Passthrough Revisions Possible as Problems Plague Tax Plan

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By Laura Davison

Passthrough tax relief could be one of the most revised sections of tax reform legislation as Congress moves to pass a bill in the coming weeks.

Many passthrough businesses—which include partnerships, S corporations, and limited liability companies—have been dissatisfied with the approaches in both the House and Senate bills for lowering tax rates on passthroughs, citing a larger tax rate reduction for corporations.

“That’s part of the equation that could change the most over the next few weeks,” Isaac Boltansky, senior vice president and policy analyst at Compass Point Research and Trading LLC, told Bloomberg Tax. “No one is planning around it yet. There is uncertainty across the board.”

Given the time constraints—Republicans hope to pass a bill by the end of the year—there’s not enough time to completely re-write the sections pertaining to passthroughs, so tax writers will likely have to make changes within the regimes that already exist. The Senate measure would provide a 17.4 percent deduction for passthrough income, which is then taxed at the individual rates. The House tax bill would allow businesses to subject 30 percent of their income to a 25 percent rate, or calculate an amount based on their income from capital assets. (For a road map of where to find key provisions and compare the House tax reform bill (H.R. 1) with the Finance Committee version, read Bloomberg Tax’s analysis.)

“The way things are moving, I don’t know that there will be a chance to start from scratch,” Liam Donovan, a tax lobbyist at Bracewell LLP, said.

Both plans include provisions that target tax cuts to lower-earning passthroughs, which helped garner the backing of the National Federation of Independent Businesses, whose membership is comprised of many small businesses with gross sales of less than $500,000.

Passthrough Fights Continue

The fight now is being led by larger passthroughs who are unhappy that the Senate plan doesn’t give them the 25 percent preferential rate outlined in a September GOP tax framework, a tax lobbyist said. Though, not all agree that passthroughs need another tax break. Steve Rosenthal, a senior fellow in the Urban-Brookings Tax Policy Center, said he’s “unsympathetic” to complaints that passthroughs don’t get enough in this bill and said creating a special regime for passthroughs opens up opportunities for abuse.

“They can be corporations if they want to compete with corporations,” Rosenthal told Bloomberg Tax.

The S Corporation Association has been one of the loudest voices criticizing the Senate passthrough approach saying in a statement on its website that the plan “abandons any notion of equity for pass-through businesses. Under the plan, no successful pass-through business will receive the promised 25 percent rate or anything close to it.”

Association President Brian Reardon told Bloomberg Tax the group is working with Sens. Ron Johnson (R-Wis.) and Steve Daines (R-Mont.) to reduce the effective rate on S corps by pushing for a larger deduction and making the passthrough deduction more widely available to companies.

The most obvious ways to improve the Senate bill for passthroughs is to increase the deduction amount—now at 17.4 percent—or make the passthrough provisions permanent so they don’t continually need to be extended, Donovan said. The passthrough deduction would expire at the end of 2025, but the corporate cuts would be permanent in the Senate plan.

The S Corp Association is looking to get the Senate to increase the tax cuts it gives to passthroughs to more closely match the $596.6 billion of cuts over a decade in the House bill. The Senate bill passthrough deduction would cost about $362.2 billion over 10 years, according to the Joint Committee on Taxation.

Any changes to the Senate legislation will largely depend on how much money they raise or lose. Senate rules require that the legislation not lose more than $1.5 trillion over a decade, and not add to the deficit after those first 10 years.

More Guardrails?

Both the House and Senate bills could be improved by providing more guardrails to prevent business owners from gaming the passthrough tax breaks, Scott Greenberg, a senior analyst at the conservative-leaning Tax Foundation, said.

“The best possible outcome is for lawmakers to concentrate as much as possible about what the opportunities for abuse are under the current bill and to beef up the guardrails to prevent abuse,” he said. “Whenever there are different rates for different income there is almost certainly gaming.”

The Senate bill places very few restrictions on passthrough owners earning less than $250,000 as individuals, or $500,000 as joint filers. Service businesses can take the tax break and aren’t limited in the size of the deduction based on the wages they pay to employees. But imposing more restrictions may not be easy and could generate opposition to the bill.

“It’s not until you move up the scale where most of the growth and employment occurs that the restrictions kick in. I don’t know that there’s necessarily a way to ‘fix’ it, because this was a main feature of the modified mark,” Donovan said. “And part of it is just the inherent trade-off between the simplicity of a deduction versus the complexity of creating a new rate with the requisite qualifiers.”

To contact the reporter on this story: Laura Davison in Washington at ldavison@bloombergtax.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bloombergtax.com

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