1991 Ad

Nation's Business, Dec, 1990 by Mary McElveen

The New Tax Law's Impact

The recently enacted tax package is better than the rejected summit agreement, but its overall impact could slow the economy.

Twenty-two days in October proved significant to the finances of many U.S. businesses.

Between Oct. 5, when the House rejected the summit agreement reached by White House and congressional negotiators, and Oct. 27, when Congress finally passed a budget bill for fiscal 1991, business won the addition, improvement, or modification of several tax provisions.

The end product is mixed.

The U.S. Chamber of Commerce represented the basic business position, both in its strong opposition to the summit package and the final bill and in its strategy of fighting to minimize the damage and, where possible, make gains.

"In general, the final bill is significantly better for business than the summit agreement," says David Burton, the U.S. Chamber's tax-policy manager. "The changes we won between the two versions of the budget package were high business priorities.

"But the bottom line is that neither the summit agreement nor the final budget bill is good for the economy. Both contain tax hikes between $130 billion and $140 billion over five years, and virtually all economists agree that tax hikes, particularly of this magnitude, will place a tremendous burden on a slowing economy."

Burton notes that the Chamber's leadership role in opposing the initial budget proposal was critical: "Had we not opposed the summit package, we would have ended up with virtually no positive provisions for business."

Among the most important improvements in the measure--which President Bush signed into law Nov. 5--are:

* Restoration of the estate-freeze method for transferring a family business from one generation to the next. A 1987 law disallowing that procedure had made family-firm transfers prohibitive in many cases.

* Reduction of the motor-fuels tax increase to 5 cents per gallon from the 12 cents in the original plan.

* Addition of a $5,000 tax credit for small businesses for making facilities accessible to the disabled.

* A reduction from 33 to 28 percent in the marginal capital-gains tax rate paid by individuals.

* Extension of several expiring tax benefits, including the 25 percent deduction for health-care expenses of unincorporated firms and the self-employed; the 20 percent credit for research and experimentation; the favorable research-expense allocation rules; the exclusion allowed for employer-provided educational assistance; and the credit allowed for the hiring of disadvantaged individuals, commonly called the targeted-jobs tax credit.

Only the extension of the research and experimentation credit was in the budget-summit agreement.

For many companies, a major advantage of the final bill over the summit agreement is a provision related to tax underpayments. The summit agreement would have disallowed corporate deductions for interest paid on tax underpayments. The new law continues the deduction but adds 2 percentage points to the interest rate businesses must pay on tax underpayments over $100,000 after notice by the Internal Revenue Service.

The most important provision for family-owned firms is the repeal of the tax code's Section 2036(c), which eliminated from tax options the estate-freeze method of transferring a business to the next generation.

The freeze approach and similar methods will again be allowed as a result of the repeal, which was a top 1990 priority of the U.S. Chamber.

"It's a godsend," says Donald R. Hull, a licensed public accountant in Westminster, Md., who advises a number of family-owned companies.

Testifying for the Chamber at a congressional hearing, Roy Hunt, president of Hunt Tractor, in Louisville, Ky., told legislators that "tax laws should help preserve family businesses and farms, not encourage their sale and breakup," as Section 2036(c) did.

The new law replaces Section 2036(c) with a narrow gift-tax valuation provision.

"The bottom line," says John Carson, a tax attorney for the Chamber, "is that family-firm owners will be subject to somewhat higher valuations of their transferred stock for gift-tax purposes as the result of the new gift-tax provision. But they will no longer have to worry about the value of the company's future growth being pulled back into the estate for tax purposes when they die."

Richard L. Dees, who specializes in estate and business planning with McDermott, Will & Emery, in Chicago, notes that Section 2036(c) treated transactions between family members more onerously than it did those between a family member and an unrelated individual.

The new gift-tax provision is "totally different," he says. "Its sole purpose addresses whether the value of the preferred stock transferred from one generation to the next is fair."

On the down side, the final budget bill will affect companies adversely in a number of ways. Many of the smaller businesses that pay taxes at individual rates--the sole proprietorships, partnerships, and Subchapter S corporations, which include the majority of small firms--face higher income-tax rates beginning Jan. 1 as a result of: