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An oversight in the Republican tax framework released last week could cause some small-business owners to lose their appetite for offering retirement plans.
The tax overhaul plan released Sept. 27 suggests creating a new top pass-through income tax rate of 25 percent and a top personal rate of 35 percent. The top corporate tax rate would be 20 percent.
A pass-through entity is a business, usually a small one, whose owners pay taxes on their profits at an individual rate rather than at a corporate rate. There isn’t a special tax rate for pass-throughs under the current tax system. These businesses avoid the “double taxation” that corporations incur when they’re taxed on their income and shareholders are taxed on dividends.
Under the proposed tax plan, retirement plan contributions from pass-through small-business owners would be deductible against the 25 percent tax rate, but could be taxed at the individual rate of 35 percent when the 401(k) funds are withdrawn.
“If we set the pass-through rate at 25 percent and I can avoid paying 25 percent tax by setting it in a retirement plan and then it’s taxed at 35 percent, that would be a bad deal,” Steven M. Rosenthal, senior fellow with the Tax Policy Center, told Bloomberg BNA.
If this plan goes through as is, the new tax rates would take the incentives that help drive small-business retirement plans and turn them “upside down,” Paula Calimafde, chair of the Small Business Council of America, told Bloomberg BNA. This would lead small-business owners to think twice before offering a retirement plan to their employees. The SBCA is a nonprofit organization representing the interests of privately held and family-owned businesses.
There are more than 28 million small businesses operating in the U.S. with over 56 million employees, according to the Small Business Administration.
The fix is fairly simple: Make sure the money going in is taxed at the same rate as the money ultimately coming out. Still, small-business advocates are worried the hiccup might be overlooked when the tax plan takes shape.
“We believe this to be a technical glitch, an unintended consequence of the tax reform plan,” Craig Hoffman, general counsel for the American Retirement Association, told Bloomberg BNA. The Washington-based ARA advocates on behalf of retirement and benefit plan professionals.
If this isn’t fixed, small-business owners would see a much bigger benefit in taking the money they would have contributed to their employees’ retirement plans and investing it on a capital gains basis.
That’s because the small business retirement plan system is based on tax incentives for business owners and small business owners need to save for retirement, too. They see any administrative costs for running a retirement plan and any contributions for employees as the “price they have to pay to save in a qualified retirement plan,” Calimafde said.
If the tax incentives are taken away, business owners will find other ways to save their own money for retirement, but they won’t be putting into retirement plans for employees, because it will be seen as too costly.
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