Senate Passthrough Approach Seen as Simpler Than House’s

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By Laura Davison

The Senate tax plan doesn’t deliver the 25 percent passthrough rate included in the GOP unified tax framework, but it does give partnerships, limited liability companies, and S corporations a more straightforward formula to compute their tax rate, tax practitioners said.

The Senate‘s plan would tax top-earning partners at a 31.8 percent rate, which doesn’t fully live up to the framework, but is also a more administrable system than the one offered by the House, which limits the 25 percent rate to a portion of a passthrough owner’s income.

The Senate measure, released Nov. 9, would create a 17.4 percent deduction for passthrough owners who would then be taxed on the bracket corresponding with their income, which tops out at 38.5 percent.

The Senate plan takes a different approach from the updated version of H.R. 1, which would keep a 25 percent rate, but limit the amount of the income it could apply to. The House legislation, scheduled to get a floor vote this week, also creates a complicated web of formulas to calculate a passthrough tax rate depending on the company’s size and industry.

(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.)

“It is certainly a much cleaner approach than the House. If the goal is simplification, that’s a simple way to do it,” said Liam Donovan, a principal at Bracewell LLP.

The 17.4 percent deduction number is “oddly specific,” indicating that the Senate tax writers needed to contain the cost of this provision, he said. The Joint Committee on Taxation estimates the deduction would add about $459.7 billion.

“You can easily run the math to see how much of a lower rate you’re getting,” Richard M. Lipton, a partner at Baker & McKenzie, LLP told Bloomberg Tax. “It makes it a lot easier and not as variable of a process.”

Exceptions Apply

The deduction wouldn’t apply to service businesses, such as architecture and accounting firms. But it would allow small-service businesses where the owner earns less than $150,000 as a couple or $75,000 as an individual to take the deduction.

The Senate version “would provide some tax benefit to those small businesses that are already in or under the 25 percent marginal tax rate,” Jason J. Ficthner, a senior research fellow at the Mercatus Center at George Mason University, said in an email. “Hence, for them, the Senate plan is superior to the House plan and presumably more politically palatable to the small business community at large.”

The Senate plan also says that for each dollar of the tax break a company receives, the business would have to pay at least two dollars in wages, a requirement intended to encourage companies to hire more workers.

That could have an unintended consequence of companies opting to bring more services in-house, rather than contracting with service providers, such as janitorial services or law firms, to fulfill certain needs, Don Susswein, a principal at RSM US LLP in Washington, told Bloomberg Tax.

That goes against the goals of tax reform, which is to eliminate tax code provisions that drive business decisions, Susswein said.

The Senate plan avoids one of the more complicated aspects of the House approach: determining what income should be taxed as wages, and what should be taxed at a preferential passthrough rate. It also isn’t clear whether passive owners—such as investors who don’t work in the business—would get a tax break close to what they would get in the House bill, which would give them a 25 percent rate on all the income they earn from the passthrough.

“It comes down to a choice—do you want a real 32 percent rate, or an inscrutably complex 25 percent rate that only applies to some of your income?” Donovan said.

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

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

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