[IMGCAP(1)]Most people think of April as income-tax month for individuals, but it’s also the biggest business tax-filing month of the year. Why? Because four out of every five U.S. businesses are “pass-throughs,” meaning they are taxed on individual returns at individual rates.
Pass-through businesses—which largely include the family-owned business that dot Main Street America—are not taxed directly like corporations. Instead their business income is passed through to the business owner and filed on his or her personal tax return.
And, of course, individual rates are higher than corporate rates for successful businesses, so pass-throughs can have a tax bill as high as 43.4 percent, while corporations pay a top rate of just 35 percent.
This ultimately leaves pass-troughs with less money after taxes to invest in equipment and hire employees than a similar corporation, making it difficult to compete.
Think this is unfair? You’re right.
Congress has the power to level the playing field, but much of the tax reform debate has focused on cutting corporate rates only. It’s hard to imagine how such reform can be successful, however, if it excludes four out of every five businesses.
But this isn’t just about the small business owner getting a fair shake. It’s about the economy.
Pass-throughs represent the fastest growing segment of the economy and are the driving force of American job creation. They are now responsible for 39 percent of all business receipts and more than half of all net income, according to IRS statistics from 2012. More importantly, the more than 23 million pass-through businesses in the U.S. employ more than half of the country’s private sector workforce, according to U.S. Census data from 2013.
There is a fairer way. If Congress cannot enact comprehensive tax reform, lawmakers should at least adopt a business equivalency rate, which will ensure all business income is taxed fairly.
A business equivalency rate is simple: It would tax all active trade or business income that passes through to an individual’s return at a rate no higher than the top rate for public corporations. It would mimic the well-understood and long-standing concept of applying lower tax rates to certain kinds of income, like capital gains and dividends.
Lawmakers owe it to America to protect the dynamic and entrepreneurial businesses that are the engine of economic growth. Business owners should lead the way, and let their voices be heard by lawmakers, who should, in turn, ensure that all business income is taxed at the same rate.
Randy Robason is the national managing partner of Grant Thornton LLP’s Tax Services practice. Visit grantthornton.com/equalrates for more information.
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