A Fiscal Cliffhanger

Even in fraught political times, good tax policy can be enacted, but it doesn’t fall from the sky “like manna from heaven,” says Brian Reardon, president of the S Corporation Association. Good policy requires people to develop and champion it.

“You have to sit down and ask what we can do here, given the parameters of what we’re going to be dealing with in the House, the Senate, the White House, and where the votes are,” says Reardon, whose association advocates for pass-through businesses. “What can we do, and what’s a good direction we can encourage people to move in that has a chance of passing? You have to start thinking about these things now. You can’t wait until the last minute, because then you’re going to end up with some sort of a half-baked compromise that’s not going to make anybody happy.”

As the midterm elections of 2022 loom, boxmakers nationwide are wondering how the outcome will impact their businesses and operations. The U.S. House of Representatives could change majority from Democratic to Republican. The U.S. Senate might stay in Democratic hands—or not. The White House remains the residence of President Joe Biden, a Democrat.

No matter the congressional configuration, tax experts say there’s work to be done to defend tax provisions that are protecting small, midsized, and family businesses but are due to sunset soon. Add the pressures of a rocky economy, and boxmakers have a lot at stake in the politics of 2022.

Tax Provisions

In 2017, Congress passed President Donald Trump’s Tax Cuts and Jobs Act (TCJA). While heralded as a business booster, key provisions that helped S corporations and family-owned businesses are scheduled to sunset by around 2025. It’s a “fiscal cliff” that demands attention and talks now, says Reardon.

“Our goal is to position the Main Street community so we can get the best results out of that coming negotiation that we possibly can,” he says.

Consider these tax benefits of the TCJA, all on the chopping block:

• Increased estate tax exemption of about $11.5 million per person. “It’s easier to tax the dead than it is to tax the living,” says Mitchell Klingher, owner of tax consultancy Klingher Nadler LLP. The increase from $5.45 million allows private business owners who have worked their whole lives to build an estate to “keep the business in the family without having to sell it or borrow tremendous amounts of money to pay the estate taxes.” As Reardon notes, estate planning is an everyday concern for private businesses, because every generation “has to buy a certain percentage of the company back from the government.”
• The 199A pass-through, which reduces qualified business income for pass-through entities by up to 20%. The provision is set to expire after 2025.
• One-hundred percent bonus depreciation for complete write-off of capital in the tax year the investment was made. This provision has provided a big boost for boxmakers who compensated for staffing shortages by investing in automation, says Klingher. But it starts phasing out in 2023 and is slated for elimination after 2026.

The last two years have been the most profitable in the independent converters’ marketplace that Klingher says he has ever seen, as demand skyrocketed and capital investments drove efficiencies. But sunsetting of the TCJA provisions would deliver a “perfect storm” of disincentives, as higher taxes drain the money that small to midsized businesses would otherwise be investing, says Klingher. “It’s a direct, dollar-for-dollar tradeoff,” he says. “If Congress can do one good thing for the small-business owner, it would be to take these things that are sunsetting and make them permanent.”

But after the midterm elections, he adds, “even if Republicans take the House and the Senate, what’s Joe Biden going to do?” Perhaps some horse trading to offer Biden some of his desired initiatives, such as renewable energy incentives, could free TCJA’s business-friendly items from the threat of sunsetting, he suggests.

In fact, when a similar fiscal cliff loomed in 2012, two political opponents hammered out a compromise, recalls Reardon. Today, those same two foes—then-Vice President Joe Biden and then-Minority Leader Mitch McConnell—are again in position to lead talks, but who occupies their seats when today’s fiscal cliff looms in 2025? “The challenge is, you don’t know who’s running the Congress in that year,” says Reardon. “You don’t know who the president’s going to be. Our goal between now and then is to provide thought leadership and come up with some good ideas and good policies that members can embrace and champion, and hopefully, they get adopted in the next three years.”

Reardon is also not counting out Biden’s signature Build Back Better Act, which would have hit private businesses with a “triple whammy” by raising tax rates, increasing the capital gains rate, and dramatically increasing the estate tax.

