Tax reform stumbling block: Individuals vs. businesses

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The biggest surprise in the Unified Tax Reform Framework released last week was the retreat over individual tax cuts, according to Dustin Stamper, director in Grant Thornton’s Washington National Tax Office.

“Not that long ago they were pushing hard for sweeping tax cuts for individuals in which individual and corporate rates would be reduced in lockstep. What we have now is a top rate of 35 percent, but with the possibility of a fourth rate that would be close to what we have now, even in conjunction with itemized deductions. It appears that they’re afraid of getting beat up over the perception they’re providing tax cuts for the wealthy.”

“One of the dangers is that almost half of all business income runs through pass-throughs,” Stamper said. “They’re providing a reduced rate for pass-throughs, but they haven’t offered any details on how that would apply. One of the threats to pass-throughs would be if they imposed an arbitrary solution, such as considering 70 percent of revenue as compensation regardless of the situation. Since pass-throughs would have to give up all the same incentives that corporations do, they’re entitled to a rate cut as well.”

“There are established principles to distinguish compensation from business income,” he noted. “They don’t want to be so afraid of getting demagogued on that issue that they hurt pass-throughs that have legitimate business income that is entitled to the lower rate.”

The reduced rate on pass-throughs could complicate matters, according to Scott Kaplowitch, managing partner of Edelstein & Co. LLP.

“I don’t see how they will make it work,” he said. “There will be a lot of lost revenue. Partners in professional services firms would have their tax reduced from the top rate to 25 percent – a large revenue loss.”

Partners in such firms would end up being taxed less than W-2 employees at the same firm. “Why should I pay less than the receptionist? Make everyone a partner, and have different levels of partners, to put them on an equal footing,” Kaplowitch added.

Owners of pass-throughs themselves believe that tax reform is necessary for their growth. In a survey of over 750 small-business owners to determine how they feel about tax reform, BizBuySell, the online business broker, 86 percent said that they believe tax reform is necessary for small business growth. However, they are divided on the best way to address tax reform: 37 percent of small-business owners think that tax rate cuts will have the most positive impact on their companies, while 24 percent believe simplifying the Tax Code will have the biggest impact.

They feel that the current Tax Code favors large business, with 83 percent saying the Tax Code does not create an equal playing field between small and large businesses. Once again, they’re split on how to level the playing field. Thirty-eight percent feel the best solution is to crack down on large corporations’ ability to move profits offshore or their headquarters outside the country, while 32 percent feel that eliminating corporate loopholes while lowering business tax rates is the best way to fix it, and 25 percent say that simplifying the tax process will equalize the playing field.

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