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House Republican tax writers are struggling with how to prevent partnership gaming if their proposed new tax rates for passthrough entities become law.
The blueprint on which the GOP members are basing their tax code overhaul talks calls for a 25 percent rate for passthrough businesses and a 33 percent top individual rate. After a Jan. 10 working group meeting on the issue, Rep. Vern Buchanan (R-Fla.) said he wanted to make sure people wouldn’t game the system by, for example, taking a salary but setting up a company or working as a consultant to get the lower rate. “We’re just trying to get somewhere where it makes sense,” he said.
The meeting was part of an effort within the Ways and Means Committee to make final decisions on unfinished parts of the plan to overhaul the tax code, including partnerships, energy and retirement savings. The groups will meet frequently in the coming weeks to resolve details before the plan is put into legislative language, which is much more difficult to revise.
Rep. James B. Renacci (R-Ohio), who was also at the meeting, told Bloomberg BNA that members discussed how to eliminate “loopholes” when it comes to the tax rate for passthrough businesses.
“Anytime you change the tax code you have to look at opportunities surrounding the changes, making corporations and passthroughs competitive,” he said.
The meeting focused on how the Treasury Department and the Internal Revenue Service would be able to write regulations implementing the changes to the tax code to prevent gaming of the system, Rep. Kenny Marchant (R-Texas) said.
With a 25 percent business tax rate and a 33 percent personal rate, partners will be incentivized to accept low salaries, which would be taxed at the higher rate, and take more of their income as business income, subject to a tax rate 8 percentage points lower. Marchant said the committee discussed how the IRS could write rules to prevent that.
One option is a safe harbor rule where the IRS would approve any arrangement in which at least 70 percent of a partner’s income is compensation and no more than 30 percent is business income, Marchant said.
A plan that would have partners paying individual rates on 70 percent of their income would be a “non-starter” in the passthrough community because people would be paying a tax rate upward of 30 percent, Brian Reardon, a principal at Venn Strategies LLC, told Bloomberg BNA.
Reardon said the government instead should introduce reasonable compensation rules that are easier to comply with and enforce than the current regulations, which are seen as complicated and convoluted.
The product from these working groups will inform the tax overhaul bill that Ways and Means Chairman Kevin Brady (R-Texas) has said he plans to have ready to release in the first 100 days President-elect Donald Trump is in office. The groups will make final decisions by early February, Marchant said.
Ways and Means Tax Policy Subcommittee Chairman Peter Roskam (R-Ill.) said the goal of the working groups was to work toward simplicity, clarity and fairness when it comes to passthroughs and the tax rate.
Roskam pointed out that an overwhelming number of businesses in his district are passthrough entities, just like they are in other congressional districts.
Businesses increasingly chose to be passthrough entities, including partnerships and limited liability companies, in the years following the 1986 Tax Reform Act. Currently, passthrough entities are taxed at the level of the investor or equity holder, not at the entity level. The House GOP plan has a special rate for passthrough income separate from the rates for compensation income.
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