Although it appears that BBB is dead, or at least on life support, it remains a significant threat because only two Democratic voices in opposition—from West Virginia’s Joe Manchin and New Mexico’s Kyrsten Sinema—prevented its passage in the U.S. Senate. “Without their leadership, this bill would have passed easily, and it would have been very, very bad for Main Street,” says Reardon. “We’re going into some economically dicey times. The odds of recession are rising. It’s hard to see how a lot of companies could have survived if they had to deal with that and the BBB adoption at the same time.”

If Democrats gain Senate seats and retain the House, BBB could see new life, so “we’re not resting easy,” says Reardon. “We think we’re in a good place, but the simple fact is, because the vote count is so close, you’re really talking about one or two votes switching. We have to remain vigilant and stand tough all the way through to the end of the fiscal year.”

The age of skirting political stalemates through temporary patches, such as reconciliation bills and sunset provisions, is eroding any certainty that businesses have relied on for planning. “Most of my members would love to have a five-year cease-fire where the policies can stay the same and they can go about focusing on running their businesses,” says Reardon.

A Stormy Economy

In a time of tax policy threats and hopes, one enormous uncertainty dangles like the sword of Damocles: the economy. The rare combination of inflation and recession, exacerbated by ongoing supply chain disruptions, puts the kind of squeeze on businesses unseen since the 1970s. Even the disco-era term “stagflation,” when prices were high but growth was moribund, is making a comeback.

In this atmosphere, Klingher sees a counterproductive push and pull between Congress and fiscal regulators. The Federal Reserve sets monetary policy that raises interest rates and dampens demand in order to “cool the economy and rein in inflation,” but will that solve the supply chain problem that’s driving up prices? In the meantime, Congress has the fiscal powers to stimulate the economy through such tools as stimulus payments and tax cuts. “Somebody’s got to try to put this together and have some cohesive plan to fix the economy,” says Klingher.

In past eras of economic tension, from World War I to the dot-com bubble and 9/11, businesses have had use of net operating loss (NOL) carrybacks to reduce their overall tax liability and receive refunds, says Reardon. Today, the once-bipartisan solution has become a political football. The TCJA, for all its business-friendly measures, eliminated the NOL through 2026, and the House-passed Build Back Better Act would have made its removal permanent.

Reardon fears that the battle to protect the NOL continues. “We had to fight to keep it in the CARES act,” he says. “Then we had to fight to keep them from repealing it. Now, I feel they’re setting themselves up for failure if they don’t use tools like this to help businesses survive.”

Preparing for Change

At the moment, Reardon is focused on ensuring the BBB Act stays dead, and on education about the importance of allowing the use of NOLs, especially with today’s economic outlook. After the elections, “we’ll start focusing on the fiscal cliff and what we need to do to make certain we’re in good shape for that.”

Klingher currently advises clients to have enough cash available to pay their taxes, while also adding some nontax-​related counsel for weathering a possible recession. First, he suggests, make capital investments before interest rates rise higher, banks tighten credit, and the bonus depreciation starts phasing out.

At the same time, have a recession plan in place. Model the business, and plot out corrective steps if sales were to decline and margins shrink. “In a recession, businesses typically lose revenue and lose margin, especially if inflation isn’t curtailed quickly,” he says. “Prices keep going up, and revenues keep going down. You’re going to have lower sales and lower margins, and you’re going to need a plan to deal with it. If it doesn’t happen, great. At least you’ve thought about it in advance, and it’s not crisis management. It’s ‘we’ve got a plan, and we’re going to execute the plan.’”

Because small businesses drive the economy and create jobs, lawmakers should write supportive policy, Klingher adds. In the meantime, those businesses should build relations with their congressional representatives and senators, while supporting the work of associations such as AICC that have pooled clout in Washington. “Let’s keep small business strong and, at the same time, let them prepare for a recession, because it looks like the powers that be are lining up for that,” Klingher says.

M. Diane McCormick is a Pennsylvania-based freelance writer.