The Big Tax Increase Facing Small Business

The Senate is set to consider a hefty tax increase owners of S-corporations in certain service industries. The House of Representatives has already approved the increase, which taxes carried interest on hedge funds. Forbes.com posted a story explaining the new tax increase, you can check out a section of their article below.

While a possible increase in taxes on the "carried interest" of hedge fund and private equity money managers is getting all the attention, in the same bill Congress is also creating a tax mess for small-business owners in the form of an $11 billion tax hike over the next 10 years.

The tax increase was included in H.R. 4213, a peddler's wagon of legislation (new spending, physicians' reimbursement, extensions of expired tax breaks, etc.) that was passed by the House in a narrow vote just before Memorial Day and is now being considered by the Senate. The Democratic-backed Senate version of the bill includes the same tax on small business.

The tax hit affects the owners of small S corporations (a common way many small businesses are organized) in "professional service businesses"--doctors, lawyers, accountants, engineers, architects and so on. An S corp pays no taxes but passes through all its profits to its owners' tax returns, even when those profits or "distributions" are reinvested in the business.

Professionals have long been able to reduce their tax bills by incorporating as S corps and then receiving part of their earnings in the form of distributions or profits, rather than taking it all as ordinary compensation or wages. Unlike wages, profits aren't subject to payroll taxes--that is, Social Security and Medicare taxes. It is this longstanding tax benefit that the House has eliminated for certain small S corporations.

Here's why this is a big deal: The Social Security tax is now 12.4% of the first $106,800 of wages, with half paid by the employer and half by the employee. A self-employed person pays the whole 12.4%. The Medicare tax is 2.9%, with no cap on the amount of pay taxed. This too is split between employer and employee, with the self-employed paying the whole 2.9%.

Oregon Approves Tax Increase on Top-Earners, Business

The State of Oregon approved a $727 million tax increase on businesses and high-earners this week, hoping to bridge some of the gap in the States budget. Well known for being a State with out a sales tax, it is not uncommon for Oregonians to approve taxes increases elsewhere. Checkout the following article on the development courtesy of Bloomberg.com.

Oregonians voted to keep taxes enacted by Democratic Governor Ted Kulongoski in July, according to a count of ballots cast by more than half of the state’s registered voters. Measure 66, which raises taxes on households earning $250,000 or more, passed by 54 percent. Measure 67, which increases corporate levies, garnered favor of 53 percent.

Legislators enacted the tax boost last year to help close a $4 billion hole that the U.S. recession opened in the state’s budget. The levies spurred a challenge from foes who gathered enough signatures to force the referendum. By targeting businesses and the wealthy, proponents parried resistance from voters who twice defeated tax increases in the wake of the 2001 recession.

“It’s a go-after-the-rich strategy,” said John Matsusaka, president of the Initiative and Referendum Institute at the University of Southern California in Los Angeles. “It shows that some voters have switched their minds and they’re more likely to go after the rich.”

The results are from an unofficial count of 1.12 million ballots released by the Secretary of State’s office by 11:15 p.m. local time yesterday. That accounts for 55 percent of the state’s registered voters, who cast ballots in a mail-in election that concluded yesterday.

Continue reading at Bloomberg.com…

Obama Drops Plan for Corporate Tax Increase

While still looking for a way to fund health care reform, the Obama administration has dropped a plan to raise over $200 billion by changing a series of tax laws affect multinational corporations. According to the Wall Street Journal, the main reason the White House was hoping to make the change was because of their need to find new sources of federal revenue to fund their increased spending.

Jason Furman, a White House economic adviser, made that point clear at the end of a session with a dozen or so lobbyists in March. Catherine Schultz, head of tax policy at the National Foreign Trade Council, who was at the meeting, says Mr. Furman basically told the group: "We need the money."

From early on, there were reservations about the proposal among key lawmakers, and the White House indicated it was open to alternatives. Prominent members of the House Ways and Means Committee from both parties worried the provision would erode the competitiveness of U.S. companies abroad.

The tax dispute is rooted in an unusual provision in the U.S. tax code. Nearly all industrialized countries tax domestic companies only for revenues earned at home. The U.S. taxes companies on world-wide profits. But current U.S. law allows American multinationals to defer paying taxes on revenues earned abroad until companies repatriate them, usually in the form of cash dividends to the parent company.

Critics long have complained that the provision encourages companies to avoid U.S. taxes by expanding production on foreign soil. On the campaign trail last year, President Barack Obama promised repeatedly to "end tax breaks for companies that ship jobs overseas."

CA Court Rejects Lawsuit Against Tax Increases

There has been a lot of talk about the California budget here in my hometown of Sacramento. Recently, a State Legislator went a roundabout way of increasing the state’s revenue without needing a super majority vote to pass a tax increase. Almost immediately, anti-tax groups here in California filed motions with the Supreme Court. However, according to the Associated Press, the appeals court has rejected the motion:

A California appeals court has tossed out a lawsuit filed by anti-tax groups that sought to block a package of tax increases passed by Democrats in the state Legislature.

Citing separation of powers, the court ruled Wednesday it could not intervene because Gov. Arnold Schwarzenegger had not signed it into law.

