Calvin Johnson at Texas is the primary author for Tax Notes for the "Shelf Project" (inventory and links to articles available on SSRN). The goal of the project is to outline reasonable changes to the Tax Code that could be undertaken and yield increased revenues without increasing rates, taking as a given Obama's pledge to retain the Bush tax cuts for those making $250,000 or less. Suggestions so far include the following (not a full list):
- removing compensation for services from capital gains (012110)
- restoring the original (English) concept of capital gains as the capital reserved for the male heir
- coordinating the withholding tax on deductible payments (Reuven Avi-Yonah)
- ensuring progressive mark-to-market taxation (David Miller)
- requiring a duty to amend returns to correct material mistakes
- limiting business/casualty losses to basis lost
- repealing stepup in basis at death
- ending specific identification of stock certificates (something I heartily support--it permits financial asset owners to cherrypick their recognition of gains or losses, purely for tax purposes--something that has no economic substance other than tax, and leads to the Treasury's wacky notion--in 2006 regulations and 2009 proposed regulations--that says that since the share is the basic unit of property, then taxpayers should be allowed to designate, in generally nonrecognition transactions, what property they receive for what shares, leading to the outrageous result that taxpayers who designate boot solely to one block of shares can recognize a loss in a reorganization!)
- imposing capital gain tax on like-kind exchanges
Now there are a number of other proposals that one might add to this list.
A. For example, I'd include restricting the availability of tax free reorgs. Various possible means of restricting reorganizations could be considered.
- Perhaps the most obvious is that public companies that can use their highly liquid publicly traded stocks to acquire other companies should never be eligible for nonrecognition reorganization transactions. (This is one that Calvin mentioned as a possible forthcoming shelf project.) The media consistently reports these deals, even when done with all stock as consideration, as purchases. That's because everyone knows that shareholders can generally dispose of the stock received easily immediately after the deal and receive whatever percentage of the deal in cash that the shareholder desires, with deferral of recognition on the uncashed shares. That deferral is not justifiable, particularly when the availability of the tax-free reorg provides a significant incentive for consolidation within industries. Not permitting tax-free reorgs of public companies would be relatively easy to administer. Companies and shareholders would complain mightily, but it is not clear that those complaints would merit much consideration.
- Further, nonrecognition treatment should not be permitted to any transaction unless there is a minimum of 80% continuity of interest (counting plain vanilla preferred). The notion that the shareholder's investment is being continued just through a more indirect corporate form is the fundamental rationale for nonrecognition, and that rationale is lost when a non-de minimis number of shareholders are cashing out.
- Moreover, one could also impose a valuation limitation on the availability of tax free reorganizations, even when the other limitations do not apply. I'd argue that transactions between corporations either of which has assets worth more than $2 million gross fair market value should not be nonrecognition transactions.
The idea here is that facilitating the consolidation of corporate enterprises does not serve the democratic interest--especially after the Supreme Court decision on Citizens United treating corporations equal to humans in terms of "free speech" rights (further complicated by the fact that the Court interprets spending money as exercising free speech). Certainly, we could have avoided many of the "too big to fail" problems if we had not made mergers and acquisitions so easy in this country. Neither workers nor communities win when corporations are so big that their executives have no connection to the community in which the corporation operates, the corporation has nothing other than profit-making as its motive and so does not care if its decisions destroy the community in which it operates, and the corporation is so large that its desires carry inordinate weight with the political powers that be (a problem that will be sorely exacerbated by the Supreme Court "free speech" decision).
B. Another "shelf project" worth considering is the elimination of the S corporation election or at least the reduction of pass-through regimes available to taxpayers (by eliminating either S corp or partnerships).
As I noted in a prior posting, the GAO reported to the Senate Finance Committee last December that there is a high degree of noncompliance in the S corporation context. See GAO,"Actions Need to Address Noncompliance with S Corporation Tax Rules" (GAO-10-195, December 2009). The report notes that a large majority of S corporations misreport at least one item (68%) and that misreporting almost always advantages the taxpayer rather than the government (80% of misreported items are taxpayer-favorable). S Corporations tend to deduct ineligible expenses and shareholders of S corporations tend to miscalculate basis when taking losses. S corporations also tend to pay inadequate wages (more than $26 billion too little in 2003-2004), which results in underpayment of payroll taxes (social security and medicare).
There is considerable anecdotal evidence of the misreporting of partnership items. I have spoken with practitioners who contend that the rules are "honored in the breach"--i.e., that much partnership reporting is simply reported as the partners want it without much regard to whether the rules are satisfied or not. The uncertainty about the interpretation of partnership rules and the treatment of service interests in partnerships are both worrisome.
It is not clear, at any rate, what rationale justifies the existence of both S corporations and Partnerships as pass-through tax regimes. In my view, Congress should limit the electibility of the tax regime applicable to taxpayers, and then we should carefully monitor taxpayers' use of whatever pass-through regime we retain to prevent basis manipulation, inaccurate deductions, and inappropriate shifting of income or losses among the owners of the entity. At the same time, Congress should eliminate the possibility that compensation payments are treated as capital gains or are understated (codifying an interpretation of the partnership rules to eliminate the carried interest scam, if partnerships are retained, or requiring adequate compensation and payroll tax payments in the S Corporation context, if S corps are retained).
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