The word of the last few weeks has been “extension.” According to the non-Mayan Washington calendar, December is hold your breath month and January consists of 31 doomsdays. The reason for the apocalyptical calendar is the one we have been pointing to since the Committee of 12 failed to reach a super federal deficit reduction deal: Boatloads of long time tax relief provisions ranging from estate tax relief to top individual marginal rate relief all expire on December 31st; across the board cuts (sequestration) in government spending start on January 1st; and, the more current tax relief (aka the two percent payroll tax relief for employees) will expire at the end of the year.
The words of the last three months have been “lame duck.” Any business owner who visited Washington in the last three months was told, “Your issue (fill in the blank) will be taken care of during the lame duck.” As I have been opining for a while, we should be so lucky. If the Republicans “run the table” and take the House, Senate and Presidency, it is hard to imagine the Democrats doing the Republicans any favors during the lame duck. A comprehensive deal during the lame duck to keep the sun from setting is more likely if the status quo remains the status quo in the New Year, that is, the President is re-elected and the Republicans keep a solid hold on the House. Republicans “running the table” is not going to produce a magic result at the beginning of 2013. Regardless of which party controls the Senate, the filibuster breaking arithmetic does not add up to a simple quick resolution.
Therefore, that is why “extension” has become the word of the last few weeks on Capitol Hill as in “During the lame duck let’s postpone the sequestration and extend the tax cuts for a short period of time in 2013 (three to six months) while a comprehensive deal is worked out.” May still be wishful thinking….
It should be noted that this relatively new talk about “extension” should not be confused with renewal of the “tax extenders.” There is a loose conglomeration of various credits and deductions that have a history of short-term renewals. The R&D Credit, which has already expired again, is a prime example. When folks talk of “extension” in the current context, they are thinking the big ticket items like the lower individual rate, lower capital gains tax rate or estate tax relief. At the end of the day, the “tax extenders” might hitch a ride on the big-ticket items extension. Confusing, I know.
A SLOW SUMMER
What can we expect out of this Congress? Reauthorization of the surface transportation programs is possible. Postal Service reform is a possibility. After that…some folks think the major tax issues will be dealt with in a lame duck. As mentioned above, I think this is getting to be increasingly unlikely because the issues are so large, complex and expensive. On the spending side, some think Congress will deal with spending issues because sequestration is looming in calendar year 2013. With fiscal year 2013 spending targets already set by the debt ceiling increase law (although the House is trying to push through deeper cuts), the typical year-end appropriations drama is less likely.
A common theme on the Hill is that the economic consequences of not dealing with these tax and spending issues are too big not to resolve this year. (Plus the debt ceiling may have to be increased again this year.) Many members believe that these major issues can be resolved during the lame duck session.
Seems to me that the Democrats, win or lose, have the lame duck leverage. The Bush tax cuts and defense spending are Republican priorities. If the President is re-elected, there is a better chance of grand deal, because then there is a “deal with me now or deal with me next year when the tax cuts have already expired” element.
WHAT’S HAPPENING WITH THE ESTATE TAX???
We have been trying to educate members of Congress on the importance of giving small business owners estate tax certainty (and for sure not making it an extender item!) Unfortunately, due to the current bleak fiscal situation combined with the zero sum game presented by the election, it is difficult to see how Congress is going to come up with a permanent fix before the end of the year. During our Public Affairs Day, we heard from a key staff member that it is very possible that the current law will be extended for another year. This has been mentioned to me several times since our Public Affairs Day by other key staff and members of Congress.
Of course, for the small business owner and his/her advisors, it is extraordinarily difficult to plan for the future when no one knows what the law will be next year or even when Congress will take action on this vital issue. Keep in mind the stakes are high… currently the estate tax exemption is $5 million per person with a 35% estate tax rate for assets above that amount (there is also no tax on assets given to a spouse). If Congress does not act then as of January 1, 2013, the estate tax exemption is scheduled to drop to $1 million with a 55% estate tax rate for assets above that amount. This change would be devastating to many small business owners.
IS THE END IN SIGHT FOR STRETCH IRAS?
Did you know that for a short period of time the Senate Highway and Transportation bill contained a provision that would have effectively killed the stretch IRA? This provision basically would have required all the money left in an IRA or retirement plan after the death of the initial owner and his/her spouse to be paid in one lump sum to the children (or other beneficiaries) within 5 years of the death of the last surviving spouse.
The retroactive nature of this provision is best understood in the context of an older husband and wife who still have money in their IRAs and had planned on providing a stream of payments to their children throughout their lifetimes with any money left in the IRAs at the time of the surviving spouse’s death. Instead, if this provision were to become law, about 50% of the value of the IRA would be lost to state and federal income taxes (within 5 years). These funds would also be subject to estate tax in the surviving spouse’s estate, without the funds receiving a step up in basis.
