Family Business Report Summer 2016 
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Family Business Report Summer 2016

Family Business Coalition goes "All In" for tax reform

With not much time left on the legislative calendar and Presidential politics taking up most of the news cycle, the Family Business Coalition is encouraging Congress to think ahead to comprehensive tax reform.
Family Business Coalition business-owner members from across the country are publishing op-eds encouraging Congress to support tax reform: To help Congress refocus on fundamental tax reform, the Family Business Coalition is launching an “All In for Tax Reform” initiative, recommending specific reforms that will help America’s family owned and operated businesses expand and pass to the next generation of business owners.

But there is one position that every candidate and a vast majority of voters agree on: America needs to completely overhaul our tax code now.

For more than a decade, I have owned and operated my own dental practice out of my home office. 

I have worked very hard over the course of my career, but with our current convoluted tax system I still have uncertainty about the future of my business and my plans to retire.

What Main Street needs most from the next president
Bruce Nevins

Running a family business is one of the most fulfilling things I have done, and will do. Unfortunately, our outdated tax system has put small businesses like mine at risk of closing.

US businesses currently pay the highest tax rate in the industrialized world — roughly 40 percent of a small business’ income goes to taxes. On top of this, we have to pay an additional 3.8 percent tax mandated by the Affordable Care Act. Small-business owners have to sift through the more than 4 million words of America’s tax code to ensure we’re complying with every arcane provision.

Progress made on death tax repeal

Congresswoman McSally (R-AZ) and colleagues are writing to Ways & Means supporting death tax repeal in tax reform. So far 94 bipartisan members have signed a letter authored by Congresswoman McSally urging the House Committee on Ways & Means to include repealing the death tax as a pillar of tax reform. The letter reads in part:
For too long, our nation’s farmers, ranchers, and small businesses have been hit by the harmful estate tax, or “death tax.” This tax is a drain on the economy and it decreases the incentive to save and invest in the future. In a nation that encourages hard work and an entrepreneurial spirit, a tax punishing Americans who have worked hard and paid taxes their whole lives simply has no place.
The full letter will be released next week and available on our website.

113 organizations signed onto FBC's letter supporting a vote on Congressman Brady's (R-TX) House passed Death Tax Repeal Act. We are encouraging all Republican Senators to cosponsor Senator Thune's (R-SD) S. 860. If you have any Hill meetings with those offices feel free to distribute the letter.
Politico Influence highlighted the coalition's support for a vote to repeal the death tax earlier this year.
Recent press about death tax repeal:
A recent Urban News Service investigation highlighted John Wesley Boyd Jr.'s fight to kill the estate tax that threatens his father's farm.
11,931 estates filed federal returns in 2014, and 5,158 returns paid $16.4 b. as reported by the IRS last October.  See also this one-page IRS fact sheet.  However, when you look at the tax paid by size of estate, it becomes clear that the really rich don't pay much estate tax, small businesses and middle class do.

Keeping an eye on technical estate tax changes

Grantor-retained annuity trusts (GRAT) would be curtailed by Hillary Clinton.  She would likely push President Obama's proposal to require a minimum term for GRAT of 10 years and a maximum term of the annuitant’s life expectancy plus 10 years and that the remainder interest at creation equal the greater of 25% of the contributed assets or $500,000, but not more than the contributed assets.  That would use up much of the grantor's lifetime exemption and would greatly increase the risk that the assets needed to fund the retained annuity would be pulled back into the grantor's estate should he or she die during the trust term.  Also, the proposal would prohibit any decrease in the annuity paid to the grantor during the GRAT term, and would prevent the grantor from engaging in a tax-free exchange of any asset held in the trust.  The usefulness of GRATs would decline as interest rates rise as well.  Bottom line: If Hillary Clinton wins on November 8, create your GRAT as soon as possible.

Estate basis consistency regulation challenged.  On June 27, the IRS will conduct a hearing on its proposed rule to implement the basis consistency law enacted on July 31, 2015 in H.R.3236.  This requires the basis of assets received from a decedent be consistent with the basis reported on the decedent's estate tax return. Lots of difficult issues will be discussed, e.g. what happens when basis is in dispute, or improvements are completed after death.  The zero basis rule for "after-discovered or omitted property" has been characterized by the American Institute of CPAs as "punitive overreach not intended in the legislation."  The American College of Trust and Estate Counsel said the zero basis rule appears to be an attempt by Treasury and the IRS to replace potentially lost revenue by increasing the income tax on the beneficiary when the asset is sold or exchanged, something which only Congress, not the IRS and Treasury have authority. There is also concern over basis reporting requirements that may be due before the beneficiary receives the bequest. See this Forbes article for more. 

