As most know by now, the "extenders" bill, which extends several of the Bush tax breaks for a few more years, will cost money. So it requires revenue raisers.
Two of those revenue raisers are things Congress should have done anyway--taxing "carried interest" for all those managers of partnerships as everybody else's compensation for services is taxed, and taxing the profits of S corporations (at least the small ones with a few people whose services are the income of the corporation) as the compensation income it is. For carried interest--especially in the case of private equity funds, real estate partnerships and other service partnerships-- that means taxing it now at ordinary rates instead of preferential capital gains rates. For S corps, the bill would recognize that distributions are really compensation on which payroll taxes are due for these corporations with 3 or fewer service shareholders.
But the wealthy lobbyiests are busy convincing Congress to let their clients continue to have their big tax giveaways. When Congress has something reasonable for the impoverished, the right wing keeps on about "entitlements" and how awful they are, even though a safety net for the vulnerable is as fundamental to a sustainable democracy as voting. But when there are preferences for the wealthy, there isn't a heavily financed contingency to protest them, and there are heavily financed contingencies fighting to preserve them for the wealthy.
So the HOuse passed a compromised provision on carried interest--phasing it in gradually, and only taxing 75% of the amount as compensation at ordinary rates. That nuts, of course. All of it is compensation for services. The idea of a compromise to preserve some of the preference for the wealthy is crazy. But the Senate is being pushed to compromise even further--leave some working partners exempted from the provision and cut the amount that is taxed at ordinary rates to 65% or less. Will they have the gumption to do the right thing? One has doubts.
And on the S corp provision, which the House passed as applicable only to S corps with three or fewer key service providers, the Senate is also waffling. The right, of course, doesn't like any tax increase for the wealthy (though it is generally just fine with pension cuts, or layoffs, or the impossibility of modifying mortgage loans in bankruptcy, or other much more serious financial hurdles for ordinary folks). See, e.g., Dean Zerbe, The Big Tax Increase for Small Businesses, Forbes, Jun. 9, 2010. Doctors, dentists and others who have established S corps to "launder" their services income so that they can avoid payroll taxation on the full amount will view this as a 15% tax increase--the 12.4% Social Security tax on approximately the first $108,000 and the 2.9% medicare tax on the full amount.
Well, it is a loophole closer and therefore a tax that these doctors and dentists and other service providers should have been paying all along, just like all of us ordinary folk who get regular salary checks from our employers pay the tax. The issue is straightforward. Some people have been sole proprietorships and had to pay ordinary rates on all of their income and payroll tax on all of their income, because all of their income (not offset by business deductions) is compensation for their services. Then they incorporate and make the S corp election. Suddenly, they claim that their compensation for services (paid in the same way by the same clients) is no longer really all compensation for services: THEY CLAIM A SALARY PAYMENT THAT IS LESS THAN THE ACTUAL COMPENSATION THEY ARE PAID, AND THEN THEY CLAIM THE REST OF IT AS "DISTRIBUTIONS" FROM THE "PROFITS" OF THE S CORPS. The government has estimated that in 2003 and 2004 S Corps underpaid their owners/service providers by $24 billion, cheating the government on payroll taxes that should have been paid on that amount. SeeForbes article (with link to GAO study and reminder that John Edwards paid himself a salary of about $360,000 when his services as an attorney actually earned him about $5 million). Not surprisingly, the Forbes article argues that the impact will be that service providers will decide to go out of business if they have to pay the regular taxes that all us ordinary folk have been paying all along. I don't buy it. Maybe there will be one or two who were ready to retire anyway. But I don't expect that people who are in the midst of their careers will quit just because they have to work a little harder to make the same amount of money because they have to pay the same payroll taxes that their employees already have had to pay forever (on much lower salaries than the jefe makes). This argument is made for every tax increase, but the work world hasn't come to a screeching halt from any of them.
This gambit should have been ended long ago--all of the profits ought to be subject to payroll taxes, as the House bill provides (in many cases). Olivia Snowe and Bill Enzi--both Republicans--want to save doctors and dentists and lawyers and others from paying the same tax that ordinary workers pay. They've offered an amendment on Friday that would remove the S corps provision.
Do we need any more evidence of the capture of Congress by the wealthy? Will ordinary people who pay ordinary income tax rates on their full salaries, and pay payroll taxes on all that salary, stand by while wealthy partners continue to get preferential treatment?