Tax reform battle zeroes in on small businesses

Small businesses — including many independent adviser firms — are at the heart of the tax-reform tug-of-war going on in Washington right now.

This week marks the tentative start of tax reform on Capitol Hill, and congressional Republicans are signaling they will resist proposals that focus only on traditional corporations because they would not address the taxes of a large swath of smaller business structures.

In his budget last week, President Barack Obama proposed lowering the corporate tax rate. Corporate tax reform has been mentioned as a possible point of agreement between Republicans and the White House.

But some lawmakers oppose reducing corporate taxes without also tackling so-called pass-through business entities, such as sole proprietorships, partnerships, limited liability companies and S corporations. These businesses pay taxes through the owner’s personal tax return and have experienced strong growth over the last couple of decades. They account for about 94% of U.S. firms and more than half of private sector employment.

“We have in every single congressional district a Main Street,” Rep. Pat Tiberi, R-Ohio, a member of the House Ways and Means Committee, said Wednesday at a Capitol Hill event sponsored by the Tax Foundation. “On that Main Street we have pass-through entities of every type, from a hardware store to a doctor’s office to a small manufacturer that pay taxes, work hard and have a tax code that, quite frankly, isn’t fair to them. As we do tax reform, they shouldn’t be left behind.”

Mr. Tiberi said he doesn’t “see the pathway” for tax reform that touches only one part of the code.

“I don’t know how you do corporate-only,” he said in an interview. “We have to do it for everybody. I wish the president would not be dividing the business community but instead would be trying to unite the business community about the need for comprehensive reform.”

Despite this sentiment, Mr. Tiberi sponsored one-off legislation, H.R. 636, that would make permanent tax deductions for office equipment purchases by small businesses, which passed the House Ways and Means Committee last Wednesday and is headed to the full House floor for a potential vote Friday. He views enshrining such deductions in the tax code rather than forcing them to be renewed repeatedly as part of a so-called tax-extenders package as a step toward broader reform.

Other GOP members on the House Ways and Means Committee also favor comprehensive reform. At a recent panel retreat, most members told Chairman Paul Ryan, R-Wisc., they prefer to do individual and corporate reform together, according to an aide to one of the members who asked not to be identified.

Pass-through entities now dominate the American business landscape, according to a Tax Foundation study released last month. In the financial services and insurance sector, they account for 876,485 out of a total 940,019 firms and employ 1.8 million of the 6.2 million people working in the industry.

The businesses, which are not exclusively small, pay a combined top tax rate ranging from 43.4% to 52.7%, depending on the state in which they’re located.

It’s impossible to separate a pass-through from a traditional corporation when it comes to tax reform, said Scott Hodge, president of the Tax Foundation.

If the corporate rate is lowered to 28% or 25% from the current 35% but the top personal income tax rate stays at 39.6%, there would be a wide disparity between corporate and pass-through taxes that might cause pass-throughs to reorganize as corporations.

In addition, if certain tax breaks are curtailed to pay for lowering the corporate rate, the pass-throughs would lose those deductions but would not have the top individual rate lowered.

Corporate-centric reform “is a very difficult thing to do at a practical level,” Mr. Hodge said. “Instead of reform, you’ve mangled the tax code even worse.”

In addition to Mr. Tiberi’s bill, the House will vote on a package of tax breaks Thursday that would make permanent certain deductions for charitable giving. The measures are almost certain to be approved by the House.

The White House has issued veto threats against both bills because the costs are not offset with corresponding budget cuts or tax increases. Some Senate Democrats, whose minority is large enough to sustain a filibuster, also are likely to oppose them.

The bills are meant to test the reform waters, according to Mr. Tiberi.

“There will be a couple of tranches of these to see how the reaction is [among] Senate Democrats and the White House,” he said. “We’ll decide from there how to move forward.”