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Lower Income Tax Rates Legislation for Flow-Through Entities is Going to Be a Hard Sell

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A plan by President Trump and congressional Republicans to slash taxes on pass-through businesses (Sole Proprietors, Partnerships and S-Corporations) is testing lawmakers’ ability to design rules to prevent wealthy people from paying a lower rate meant to help small businesses grow.

Businesses ranging in size from the Mom-and-Pop shops to large businesses are called “pass-throughs” because their profits flow to owners and are taxed as individual income, often at the top 39.6% rate.

Publicly held corporations have their own top corporate income tax rate of 35%. Corporate profits are further taxed when they flow through to shareholders as dividends taxed at 20%.

Republicans have vowed to get tax legislation to Trump’s desk before the end of 2017. The Republican timeline is in doubt because of complexities posed by pass-throughs issue.

Trump and Republicans want to give pass-throughs their own tax rate of 15-25%, saying such a low rate would help economic growth by leaving owners with more money to hire and invest.

The issue of concern to Democrats with this proposal is that high-income people who pay the top individual tax rate could reap enormous windfalls simply by reclassifying their wages and salaries as pass-through business income to qualify for the new low rate. Such a windfall could erase up to $584 billion from government coffers over the next decade per the nonpartisan Tax Policy Center.

The nonpartisan Tax Foundation estimates that over 28 million businesses are organized as pass-throughs. Income from them has been taxed at the same rates as wages and salaries since the individual income tax was enacted in 1913.

Policymakers are looking at limiting how much of a business owner’s income should get pass-through treatment. One proposal under consideration would apply the pass-through rate to only 30% of a business owner’s income. The remaining 70% of income would be taxed at the higher individual rate.

Other proposals would limit the pass-through rate according to the business owner’s capital or stock value; exclude income from partnerships engaged in “personal services” such as law, accounting, medicine and engineering; or exclude passive income from royalties, rents, dividends and income.

Stay tuned – we will get more information out to you as it becomes available.

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