Closely Held Business Valuation Discounts May Be Curtailed.  At the May American Bar Tax Section meeting in D.C., Treasury Attorney-Adviser Cathy Hughes said Treasury would issue a regulation limiting valuation discounts for estate and gift tax purposes for transfers and sales of closely held interests in non-operating businesses.  It won't be easy to stop this in court or with legislation. See this Bank of America Tax Alert for more.

President Obama's estate tax proposals won't go anywhere this year but Hillary Clinton would revive them next year.  Unless you're a tax professional, we wouldn't recommend wading through all 300 pages of the Treasury "Green Book" explanation of President Obama's FY16 Budget revenue proposals, but we would highlight his estate & gift proposals because they could form the basis for future changes if a Democrat succeeds Mr. Obama in the White House.

  • Restore the estate, gift, and generation-skipping transfer (GST) tax parameters in effect in 2009;
  • The exception:  Require consistency in value for transfer and income tax purposes (enacted July 31, 2015 in H.R.3236);
  • Modify transfer tax rules for grantor retained annuity trusts and other grantor trusts to require 10-year trusts, limiting this as an estate planning tool;
  • Limit duration of GST tax exemption;
  • Extend the lien on estate tax deferrals where estate consists largely of interest in closely held business;
  • Modify GST tax treatment of Health and Education Exclusion Trusts;
  • Simplify gift tax exclusion for annual gifts; and,
  • Expand applicability of definition of executor.

End of year tax bill likely  

Although there's some chance tax amendments could ride the FAA authorization by July 15, a year end tax bill is much more likely to be the vehicle for a host of proposals and tax extenders.  Possibilities include:

  • Energy incentives as described in the June 14  Senate Finance Committee hearing.
  • Extending the $1/gallon biodiesel tax credit through 2019, H.R.5240;
  • Extending the Section 170D energy-efficient building deduction; 
  • Restoring Section 45 and Section 48 renewable energy tax incentives that expired at the end of last year, but they face the same opposition that knocked them out of the Senate's FAA authorization last March. 
  • Senator Carper's (D-DE) bill, S.1736, to provide an investment tax credit for offshore wind farms;
  • Senator Coons' (D-DE) bill, S.1656, to allow renewable energy projects to be financed with master limited partnerships.
  • H.R.3161, a timber capital gains extender;
  • H.R.4381, to double the current $9,000 cap on retirement plan contributions of National Guard and Reserve;
  • H.R.5191, to provide tax incentives for employers to help workers repay student loans.

Congressional tax reform proposals take shape

Congress has legislated little so far this year, but tax reform proposals abound for consideration next year.  Getting any tax reform legislation through Congress will be very difficult no matter who wins the election because it would invariably create lots of winners and losers if done on a revenue neutral basis, even counting economic growth effects.  Eliminating most losers with transition rules or permanent changes would greatly add to the deficit.  That said, there is a strong desire in Congress to fix our tax system, particularly for small businesses and U.S. corporations.  Tax reform could be enacted if the next President pushes hard enough for it.

The problem with tax reform for large U.S. multinational corporations is that they face the highest marginal tax in the world at 35%, leaving them at a competitive disadvantage and trapping an estimated $2.4 trillion overseas that could be brought home with a lower rate of at least 25% and preferably lower.  Most other countries have lowered their tax rates below 25%, and the European Union has launched the so-called Base Erosion and Profit Shifting (BEPS) program to force U.S. companies to pay taxes on U.S. products and services sold in their countries.  So there's a lot of pressure from U.S. firms to lower the U.S. corporate rate.  A reduction in corporate rates would require Congress to lower the top individual rate in similar fashion to avoid leaving out most small businesses, who file as pass through entities on individual returns.  This leaves a large hole on the revenue side.  Also, small businesses desperately need expensing of all investment, as they enjoy in a limited way now, to promote job creation and the elimination of the alternative minimum tax to simplify their tax returns, cutting down their expenses for tax preparation and for dealing with the IRS.

Keeping the same relative tax burden by income class is another important consideration.  By definition, a consumption tax, which excludes savings and investment from taxation, or a tax that curtails the double taxation of dividends would reduce taxes for those with higher incomes because they're are more likely to have savings and dividends.  That can be offset by rebalancing the tax rates, but there are limits to how much of that can be done.

As former House Ways and Means Chair Dave Camp (R-MI) found with his 2014 tax reform proposal, balancing all of these competing interests and lowering the top rates for businesses and individuals to 25% forced him to cut back on so many tax deductions and credits that he never attracted enough support to get his own committee to adopt it.  Most people expect tax reform to lower their taxes.  When they find out that it may not, then it goes nowhere even though tax reform done well would boost economic growth and job creation.

