit contend that successful tax policy is predicated on permanence. The temporary nature of the credit undermines the incentive effect. Without confidence, firms may not increase R&D spending as much as they would if the credit were permanent. Currently, the U.S. R&D credit ranks 17^th out of 21 of the nations that offer research incentives in the Organization for Economic Co-operation and Development (OECD).

“Development and innovation here at home boosts our economy and creates jobs. Making the research and development tax credit permanent will provide certainty and help spur economic growth for generations to come,” Baucus said. “Global competition is fierce, so it is crucial we remain the leader in research and development now more than ever.”

The Senators are ranking members of the Senate’s bipartisan Committee on Finance, which according to the Committee’s website, is comprised of 24 Members – 13 Democrats and 11 Republicans. Among the Finance Committee’s priorities is creating jobs, simplifying the tax code, and reducing the deficit. In addition to Baucus and Hatch, the current members of the Finance Committee are listed as: Benjamin L. Cardin (MD); Robert Menendez (NJ); Richard Burr (NC); Michael B. Enzi (WY); Pat Roberts (KS); Bill Nelson (FL); Maria Cantwell (WA); Thomas R. Carper (DE); Tom Coburn (OK); John Cornyn (TX); John Thune (SD); Debbie Stabenow (MI); Charles E. Schumer (NY); Ron Wyden (OR); John F. Kerry (MA); Jeff Bingaman (NM); John D. Rockefeller (WV); Chuck Grassley (IA); Olympia J. Snowe (ME); Jon Kyl (AZ); Kent Conrad (ND); and Mike Crapo (ID).  Please contact your members of Congress in support of making the R&D credit permanent.

For questions about R&D credits, please contact Mark Dunning at 720.227.0420 or mdunning@taxops.com.

President Obama’s recent tax proposals are unlikely to be approved by Congress in 2011 or 2012, Peter M. Kravitz, director of Congressional and Political Affairs, American Institute of Certified Public Accountants (AICPA) said on September 23. Kravitz, speaking during a webcast sponsored by the AICPA, added that the fate of many soon-to-expire tax extenders is also up in the air.

On September 12, President Obama proposed the $447-billion American Jobs Bill, followed by a $3-trillion, deficit-reduction plan on September 19. Both proposals include changes to tax laws impacting businesses and were intended to spur economic growth and job creation. Among the changes, Obama proposed:

• Extending the employee-side payroll tax cut into 2012 at a reduced rate of 3.1 percent compared to 2011’s rate of 4.3 percent;
• Provide payroll tax cuts for qualified employers;
• Expand the Work Opportunity Tax Credit for employers that hire long-term unemployed individuals and unemployed military veterans; and
• Limits on itemized deductions, certain above-the-line deductions and exclusions to 28 percent for higher income taxpayers, beginning in 2013.

Congressional Democrats and Republicans are divided on these tax reform proposals, as well as extensions to tax provisions found in The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Without an extension beyond 2013, several popular estate tax exemptions and reductions in the estate and gift tax rates will expire. Congress has proposed a number of tax reform ideas themselves, among them a bill to make the U.S. Research & Development credit permanent.

The longer tax reform and tax extensions remain unresolved, the more uncertainty there is in the business environment. Uncertainty negatively impacts business investments, strategies, operations, and staffing. If Washington truly wants to get more Americans to work, decisions need to be made about the direction of tax law so companies can get back to work.

What tax reforms would your business like to see enacted in the remaining days of the 112^th Congress?

Down-to-the-wire negotiations over increasing the debt ceiling. An unprecedented downgrade in the U.S. credit rating. A breathless roller-coaster ride in the financial markets. Talk of sweeping tax reforms and cuts in entitlement programs. It is a lot uncertainty for today’s company’s to take in at a time when the economy is uncertain enough.

The Budget Control Act of 2011, which President Obama signed into law Aug. 2, 2011, triggered most of the uproar. It raises the nation’s $14.3 trillion debt ceiling and takes a two-step approach to cutting about $2.5 trillion in government spending over 10 years.
 
It does not include tax increases or new tax revenues. However, the law calls for a bipartisan congressional committee to recommend measures for an expanded deficit reduction package before Thanksgiving. Some of those changes could involve heavy spending cuts and tax increases. It is uncertain whether recommendations will focus on raising taxes for high earners, tax rate changes, or deduction and tax cut sunsets.

