Proposal Could Make S Corp Status More Popular

Congressman Dave Camp wants to tax S Corporations and partnerships the same way.
Kathy HoffelderMarch 20, 2013

A proposal last week by House Ways and Means Committee chairman Dave Camp (R-Mich.) would, if adopted, level the playing field of tax responsibilities between small businesses structured as S Corporations and those considered partnerships, such as hedge funds and law firms.

Camp called for the structure of partnerships, which are typically more flexible than S Corporations in the way they can allocate income and expenses among partners, to be more in line with S Corporations, which have a more rigid, even allocation structure based on the number of shares each company owner holds. Both are pass-through entities, where company earnings are taxed at the individual shareholder level rather than the corporate level.

Clarence Kehoe, tax partner with accounting firm Anchin, Block & Anchin, whose client base is about 90% pass-through entities, says Camp wants to eliminate some of the tax irregularities related to partnership structures by having more uniform allocations.

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As S Corporations and partnerships both provide flow-through taxation benefits, Camp’s thinking goes, “why not meld the two together and have one [tax] regime instead of two separate ones, since there are lots of rules and it’s very confusing,” according to Kehoe.

CFOs and company principals have long chosen the S Corporation structure to keep from being taxed twice: once at the corporate level and again at the shareholder level when making distributions to shareholders in the form of dividends. S Corporations would, though, get hit by President Obama’s latest tax-reform policy proposal, which would raise the individual marginal tax rate to 39.6% from 35%.

But Camp’s proposal could add a layer of interest to S Corporations by making their accounting easier. He specifically favors standard deductions for start-up costs, as well as simplifying the tax treatment of privately held pass-through entities.

His plan also calls for reordering the due dates of tax returns for partnerships and S Corporations, which has been a challenge for CFOs and their tax directors. The current common practice of providing supporting documentation just ahead of the six-month extension deadline of October 15 for personal income-tax returns puts a burden on accounting firms, Kehoe says. The hefty work load compressed into a short time makes it difficult for accountants to do a good job and give good client service, he notes.

A further complication, Kehoe says, comes when there are dozens of partnership investments to account for regarding one client. Camp favors spreading out the due dates to make the flow of work easier.

Camp’s proposal also provides special help for the smallest S Corporations by expanding the use of the simpler cash-accounting method to those with gross receipts of $10 million or less. Until now, some smaller firms have been required to use the more tedious accrual-accounting method, in which expenses are not necessarily deducted at the time they are paid out. That may make Camp’s plan particularly appealing for those small S Corporations, but it gets a nod from larger ones as well.

Termax, an Illinois-based plastics and metals fastener, has more than $10 million in gross revenues. But CEO William Smith, formerly the company’s CFO, notes “that most companies will find value from the easier accounting” proposed by Camp. “It would surely simplify the hodgepodge of tax codes that deal with partnerships and S Corps,” he says, adding that “a unified system should make it easier for companies like mine to comply with the rules. I think Dave Camp is on to something.”

Camp is also recommending tax savings for C Corporations that become S Corporations. He wants to eliminate some of the tax burden on C Corporations, which are taxed at both the corporate level and when distributing dividends to shareholders. Whereas current law requires a 10-year look-back on C Corporations that opt to change into S Corporations for tax purposes, Camp is recommending that time period be shortened to 5 years.

But at least some rules are needed, many believe, when changing structures to thwart any abuse that could take place in a situation where, for example, a building that’s currently up for sale may have appreciated dramatically over the years. While C Corporation structures may have suited the entity originally, when it comes time to sell, the firm inevitably wants to benefit from the S Corporation structure, which is not taxed twice.

But whether S Corporations should continue to be taxed at the individual level is still up for debate among all sizes of entities in the category. A KPMG survey released last week noted that among 840 CFOs and other business executives, 61% either believed Congress should not expand the corporate tax rate to pass-through entities or were unsure whether it would be a good idea; and 39% believed Congress should actually expand it to include large pass-throughs.

“The corporate tax is a terrible tax. We ought to be getting rid of it,” says “Hank Gutman, director of KPMG’s Tax Governance Institute and former chief of staff of the U.S. Congressional Joint Committee on Taxation, in speaking about the survey results.

But, he adds, the survey does bring up the complexity of the topic for both those firms involved and Congress. “There’s a huge problem here,” he says. “If the way you finance a corporate rate reduction is by eliminating business-tax preferences, you have to be very careful about how you do that because if you just eliminate business-tax preferences across the board, you are going to increase the taxes on pass-throughs. I believe that would be a political nonstarter.”

Any change in the tax code for S Corporations or partnerships will have far-reaching implications. According to Camp, 75% of the small businesses in the United States are unincorporated pass-through entities. And more than half of the respondents in the KPMG survey (56%) are in favor of the proposals brought by Camp.

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