Many believe, and I stand firmly with this group, that if this provision were to become law that many small business owners will decide that they have “enough” funds in their retirement plans and either freeze or terminate them. Because this legislation will have such a draconian impact on the income tax treatment of the IRA money, we are hoping that Congress will understand that it should grandfather all funds currently in the retirement plan system. Otherwise, it appears to be an unlawful taking of funds.
Interestingly, Senator Baucus is a major proponent of this legislation and those in the know on the Hill tell us it is likely to emerge in an estate tax bill which would likely extend the current exemption and estate tax rates for a year. It’s strange to have Senator Baucus in favor of this provision since he is such a strong proponent of the small business qualified retirement plan. We believe his backing is partly due to a mistaken belief that the money in an IRA can continue for generations (it can only be paid over the contingent beneficiaries lifetime and even then only under certain circumstances.) We also think that the tax incentives underpinning the small business qualified retirement plan system are not clearly understood by members of Congress or how interdependent all the provisions are.
For instance, an example in the Simpson-Bowles Deficit Reduction Report illustrates how if the contributions to a 401(k) and/or profit sharing plan were to be cut back to a total contribution equal to the lesser of 20% of compensation or $20,000, along with significant reductions in a number of other so-called “tax expenditures” that the income tax rate could be reduced significantly. What they failed to grasp is that the lower the income tax rates, the less valuable the deduction for qualified retirement plan contributions becomes (particularly when taking into account that all retirement plan contributions plus their earnings are taxed at the end of the day at ordinary income tax rates and subject to estate tax while not receiving a step up in basis through the estate).
Combine lower income tax rates with lower contribution levels and many small business owners are likely to throw in the towel on a system that they see as overly complex but worth it because it is the best way for them to save for retirement. [As an aside, Congress and IRS have done an excellent job of finding the correct balance between what the owners are required to contribute for all of the small business employees in order to receive the desired contribution for the business’ key employees.] Now throw on top of this the possibility of the loss of the stretch IRA which tempers the undesirable tax treatment of these funds being brought into income and does the system come to a grinding halt? Or will that happen if the President’s proposal to subject 401(k) deferrals to an income tax for those in the higher income tax brackets becomes law?
We know that when the system went out of balance in the 1980s, it came to a grinding halt and required significant action by Congress and the Treasury to breathe back life into it. During those years countless small business employees were hurt by not having retirement contributions made on their behalf by the small business and by not having access to a 401(k) option. The SBCA believes that any one of these actions by Congress could end up with the system in disarray, particularly against the backdrop of lower income tax rates – more than one will certainly have a chilling effect. Of course, the proposal recently advanced by some of not taxing any savings would also have a negative impact on retirement plan savings. If this is an important issue to you, please let us know and also let your representatives know.
STIMULATING CONVERSATION – NOT!
This being a congressional election year, the folks on Capitol Hill believe we should have at least one more conversation about short-term economic stimuli. This being Washington, it has to have a partisan ring tone. In case you were wondering what Washington has been doing in this arena, here is an overview of their fruitless efforts.
The House passed H.R. 9, basically along party lines, the Small Business Tax Cut Act (introduced by Majority Leader Eric Cantor (R-VA)) that would allow profitable small businesses to reduce their tax liability by up to 20 percent for one year (the current taxable year for most). There are a number of eligibility conditions that must be met and limitations on how much can be deducted. A small business is one with less than 500 full time employee equivalents for the purpose of the bill. The reduction is limited to not more than 50 percent of wages paid in the year basically to non-owners.
The Senate did not approve this legislation.
Senate Majority Leader Harry Reid (D-NV) has introduced S. 2237, the Small Business Jobs and Tax Relief Act. His bill would provide a one-time tax credit of up to ten percent of the increase in wages paid by an employer in 2012. (“Increase” is measured by subtracting the wages paid in 2011 from the wages paid in 2012.) Credits (as opposed to deductions) reduce taxable income dollar for dollar. The “increase amount” of wages eligible for the credit is capped at $5 million. His bill would also extend the temporary 100 percent depreciation bonus through 2012. At the end of 2011, the temporary bonus dropped to 50 percent and it will expire at the end of the year. The bill has been read twice and placed on the Senate Legislative Calendar.
Assuming this bill gets out of the Senate, it is not likely to be passed in the House.
By the way for those of you wondering what happened to the “Buffett rule” tax on millionaires, S. 2230 — it died in the Senate.
For more information about the Small Business Council of America, click www.sbca.net.