Senate tax bill changes for pass-throughs more generous than House version, experts say

Senate measure's handling of such small-business income is simpler and makes allowances for more service companies

Dec 6, 2017 @ 2:44 pm

By Mark Schoeff Jr.

Financial advisers and their clients would be better off under the Senate's tax plan for small businesses than the House version, according to experts.

Each chamber has approved its own tax-reform legislation. The two measures are headed for a conference committee to resolve the differences.

One of the ways the tax bills diverge is in their treatment of so-called pass-through businesses — partnerships, S corporations and sole proprietorships in which the owners pay their business taxes on their personal returns at marginal rates that can reach 39.6%.

The House bill would provide a 25% rate on a portion of pass-through income that is determined through a formula in the bill. The House bill would not allow most service businesses, such as accounting and financial advice, to use the lower rate. But it was amended to provide a 9% tax rate on the first $75,000 of income for any business in which the owner earns less than $150,000.

The Senate is more generous to pass-throughs. Its bill would provide a 23% deduction on taxable income for any business with income below $500,000 for married couples and $250,000 for individuals. At incomes above that threshold, the deduction is capped at 50% of wage income.

The Senate's idea is better, according to Paul Samuelson, chief investment officer and co-founder of LifeYield, an asset-management outsourcing firm.

"The deduction is worth more than the lower rate," Mr. Samuelson said. "I like the idea of a certain percentage of deduction rather than dropping the rate. It will help people with less income. Its like a less complicated way of proceeding."

Tim Steffen, director of advanced planning at Robert W. Baird & Co., also likes the relative simplicity of the Senate policy.

"The Senate plan is easier overall to understand because it's a flat exemption," Mr. Steffen said. In addition, the "Senate version is more friendly to service corporations."

Leon LaBrecque, managing partner at LJPR Financial Advisors, agreed that the Senate approach would encompass more business owners.

"It's highly stimulative to small businesses and pass-throughs, including advisers," said Mr. LaBrecque, who is also a CPA and participated on a Michigan Association of CPAs task force that examined the tax-reform bills. "It [provides] a substantial benefit. It's a way better version."

The effective tax rate for small businesses qualifying under the Senate plan would be around 30%, a big drop from the current top individual rate of 39.6%. Such a change in taxation also could affect how much an advisory practice set up as a pass-through is worth.

"It will clearly change the valuation multiplier," Mr. LaBrecque said.

The pass-through provision was a key area of negotiation in the Senate to ensure enough support for the measure, which was approved Saturday on a nearly party-line vote of 51-49.

Conference negotiators will have to keep in mind the narrow Senate spread. Each chamber has to pass an identical bill before it can be sent to President Donald J. Trump to be signed into law. Congressional Republicans want get to the finish line by the end of the year.

"In general, I would expect the House to give up more of their provisions than the Senate would give up of theirs," Mr. Steffen said.

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