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Oct. 14 — Higher taxes for small businesses and other entities organized as passthroughs could be an acceptable trade-off for lower corporate tax rates, according to a Congressional Research Service report.
The reason relates to efficiency, because the U.S. tax code currently favors the noncorporate sector, in general.
The 35 percent statutory corporate tax rate tends to be higher than the average marginal statutory rate for noncorporate business, estimated to average about 27 percent, according to data from the Internal Revenue Service. In addition, effective corporate tax rates are higher in most cases and for most assets than effective rates for passthroughs, and administrative and compliance costs would be lower if tax provisions such as depreciation and inventory accounts were harmonized across organizational forms.
“There is not a clear fairness argument against this approach,” said the CRS report, which was dated Oct. 8. “Note also that if the corporate tax rate cut were generous enough, many pass-through businesses might recoup some of the loss by incorporating.”
But that argument didn't hold water earlier this year when passthrough businesses effectively lobbied against reduced corporate tax rates without enough concessions to the passthrough community.
According to the CRS report, other options are available to business-only tax changes, including a focus on base-broadening provisions that are primarily corporate, such as slowing depreciation for buildings and equipment. Alternatively, new provisions could be introduced or others expanded to primarily benefit passthroughs, such as boosting expensing under tax code Section 179.
In addition, individual rates could be lowered for only business income, akin to the different tax rates applied to dividends and capital gains. A simpler approach would reduce effective statutory rates for unincorporated businesses by allowing a deduction from taxable income for passthroughs, modeled on the production activities deduction, the report said.
Changes to international taxes would largely insulate passthrough businesses because almost all multinational business income is in the corporate sector. Such narrow revisions have been under consideration more than others, of late.
But like the other options in business-only or corporate-only tax changes, there are limits. International-only changes might not produce adequate revenue to cut the corporate rate and remain revenue neutral, the CRS report said.
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Text of the CRS report is in Tax Core.
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