If the committee fails to produce recommended legislation achieving at least $1.5 trillion in deficit reductions, the act sets automatic procedures to cut $1.2 trillion more from federal budgets through 2021 from both entitlement programs and defense spending. There are several areas where bipartisan support does seem to exist and present starting points for negotiations:
 
1. Cutting the corporate income tax rate to as low as 23 percent. This would also involve replacing the current individual tax rate schedule with three tax brackets: 8 to 12 percent, 14 to 22 percent, and 23 to 29 percent.

2. Eliminating business deductions, credits and other preferences would offset those cuts. Repealing the alternative minimum tax (AMT) for individuals would be combined with reducing key deductions for mortgage interest, charitable contributions and miscellaneous itemized deductions.
 
3. Doing away with the tax-favorable LIFO method of inventory valuation. The IFRS doesn’t recognize LIFO so why should the IRS?
 
4. Moving to a territorial-based international tax system so profits are taxed where income is earned. Coupled with a favorable tax rate on repatriated funds, corporate dollars will return to U.S.
 
Of these reforms under consideration, which would be most beneficial to your company? Which may be most detrimental?

For tax planning questions, please contact Dan DeLau at 720.227.0065 or delau@taxops.com.

If U.S. multinationals were allowed to repatriate the estimated $1 trillion in profits overseas at a lower tax rate, the result could be 2.9 million jobs, according to a report by economist Douglas Holtz-Eakin. Released earlier this month by the U.S. Chamber of Commerce, the author argues that a repatriation holiday could pave the way to broader tax reform, and put much needed cash into the hands of investors and consumers.

Multinationals are taxed on profits made worldwide, but can defer paying until that money is brought into the United States. A tax holiday would create a temporary reduction in the taxes on foreign earnings brought back to the United States by its multinational corporations.

In earlier days, tax holidays were a heralded event. Today, the idea of a tax holiday has been shunned by some in corporate America as a Band-Aid approach to deep seeded problems with the tax system. In short, many in corporate America are willing to pass up short-term tax breaks for long-term tax reform. Moreover, studies of previous tax holidays demonstrate that repatriated funds were used more for dividend payments and to retire debt than for job creation.

Proponents, such as Oracle and Cisco, have taken an opposing view pressing for a repeat of a tax holiday enacted in 2004. A number of policymakers agree, and have introduced legislation that would temporarily reduce tax rates on repatriated funds. The “Freedom to Invest Act of 2011,” for example, would reduce the tax on repatriated dollars to a maximum of 5.25 percent from 35 percent.

In the short run, proponents say the stimulus provided by repatriated dollars would increase GDP by roughly $360 billion, speeding the pace of economic recovery. In addition, a reduced tax on repatriated earnings is a step toward a territorial tax system – a system where only U.S. profits are taxed. Repatriated funds would not be taxable or would be taxed at a very low rate.

While repatriation is a highly contentious subject, the need for corporate tax reform is widely viewed as a necessary step to making U.S. firms more competitive in the global markets. In closing, the report states a common belief:

“The U.S. corporation income tax is in need of fundamental reform. In addition to the fact that its worldwide scope is damaging the ability of the U.S. to compete in foreign markets and retain the headquarters of large, successful multinational firms, the corporate tax rate is too high, the corporate tax is anti-growth, and the tax is too complex. Fundamental reform would aid investment in the United States, the compensation of U.S. workers, and the overall pace of economic growth.”

Copies of the report are available at http://www.uschamber.com/reports/need-pro-growth-corporate-tax-reform. Question about tax holidays and corporate tax reform can be directed to Mike Abramovitz at 720-227-0423 or mabramovitz@taxops.com.

At a time when legislators are considering tax reform that includes a drop in corporate rates, news that more “small businesses” may fall under corporate tax rates formerly reserved for C corps could mean an effective tax hike for all but the smallest businesses.

Treasury Department deliberations on a new definition are contained in an August 9 Treasury report. There is currently no size limit on what constitutes a small business for purposes of tax policy discussions. The Treasury Department is considering a $10 million income cap for small businesses, raising concerns that some closely held companies earning more than that could end up paying corporate tax rates.

The move could also affect larger flow-through entities such as partnerships, S corporations and limited liability companies, whose owners currently pay income tax but not corporate taxes on the companies’ earnings. More than 90 percent of businesses are structured as flow-through entities and their owners pay about 43 percent of all U.S. business taxes on their individual tax returns, according to the S Corporation trade group.  

For questions about tax reform, please contact Dan DeLau at 720.227.0065 or
delau@taxops.com.