Corporate Tax Reduction to be Paid for by Smaller Companies

IMGCAP(1)]Despite delays in expected tax reform, companies are engaging, modeling and planning in order to manage uncertainty, according to survey findings released at Ernst & Young LLP’s Ninth Annual Domestic Tax Conference in New York.

Although the prospects of imminent tax reform have stalled since 2013, 27 percent of the survey respondents see it gaining traction, and 47 percent are engaging, or taking preliminary steps to engage in the process. Among respondents, 31 percent have modeled the proposal by House Ways and Means Committee Chairman Dave Camp, R-Mich., to determine its impact on their business. Though the changes show winners and losers, overall the two balance, according to the survey.

Among those that might fare worse are small and midsize companies that will ultimately be on the hook to pay for the corporate tax reduction, according to Don Susswein, a principal at McGladrey LLP.

Susswein said that under the Camp proposal, large C corporations would see their overall statutory rates reduced by 7.25 percentage points, from 48 to 40.75 percent, while smaller and midsize companies organized as pass-throughs would see a reduction of 4.6 percentage points, from 39.6 percent to 35 percent. At the same time, large and small companies will pay equally for the base-broadening measures (the elimination of bonus depreciation acceleration) that the proposal uses to offset those rate cuts. In other words, Susswein said, the rate cuts for a large company at 7.25 percent are almost twice those for smaller businesses, at 4.6 percent, but both will pay equally for the offsets.

“Most of the focus of tax reform has been on the corporate side,” he said. “There’s been a lot of focus on big multinationals, and whether the tax system is a disincentive from bringing back money from overseas to supposedly reinvest in the U.S., and whether the corporate tax rate is too high.”

“But in the last 20 years, more and more business is being done not just by the biggest corporations but by smaller and midsize businesses, including pass throughs,” he added.
“If you want to do something for the future of American business, you should realize that the trend is toward smaller entities,” he noted. “Corporate taxes account for a much smaller percentage of income tax.”

Partnerships, S corporations and LLCs are not subject to tax, but their owners are, and their rates are now actually higher than the corporate tax rate, Susswein pointed out. It’s 35 percent versus 39.6 percent. “If you’re of the view that tax rates on business income are important to the economy, building business and having more investment and jobs in the U.S., then you have to look at least as much to the individual side as the corporate,” he said.

“For example, an investor in a business that’s an S corporation or partnership may lose some of the tax credits, deductions, and accelerated cost recovery under the Camp proposal. The big corporations will lose those too, but as they lose them they will see their tax rates go from 35 percent to 25 percent,” he said. “If a pass-through loses those tax breaks while its tax rate is stuck at 39.6 percent, it will be paying the bill that enables tax rates to come down for others, but its rates won’t go down.”

Another issue to bear in mind is that what happens today may not reflect what will be the case in 10 years, according to Susswein. “The 1986 [Tax Reform] Act knocked down the tax rates for individuals from 50 percent to 28 percent across the board. To pay for the rate reduction, a lot of special deductions were eliminated. But 28 years later, guess what? The individual rate is no longer at 28 percent; it’s now at 39.6 percent. If you eliminate tax breaks in exchange for lower rates, the rates may go back up in just a short while.”

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