By Ethan Gibble
The Build Back Better framework, a nearly $2 trillion legislative bill that’s working its way through Congress, is built on a foundation of lofty goals. The White House calls it, “The most transformative investment in children and caregiving in generations, the largest effort to combat climate change in American history, the biggest expansion of affordable health care in a decade and the most significant effort to bring down costs and strengthen the middle class in generations.” The Tax Foundation General Equilibrium Model’s preliminary estimates, however, project that the bill will produce $1.01 trillion in net revenue with a 0.38 percent drop in long-run GDP, a 0.27 percent wage decrease, and 107,000 full-time equilvent jobs lost. As some bristle at the spending while others applaud, the White House says that the framework is fully paid for. But how it is funded could have a profound impact on many FEDA members.
“This bill’s been a moving target,” says Brian Reardon, president of
S Corporation Association. He also helps run the Main Street Employers coalition, a large group of business trades focused on defending pass-through businesses. A longtime advocate on behalf of America’s nearly 5 million S corporations, Reardon sees the bill putting pass-through businesses squarely in the crosshairs. “We’re successful in getting one provision we don’t like out of the bill, but then another one we don’t like pops up and becomes an essential part of the bill. So, we’re having to scramble just to keep up with the changes and make sure our members are aware of the newest dangers so they can fight it on Capitol Hill.”
Reardon’s advocacy has already helped strip several potentially harmful provisions from the bill. The bill originally called for an end to stepped-up basis, which currently adjusts the value of an inherited asset after death to reduce the heir’s tax liability. It would have also taxed unrealized capital gains at death. “I called it the double death tax,” Reardon says. “Fortunately, we were able to get that out of there.”
Phasing out the Section 199A qualified business income deduction was also under consideration. According to Reardon, such a repeal would have ruined the general parity between S and C corporations that was created by the 2017 tax cuts. “That was another one of the whack-a-mole opportunities that we had,” he says. “We got everybody ramped up, got the business community to raise concerns, and it has since come out. Now we’re focusing on other threats to businesses.”
While several smaller provisions in the bill concern him, Reardon is largely focused on what he considers “the big three” issues that members are most concerned with: expanding the Net Investment Income Tax and expanding and making permanent loss limitation rules and surtaxes.
When a 3.8 percent Net Investment Income Tax was introduced a decade ago to help fund the Affordable Care Act, the Obama administration explicitly decided that the tax would not apply to pass-throughs. In its current form, Build Back Better would apply that tax to all pass-through incomes. “It would even tax the income of active S corporation owners, partners and partnerships. That’s like a $230 billion tax hike on only S corps and partnerships,” Reardon notes.
As part of its base-broadening efforts in the 2017 tax cuts, the Trump administration limited business owners to offsetting up to $500,000 of other income, beginning in 2018 through 2025. “Any more than that, and I have to take those losses and kick them into coming years and treat them as a net operating loss,” Reardon explains. “This current bill would make that provision permanent and would also expand it so that the treatment of these active business losses, in our assessment, is actually worse than the treatment of passive losses under the current rules. It really is an imbalance and it’s a very large revenue raiser that applies exclusively to pass-throughs.”
The Build Back Better plan would ostensibly impose a 5 percent surtax on income above $10 million and an 8 percent surtax on income greater than $25 million. Yet when it comes to this provision, the devil is in the details. “For S corps, you might have an ESBT (electing small business trust) where you use the trust to give your child some shares in the business. Or you might want to make sure there’s a smooth transition after you pass away, so you put controlling ownership shares in a trust for continuity in control over the business. For family businesses, that’s common. But if you have that income in a trust, the threshold for these surtaxes isn’t $10 million and $25 million, it’s $200,000 and $500,000.”
Some S Corps will pay 50 percent marginal rates, competing with Amazon, for example, paying a 21 percent marginal rate. It’s totally imbalanced, it certainly isn’t fair, and it’s not going to be good for the country because it will create all sorts of economic distortions and job losses.”
Congressional Assistance and Misconceptions
According to Reardon, this legislative process has been uniquely partisan, with no attempt whatsoever to bring Republicans along. “We have many friends on the Republican side, but they’re not really part of this discussion,” he says. “Our focus has been on about a dozen moderate Senate Democrats and maybe twice that number in the House.” Reardon pointed to Sens. Joe Manchin (D-WV) and Kyrsten Sinema (D-AZ) as being particularly sympathetic to the Main Street business messaging, with others like Jacky Rosen (D-NV) and Maggie Hassan (D-NH) being responsive as well.
One of the truly fundamental challenges is just getting Congress to appreciate the impact of S corporations and to understand how they operate. “Pass-throughs represent 95 percent of all businesses,” Reardon says. “Nearly two out of three jobs in this country are created by pass-through business owners. I also think they don’t recognize just how the individual and pass-through tax codes are tied together. If I’m the owner of a business and I’m reinvesting my profits in plants and people, I still have to pay taxes on that income even though I’m not seeing it.”
With slim Democratic margins in the House and Senate and months-long negotiations over the bill continuing, it is fair to wonder if, when and in what form Build Back Better ultimately passes. “It’s a massive undertaking,” says Reardon, putting the bill’s chances for passage at 50-50. “I think there’s a good chance the whole thing falls apart just because it’s so big, so cumbersome and some of the provisions are just too complicated to get done these days with such a narrow majority.”
If the bill were to be enacted in its current framework, Reardon is concerned many of the businesses he works with will be forced into the C corp structure. “That’s not going to be good,” he says. “It’s not going to be good for Main Street, it’s not going to be good for the people that work for those businesses and it’s not going to be good for the communities that rely on those businesses. We need to make sure that people are aware of that.”