House Republicans are working on a consumption-based income tax proposal that Speaker Paul Ryan (R-WI) and Ways and Means Chair Kevin Brady (R-TX) plan to unveil later this month.  It is expected to lower taxes and tax rates for many Americans and to boost economic growth by lowering taxes on savings and investment.  Presumably, deductions will be retained for home mortgage interest, charitable contributions, and employer provided health insurance.  Expensing business investment is likely  to be part of the plan, which would be a boon to small and large businesses alike.  However, the proposal may limit or do away with interest and advertising deductions.  Financial institutions are usually exempted from such proposals because of the difficulty in determining their interest income net of interest expense in complex transactions.  

Senate Finance Chair Orrin Hatch (R-UT) is working on a corporate dividends paid tax deduction plan coupled with lower corporate tax rates, but it would impose a withholding tax on dividends paid to tax-exempt retirement accounts, charities, and foreigners, which will prove controversial.  Hatch is determined to stop so-called tax inversions, where U.S. firms sell themselves to a smaller foreign parent to reduce their taxes.  Hatch's plan would also level the playing field for U.S. multinational companies facing foreign competitors that have won substantial tax cuts from their governments in recent years.  The U.S. top corporate tax rate of 35% is now the highest in the world.  However, Senator Hatch is expected to propose tough income shifting rules which may impede legitimate business transactions.

Both House and Senate plans are slated to be released this summer.

Senate Finance Ranking Democrat Ron Wyden (D-OR) has proposed greatly simplifying the Tax Code with lower rates by eliminating many deductions and credits.  He would expense business investment and require derivatives to be market-to-market annually and taxed a ordinary rates.

Presidential tax plans

Donald Trump's tax plan.  (Tax Foundation's analysis) If Donald Trump wins the White House, he has a good chance of enacting many of his tax proposals, including:

  • Eliminates the Estate Tax.
  • Consolidates the current seven tax brackets into four, with a top marginal income tax rate of 25 percent.
  • Taxes long-term capital gains and qualified dividends at a top marginal rate of 20 percent.
  • Creates a substantial zero bracket for lower income individuals.
  • Steepens the curve of the Personal Exemption Phase-out (PEP) and the Pease Limitation on itemized deductions.
  • Eliminates the Alternative Minimum Tax.
  • Eliminates the Net Investment Income Tax of 3.8 percent, which was passed as part of the Affordable Care Act.
  • Taxes carried interest at ordinary income tax rates instead of capital gains and dividends tax rates.
  • Phases out the tax exemption on life insurance interest.
  • Cuts the corporate income tax rate from the current 35 percent to 15 percent.
  • Ends the deferral of income from controlled foreign subsidiaries, but preserves the foreign tax credit. It would also enact, as a transitional revenue raiser, a one-time deemed repatriation tax of 10 percent on all foreign profits currently deferred.
  • Taxes pass-through businesses at the rate of 15 percent commensurate with the traditional corporations.
  • Caps the deductibility of interest expenses.

Hillary Clinton's tax plan. (Tax Foundation's analysis) If Hillary Clinton wins the White House, the Republican controlled House will stop most of her tax proposals, including:

  • Restores the federal estate tax to 2009 levels. This would increase the estate tax rate to 45 percent, reduce the exemption to $3.5 million, and eliminates portability between spouses.
  • Creates a 4 percent “surcharge” on high-income taxpayers, which effectively adds an additional marginal tax rate of 43.6 percent for taxable income over $5 million and a 24 percent top marginal tax rate for qualified dividend and long-term capital gain income.
  • Enacts the “Buffett Rule,” which would establish a 30 percent minimum tax on taxpayers with adjusted gross income (AGI) over $1 million. The minimum tax would phase-in between $1 million and $2 million of AGI.
  • Caps all itemized deductions at a tax value of 28 percent.
  • Adjusts the schedule for long-term capital gains by raising rates on medium-term capital gains to between 27.8 percent and 47.4 percent.
  • Limits the total value of tax-deferred and tax-free retirement accounts.
  • Taxes carried interest at ordinary income tax rates instead of capital gains and dividends tax rates.
  • Enacts a new $1,200 tax credit for caregiver expenses.
  • Eliminates the deductibility of reinsurance premiums paid by corporations to foreign subsidiaries and provides an exclusion from income for reinsurance recovered for any arrangement where the deduction was disallowed.
  • Establishes business tax credits for profit-sharing and apprenticeships.
  • Enacts a tax on high-frequency trading, at an unspecified rate.

