taxes

ISSUE BRIEF Federal Taxes and Tax Reform

Issue:

Rental businesses, of all sizes are sensitive to changes in the tax code. All rental businesses require significant capitalization, thus provisions that affect depreciation and expensing rules can have a significant impact on capital formation in the rental industry. Tax treatment of dividends has an effect on rental businesses that are organized under Subchapter C. Capital gains and estate taxes affect rental businesses of different sizes and structures in different ways.

Background:

Current provisions that significantly affect rental businesses are:

Depreciation: Cost recovery on real estate property occurs over 39 years. There is a 15-year recovery period for certain qualifying leaseholder improvements expiring in 2006. The code should be revised to allow businesses to depreciate real property and improvements to real property in 15 years. This will increase business investments in physical plants and expand businesses that are currently discouraged from expanding because of unfavorable depreciation rules.

Section 179: Expensing limits of $100,000 annually (indexed for inflation) for small businesses investing less than $400,000 annually, expiring in 2008. Most rental businesses are capital intensive and require significant expenditures each year to replace aging equipment in the rental fleet. The $25,000 annual expensing limit that began phasing out at $200,000 in annual investment is inadequate for small businesses competing in today’s economy. ARA supports extending the current Section 179 provision in the tax reconciliation package.

Dividends: Taxing dividends at the rate of 15 percent expires in 2008. Corporate income is taxed when the corporation declares the income at the corporate rate. When companies distribute earnings in the form of dividends, those dividends are taxed as part of the shareholders’ income. This amounts to double taxation on income that reduces incentives for companies to pay dividends which, in turn, reduces the purchasing power of shareholders. ARA supports extending the 15 percent rate on dividend income in the tax reconciliation package.

Capital Gains: Taxing capital gains at the rate of 15 percent expires in 2008. Rental business operators make significant long-term investments in land, buildings, and equipment. The sale of these assets often involves capital gains that have been taxed at the corporate or individual rate. High capital gains tax rates reduce the incentives for rental businesses to invest in capital and create a drag on economic growth. A continued reduction in capital gains tax rates will spur increased long-term investment in business capital. ARA supports extending the 15 percent rate on capital gains in the tax reconciliation package.

Estate Taxes: Declining rates coupled with increasing exemptions and the ultimate elimination of estate taxes expires in 2011. Many rental businesses are multi-generational enterprises. Estate taxes create a costly burden on rental business owners because estate taxes force them to either make large expenditures for insurance and estate planning or pay the resulting estate taxes upon the death of the owner. In some cases, rental businesses cannot continue to operate because heirs are forced to liquidate the business’ assets in order to pay the estate taxes. Eliminating estate taxes will create incentives to invest more in the business; increase available cash to hire workers and invest in assets, rather than paying for insurance and estate planning; and allow businesses to survive intergenerational change. ARA continues to support full elimination of the estate tax. However, ARA members will consider supporting any reasonable compromise on the estate tax issue that provides relief for most small businesses.

Conclusion: All of these provisions have two things in common. They reduce taxes paid by rental businesses and they all expire. Moreover, while providing short-term stimulus, they maintain long-term uncertainty for business owners. If these expiring tax cuts that have created jobs and spurred economic growth in America are not renewed, we will face tax increases that will cost businesses billions of dollars and the economy millions of jobs. The U.S. economy simply cannot afford these tax increases.

Action Requested:

Congress should act to pass legislation that creates certainty in the tax system for businesses and encourages investment in long-term economic growth. Extending these provisions will provide some level of certainty for all businesses. We support passage of a tax reconciliation that extends current expensing levels for Section 179, and the 15-percent rate for dividends and capital gains. Moreover, ARA supports elimination of estate taxes on small businesses so that certainty is returned to the planning associated with the intergenerational transfer of business assets.