by Roger Russell

While the House and Senate negotiate the differences in their tax cut packages, tax simplification action is heating up.

There are more than 15 bills in Congress having to do with some aspect of tax simplification, and the American Institute of CPAs has come out strongly in favor of two of them. The bills are H.R. 22, the Individual and Small Business Tax Simplification Act of 2003, and H.R. 285, the Fairness, Simplification and Competitiveness for American Business Act of 2003.

AICPA Tax Executive Committee chair Robert A. Zarzar praised H.R. 22’s provision to increase the alternative minimum tax exemption amount and adjust it for inflation. He said that, while “the AICPA supports outright repeal of the AMT,” the proposed changes in H.R. 22 are “a reasonable compromise.”

H.R. 22’s provisions to accelerate repeal of the phase-outs for personal exemptions and the limitation on itemized deductions “will make tax planning easier for individuals and eliminate some of the confusing marginal rates,” said Zarzar. Furthermore, he said, the sections of H.R. 22 to simplify and harmonize the definition of “child” will clear up the confusion for taxpayers surrounding filing status and dependency exemptions and credits related to children.

A separate provision of H.R. 22 would eliminate the S corporation filing category and allow eligible corporations that are not publicly traded to be treated as a partnership. Zarzar said that the AICPA opposes this part of the bill.

“There are a number of technical issues that could create havoc for small businesses and practitioners,” said Zarzar. “Our primary concern is not with the idea in general, but with the fact that it must be handled so carefully that we question whether it could be accomplished.”

He noted that combining partnerships, limited liability companies, and S corporations would cause the vast majority of small businesses now operating as S corporations to need expensive, sophisticated tax advice that few of them could afford.

“Any such sweeping federal change would also require coordinated changes in state legal infrastructure to help transitioning S corporations with needs such as the creation of simplified, uniform and affordable partnership and LLC operating agreements,” Zarzar commented.

“We believe that liberalizing the eligibility rules for S corporations would be a better approach, simplifying the tax code and bringing the two regimes closer together, while preserving the fundamental differences between Subchapters K and S,” he added.

For Lynbrook, N.Y.-based CPA Vinnie O’Brien, the S corporation has advantages that he would not want to lose. “From a tax planning perspective, one of the key benefits of an S corporation over an LLC or corporation is the lack of self-employment tax,” he said. “If you have an active trade or business that’s a partnership, every dollar of profit would be subject to the self-employment tax, but with an S corporation there is none.”

“There are some advantages to an LLC if it’s not an active trade or business,” he added. “An LLC which holds real property can get better loss deductions if debt is involved, and it can also have a distribution of assets out to the owners without treating it as a sale - those aspects don’t exist for an S corporation. Typically, you would use the S corporation for a trade or business and the LLC to hold real property.”

Zarzar cited provisions of H.R. 285 that would greatly increase compliance in the international arena, including repealing the controlled foreign corporation rules on foreign-based company sales and services income; deleting overlapping provisions of Subpart F, such as the foreign personal holding company and foreign investment company rules; and expanding de minimis rules for the tax treatment of income that is earned between subsidiaries under Subpart F.

“As global trade increases,” said Zarzar, “legislative changes, such as those in H.R. 285, are needed to allow U.S. businesses to react more nimbly and on a par with foreign competitors having less complex tax systems.”

Selva Ozelli, an international tax expert at RIA, a Thomson business, said that one of the simplification provisions might be the answer to the earnings stripping problem. “Earnings stripping is a problem that has been a concern for awhile. Companies enter into intercompany lending transactions which allow an interest deduction in the U.S. and income deferral offshore. Allocating interest on a worldwide basis might be the answer to this.”

Any tax simplification proposals that become law are likely to be the least controversial, since politics sets limits to the playing field, according to George Jones, managing editor of CCH’s Washington D.C. office.

“Generally, tax itself is so charged with divergent opinions that something as controversial as simplification would only stand a chance in a reconciliation bill where there is no 60-vote Senate filibuster rule to prevent it from being passed,” Jones said. “In every bill there are a few non-controversial provisions that could find themselves included in a general bill or reconciliation package.”

“Simplification will probably pass in some form in the House because members want to go back to their constituents and show them how proactive they are, but they’ll do that knowing that the Senate is not going to pass anything like that,” he added. “At the last moment in these reconciliation bills - usually in the Conference Committee - they frequently dump into the final bill all of the outstanding technical corrections which have been on the sidelines for a while, along with some of the non-controversial procedural provisions.”

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