Earnings stripping, anti-inversion regulations proposed by Treasury and the IRS

April 4th, the Treasury Department took extraordinary regulatory action to stop the Pfizer and other corporate inversions. See the action, fact sheet, and Secretary Lew's remarks. This may curtail U.S. firms from sham foreign buyouts for a while, but, as long as the U.S. persists with its 35% top corporate tax rate on worldwide income, while just about every other country in the world applies much lower rates in territorial tax systems, new ways will be found to to get around it, just as with Treasury's two previous attempts in September, 2014 and in November, 2015. The new rules apply to any transaction closed after April 4th.  Senate Finance Chair Orrin Hatch (R-UT) chided the Administration for continuing "to tinker along the regulatory edges with unilateral proposals to address the symptoms of inversions, but not the disease. Proposed regulations aimed at curbing earnings stripping may limit some incentives of inverting, but it will not prevent companies from restructuring for tax purposes."  Ranking Finance Committee Democrat Ron Wyden (D-OR) called the action, "another step in the right direction, but only Congress can cure the disease."  More in this New York Times article.

Treasury is taking action to:

  • Limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of U.S. companies. This will prevent a foreign company (including a recent inverter) that acquires multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition.
  • Address earnings stripping by:
    • Targeting transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States.
    • Allowing the IRS on audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other.
    • Facilitating improved due diligence and compliance by requiring certain large corporations to do up-front due diligence and documentation with respect to the characterization of related-party financial instruments as debt.  If these requirements are not met, instruments will be treated as equity for tax purposes.

Overtime rules disrupt family businesses

On May 14, President Obama and the Labor Department announced new rules requiring overtime pay for approximately 5 million workers with annual base salaries between $23,660 and $47,476.  While the intended purpose was to increase their compensation, market forces will react, shifting their employment from salary to hourly wages and curtailing employment as described in this 53-page Mercatus Center analysis.  Here's another example of federal government overreach and unintended consequences for small businesses and their workers.

More Members of Congress sign Death Tax Repeal Pledge

Ways & Means member Congressman Sam Johnson (R-TX) signed the Death Tax Repeal Pledge
This year several new Members of Congress have joined more than 150 members in signing the Death Tax Repeal Pledge:
  • Congressman Bradley Byrne
  • Congressman Jeff Duncan
  • Congressman Randy J. Forbes
  • Congressman Tom Graves
  • Congressman Sam Johnson
  • Congressman Lamar Smith
  • Congressman Glenn Thompson
  • Congressman Bruce Westerman
Past signers of the Death Tax Repeal Pledge include:
  • Presidential Nominee Mitt Romney
  • Speaker John Boehner (R-OH)
  • Majority Leader Kevin McCarthy (R-CA)
  • Congresswoman Cathy McMorris Rodgers (R-WA)
  • Congressman Steve Scalise (R-LA)
  • Chairman Fred Upton (R-MI)
  • Senator Joe Manchin (D-WV)
  • Former Speaker Newt Gingrich
During the 2016 Republican Presidential Primary, every major candidate either signed the Death Tax Repeal Pledge or included death tax repeal in their tax plans:
  • Donald Trump
  • Senator Marco Rubio
  • Senator Ted Cruz
  • Governor Jeb Bush
  • Carly Fiorina
  • Ben Carson
  • Senator Rand Paul
  • Governor John Kasich
  • Governor Chris Christie

State transfer tax changes possible

New Jersey legislators have proposed phasing out the state's estate tax in exchange for increasing the gas tax to pay for their transportation fund.  Plans by both the Assembly and Senate would phase out the estate tax by four and three years respectively. Governor Christie has said he wants to see the estate tax repealed before he leaves office after the 2017 election. Prominent Democratic candidates for governor have come out against the plan fueling fears that the phase out would be delayed once Governor Christie leaves office.

29 FBC members wrote to Governor Christie supporting repeal in 2014 when a similar proposal was first considered. Read FBC op-ed encouraging Governor Christie to repeal the estate tax here. FBC continues to work with allies in the state to push repeal forward.

Severals states have made efforts to repeal or reform their state transfer taxes in recent years: Georgia, Wisconsin, and Kansas repealed dormant pick-up taxes, New York, Maryland, and Minnesota have increased their exemption levels, and Indiana, Ohio, North Carolina, and Tennessee have repealed their state death taxes. 

Please continue to stay engaged be on the lookout for our next FBC meeting invitation. Thank you all for your hard work so far this year!

Still not a FBC member? Attend meetings, sign letters, and stay in the loop by contacting us
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