Senate bill retains differences with House on taxation of pass-throughs

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The tax reform bills passed by the House, and soon to be passed by the Senate, have many similarities. And you can count on measures that are the same in both bills to end up in the final version to be signed by the President.

The standard deduction of $24,000 is an example of an item that is similar in both bills and will likely end up in the final law. But there’s one area where the two ideas are so different, it’s difficult to determine what path reconciliation will take. It will be difficult to reconcile the Senate’s approach to the taxation of pass-through entities with the measure passed by the House.

The Senate envisions a deduction for pass-throughs (currently slated at 17.4 percent, though there are discussions going on about raising it to satisfy senators who feel the bill does too much for large business at the expense of small business). The House, on the other hand, goes a different route. It taxes pass-through entities at 25 percent, and solves the problem of active and passive participants by giving them a 70-30 split. Only 30 percent of the salary of an investor in a pass-through would be subject to the 25 percent rate, while an investor who is not an employee of the entity would receive 100 percent of the income from the entity at the 25 percent rate.

Meanwhile, under the House version, service industries, including accounting firms and law firms, would not get the benefit of the lower 25 percent rate. However, the Senate bill as it currently reads would give the benefit of the deduction to service firms on income up to $500,000. And if they decided to operate as a C corporation rather than a pass-through entity, they would qualify for the 20 percent corporate rate.

The two bills are not far apart on many issues, agreed Howard Wagner, managing director at Crowe Horwath LLP. “But they’re very far apart on taxation of pass-through income, and that’s where they’ll have to reconcile their differences.”

“The vote will happen when the guy that counts votes walks in and says to [Senate Majority Leader Mitch] McConnell ‘You’ve got 50,’” said Roger Harris, president of Padgett Business Services. “That’s when we’ll find out what is actually in the bill.”

Lawmakers from both chambers will ultimately need to meet in conference to hammer out differences between the two bills. “The House could do a ‘wraparound’ and vote the Senate bill out, but it’s unlikely because there are some things in the Senate bill that they’ll want changed,” said Harris. “We’re not ready to start teaching a class on the tax bill yet.”

Pass-through businesses, such as accounting firms and many of their small-business clients, will have to wait to see what happens in the final version of the legislation.

“It’s hard to predict the outcome on pass-through entities,” Harris agreed. “Both chambers understand that they have to do something, but how do you reconcile a deduction with a lower rate? Of course, there’s no rule that says they can’t come up with something completely different to reconcile the two. They could come up with a third way, or a combination of a smaller deduction and a different tax rate.”

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Tax reform Trump tax plan Small business Tax planning Tax rates Crowe