S-Corp at Brookings—Making the Case for Tax Parity

On Tuesday the Urban-Brookings Tax Policy Center held a forum on the new tax bill entitled “The Tax Cuts and Jobs Act: The new business tax landscape.”  The forum focused on two of the more confusing aspects of the new law – the treatment of pass-through businesses and the treatment of international income.

S-Corp was represented on a panel discussion devoted to the pass-through issues, with S-Corp President Brian Reardon joining Lilian Faulhaber of Georgetown Law and Joseph Rosenberg of the Tax Policy Center.  Reardon made a strong case for the pass-through structure as a preferred mode of business taxation, and highlighted the opportunities and challenges presented by the new deduction for S-Corp members (see below).

You can view the entire event, including Senate Finance Committee Chairman Orrin Hatch’s opening remarks, here.  (Brian’s portion begins around the 47-minute mark.)

SALT & the States—Connecticut Leads the Way

One S-Corp 2018 priority is to level the playing field with C corporations on the ability to deduct state and local tax deductions.

Under the federal tax overhaul, C corporations can continue to deduct these taxes as a business expense, whereas S corporations, as pass-throughs, generally cannot.  Only those taxes paid at the entity level are deductible, and since most S corporation income is “passed through” to their shareholders, they don’t get the deduction.  This result violates basic fairness.  If a C corp down the street can take the deduction, why not the S corp next door?

S-Corp is working at the federal level to get this fixed, but a tax bill like that is unlikely to move through Congress anytime soon.  But what about the states?  Can they help?  If only entity-level taxes may be deducted, why not collect state income taxes at the entity level?  It’s a solution S-Corp and its allies have been pushing since the beginning of the year and states are beginning to respond.

First out of the box is Connecticut, where the Governor has proposed legislation to allow partnerships and S corps to pay their state income taxes at the entity level.  As Tax Notes reported:

The Tax Cuts and Jobs Act allows corporations and pass-through owners and investors to continue deducting state and local taxes paid or accrued in carrying on a trade or business. Connecticut’s proposal would impose a 6.99 percent income tax on the net receipts of partnerships, S corporations, and limited liability companies that are partnerships for federal purposes. [Revenue Commissioner] Sullivan said that because the new limits on SALT deductions do not apply to businesses, pass-throughs could claim the amount as an expense for deduction purposes, “so they are made whole for the tax, essentially, by getting it back from the federal government.”

For Connecticut S corps that get the new 20 percent deduction, regaining the lost deduction will reduce their effective marginal rate by more than two percentage points.  S corps that don’t get the deduction will save 2.6 percent.  That may sound like an accountant’s quibble, but if we increased the C corp rate from 21 to 24 percent, do you think they would notice?  You bet they would, and pass-through businesses in Connecticut and elsewhere have noticed this stealth tax hike too.

For S-Corp, we’re working to see that other states take up this challenge, and make sure it’s done effectively.  The best SALT fix would make the entity-level tax an election rather than a mandate, and the effort must be coordinated with other states to ensure that taxes paid in one state are credited to shareholders living in another.

Those details matter, but the headline from Connecticut is positive and makes clear the effort to level the playing field for pass-through businesses on SALT is underway.  We’re confident it’s going to spread.

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