How best to ease taxes on businesses is among many unresolved issues roiling the tax reform debate.
Congressional Republicans have for months touted a “pass-through” proposal that would reduce taxes for businesses currently taxed at levels that individuals pay — often at the maximum rate of 39.6 percent. Pass-through entities are businesses whose income is taxed through their owners’ individual tax returns, rather than corporate returns. Those businesses bring in money for two different coffers: the owners’ compensation and the business income.
More than 90 percent of U.S. businesses are structured as pass-throughs, according to the Washington-based Tax Foundation.
Many lawmakers and policymakers agree that individual and business earnings should be taxed differently. But how best to make that division remains a matter of debate.
“The biggest question that remains on pass-throughs is how do you segregate the income, and how do you determine — if you’re a business owner — what is your business income and what is your compensation, and how do you divide those buckets?” Carolyn Lee, senior director of tax policy at the National Association of Manufacturers, said in an interview Wednesday.
The House GOP blueprint would tax pass-throughs at 25 percent, compared to a top individual rate of 33 percent and a 20 percent corporate rate. President Donald Trump’s proposal, espoused on the campaign trail last year, would tax all businesses at a 15 percent rate.
House Ways and Means Committee Chairman Kevin Brady (R-Texas) told reporters in March that his Republican colleagues and the White House are “having discussions” about bridging differences over pass-through rates.
The House GOP plan “will deliver much needed relief to many manufacturers across America that are currently taxed at the top individual rate,” Emily Schillinger, a spokeswoman for Brady, said Thursday in an email. “Our lower pass-through rate will help ensure American manufacturers are more competitive, have more money to invest in their businesses and can create new jobs across our country.”
The White House did not immediately respond to a request for comment on Trump’s tax plans.
Any resolution to the differing approaches would need to ensure a new system isn’t used as a shelter for many to avoid paying taxes, said Scott Greenberg, an analyst at the Tax Foundation, in a Thursday interview.
“If you have a different rate on business income than you do on compensation, then what rules are you going to put in place to make sure not everyone re-categorizes all their compensation as business income?” Greenberg said.
Policymakers could designate a formula for pass-through businesses to classify a certain percentage of income as business income and put aside another portion as owner compensation. But pass-through businesses are different from each other, ranging from mom-and-pop stores to large companies, and “it’s certainly less elegant” to apply one calculation to all of them, Greenberg added.
Changes in pass-through rules are a high priority for many in the business community. Manufacturers, whom Trump often praised on the campaign trail in 2016, are among those eager for pass-through taxation changes. Two-thirds of manufacturers are organized as pass-throughs, according to Lee of NAM.
While Lee’s group hasn’t taken a position on the House Republican plan, NAM has its own ideas about what pass-through legislation should look like. That includes a “business equivalency rate,” a concept Lee said is incorporated into the House blueprint. Under that system, owner compensation would still be taxed at a marginal rate, while “business return as an owner is taxed at a lower rate,” she said. The lower rate would allow manufacturers more cash on hand to drive reinvestment in their businesses, a priority for GOP taxwriters.
Manufacturers are encouraged to see GOP enthusiasm for lower pass-through tax rates, Lee said, despite discrepancies between Trump’s treatment of the entities and the House GOP plan.
“There’s a lot of similarities there,” Lee said. “I don’t think we’re talking about apples and turnips. We’re talking about different flavors of apples.”