Schwarzenegger eventually vetoed the $18 billion proposal to help close California's $42 billion budget deficit.

The lawsuit was filed by the Howard Jarvis Taxpayers Association, with support from most Republican state lawmakers.

They argued that the Democratic majority acted illegally when it passed the tax increases because it did so with a simple majority vote. The state Constitution requires a two-thirds majority for tax increases.

Editorial Opinion on CA Proposed Tax Increases

Last week, I posted on the new plan from California Democratic lawmakers to increase taxes, which is quite a controversial issue here in Sacramento. The other day I saw this interesting opinion article on NCTimes.com. The author thinks the proposals are “hogwash,” and encourages readers to take action. Below is a quote from the opinion.

“On Thursday, we began publishing a ‘days without a state budget’ box on this page as a reminder of the ineptness of our state's policymakers. Today we add a "who to contact" box. We intend to continue publishing both until California gets a spending plan for its current fiscal year.

Despite the voters' best intentions (voiced through the California Constitution and an approved ballot proposition) and a growing $15 billion deficit, the legislative budget talks are a mess.

The matter is now headed to the so-called Big Five, Assembly Speaker Karen Bass said Wednesday, referring to the state's top five legislative leaders. The five are the governor, Bass (because of her position as speaker as the ranking Assembly Democrat), state Senate President Pro Tem Don Perata (the top Senate Democrat), and the top Republicans in their respective houses, state Sen. Dave Cogdill and Assemblyman Mike Villines.

Bass spoke after the Democrats presented their plan to fix the deficit: $8.2 billion in new money, primarily through tax increases. Bass said, in essence, ‘no more cuts’ and fell back onto the controlling Democrats' long-standing line that California does not have a spending problem; ‘It has a revenue problem.” (Republicans are holding firm to a no-tax-increase stance.)

And, in hyperbole at its lowest extreme, Bass asserted there was nothing left to cut except the pay of elementary school teachers, high school principals or firefighters.”

New Law Could Drastically Raise Taxes On Multinational Corporations

Pressure is growing in Washington to force a tax on foreign companies with subsidiaries in the United States who move funds back to their parent countries that have more favorable tax rates. These businesses currently pay next to nothing in taxes. In response, the United States House of Representatives has already voted to increase tax rates to as much as 30%. However, business groups are saying the measure could deter firms from investing in the United States. Multiple lobby groups state that about 60 multinational companies have already expressed concern about the proposal, which is likely to be considered by the United States Senate some time next month.

Democrats in Congress are regarding the proposal, known as the Doggett law, as a legitimate crackdown on cooperate tax avoidance. They are hoping the tax could raise an estimated $7 billion per year.

The goal of the proposal is to stop multinational corporations from going "treaty shopping" to find countries with more friendly tax laws. If approved by the Senate, the proposal could see firms paying a tax of up to 30% on interest payments and other capital flows between US operating countries and their parent businesses. This tax would be enforced even if the funds were being transferred to affiliates in the United Kingdom and the Netherlands. This would disrupt a historically tax fee practice that was based upon existing "tax-free" treaties between the United States and these countries. Yet, experts claim that firms based in countries without treaties such as South Korea and Singapore would be hit even harder by the new tax.

The new tax was added as an amendment to a farm appropriations bill drafted earlier this year by a Texas congressman. The practice of adding new legislation as an amendment to another popular bill is common in Congress as a way of negotiating the approval of a law. When making such an amendment to a popular bill members of Congress can dramatically improve their chances of getting a controversial new law passed.

However, numerous Republicans fighting in the Democrat controlled Congress have said the proposals flew in the face of existing treaties with other countries, and were based on a misconceived idea that equates tax avoidance with seeking to find a competitive tax position. "These companies are not doing anything illegal," claims Rhian Chilcott, director of a lobbyist group in Washington. "They are taking advantage of a tax treaty that the United States negotiated years ago." He went on to explain that many local subsidiaries are already paying taxes and would effectively be taxed twice on their income.

However, the Democrats who support the law are emphasizing that the law will be specifically focused on preventing tax havens that are used to hide earning. They claim the goal of the law is not to target legitimate companies that are paying their taxes. Rather it will attempt to gain revenue from companies abusing the treaties to pay little or no taxes on their income. Many massive multinational corporations setup offices in locations that have tax-free treaties with the United States for the sole purpose of avoiding tax liabilities.

For example, if the legislation passed, Samsung’s South Korean conglomerate would not be eligible to make tax-free transfers from it’s United States division to it’s United Kingdom financing unit. Currently the company pays a zero tax rate on such transfers because of the Anglo-American treaty. Samsung’s United States subsidiary would instead be forced to pay the 15-cent tax rate that applies to all Korean companies on transfers from the United States. Unfortunately, no representative from Samsung would comment on the new law.

The measure would also dramatically hit Japanese carmakers with large United States operations. Nissan is one automaker that would likely see increased taxes as a result of the legislation. Several international companies are currently lobbying against the legislation including Panasonic, Unilever, Alcatel-Lucent, Swiss Re, and Allianz. An executive from an undisclosed global corporation said, "this is another signal that the United States is not a friendly place to do business. We do not need this. We can go to Canada or Mexico."