By Richard Rubin and Laura Saunders
WASHINGTON -- Today, a business owner making $500,000 gets taxed
much like a corporate executive with a $500,000 salary. How they
make their income doesn't matter much.
That could change dramatically under Republican plans aimed at
driving down tax rates on business income, leaving high-income wage
earners with much less to gain from a tax overhaul.
Republicans, eager to drive down business tax rates in a bid to
boost economic growth, want roughly similar tax rates for
corporations and for so-called pass-through firms that report
business income on the individual tax returns of their owners.
For them, lowering the 35% corporate tax rate requires also
lowering the 39.6% top rate for pass-through business income, even
though creating a new special rate for that business income leaves
a potentially large gap with the top rate for high-income wage
earners.
The exact contours of the GOP tax agenda aren't set. Top
lawmakers and administration officials say they will release
another blueprint in the coming days.
The 2016 House GOP blueprint called for a 20% corporate tax
rate, a 25% tax rate on pass-throughs and a 33% top individual
rate. In April the White House proposed a 35% top rate for
individuals. President Donald Trump has said he might not cut taxes
for the wealthiest Americans, and recently Republicans have talked
a lot less about the importance of reducing the 39.6% top tax rate
on ordinary income. In the end that rate might not come down much
and some deductions could go away.
With GOP senators agreeing to, at most, $1.5 trillion in tax
cuts over the next decade, there is a limited amount to go around.
Republicans are focused on cutting business taxes and offering a
larger standard deduction for middle-income households.
The emerging Republican plan would "open a gulf between wages
and pass-through business income that has never existed before,
putting the high-wage earners at a disadvantage," said Andy
Mattson, a certified public accountant with Moss Adams in Campbell,
Calif.
Keeping the top tax rate on wages near 39.6% would be a way for
Mr. Trump to defend his argument that he isn't prioritizing tax
cuts for the rich, even if other pieces of the tax plan favor
wealthy business owners, investors or heirs of large estates.
Under current law, pass-through businesses include partnerships,
limited liability companies and S corporations. The income they
earn doesn't face the corporate income tax and then a potential
second tax layer on capital gains or dividends; instead, it passes
through to owners' tax returns and is taxed at their individual
rates.
Such firms reported more than 40% of net business income in
2014, according to the congressional Joint Committee on
Taxation.
They include global law and accounting firms, real-estate
investors, hedge funds, doctors' offices and manufacturers. About
60% of pass-through income goes to households making over $500,000,
according to the Tax Policy Center.
In the past, Republicans have seized on the importance of
pass-through income to argue against raising the top rate on
individuals. They warned tax increases would punish successful
small businesses, although many aren't small. By splitting wage and
business taxation, the approach under consideration could undercut
future arguments against raising the top rate.
Lowering the corporate rate to improve U.S. investment
incentives is a core driver of the planned tax overhaul. Other
large industrialized countries have lowered their rates. The gap
between the U.S. and others affects business investment decisions
and encourages tax avoidance, experts say.
Politically, it is nearly impossible to cut corporate rates
without cutting the rate on pass-through income. Pass-throughs,
prominent in every congressional district, form an essential part
of the Republican coalition.
"The pass-through community demands something in the process of
the corporate rate going down," said Douglas Holtz-Eakin, president
of the center-right American Action Forum.
"There is a difference between high-wage income or some other
[business] income," said Sen. Mike Crapo (R., Idaho). "It doesn't
have to all be treated identically."
The challenge for policy makers will be separating wage income
from business income for high earners. The proposed lower
pass-through rate wouldn't help the large share of business owners
who don't generate significant high income, because their top rates
are below the 25% proposed rate in the House plan. The biggest
winners are high earners who can classify their earnings as
business income.
"The real fight here is going to be over what income qualifies
for the rate reduction and what income doesn't," said Warren Payne,
a former House GOP aide who wrote a policy paper for the Bipartisan
Policy Center on pass-through taxation.
For more than a year, Republicans have been floating
alternatives for defining the line between wage and business
income. They haven't settled on anything. One option would assume
that 70% of pass-through income is taxable at the wage rate and 30%
at the lower business rate.
Alternatively, Treasury Secretary Steven Mnuchin said certain
service providers wouldn't get the lower rate. He named accountants
specifically, but others could include doctors, lawyers,
consultants and architects.
"You have to have dollar bills that are labeled wage income and
business income and they don't come that way," Mr. Holtz-Eakin
said.
Creating a special, much lower pass-through rate only for
business income will lead to big changes in tax planning, said Lily
Batchelder, a law professor at New York University who was an Obama
administration tax aide.
Already, some pass-through owners engage in techniques to avoid
or minimize a 3.8% payroll tax; a bigger tax-rate gap would
encourage more avoidance.
"Everyone whose income is high enough to benefit and who can
afford excellent tax advice will figure out how to get the lower
rate," she said.
Write to Richard Rubin at richard.rubin@wsj.com and Laura
Saunders at laura.saunders@wsj.com
(END) Dow Jones Newswires
September 24, 2017 17:26 ET (21:26 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.