A Bloomberg article from Friday morning has been flying around tax policy circles here in D.C. and elsewhere. From the article:
The Obama administration is seeking to widen the scope of its proposal to overhaul the corporate tax code, urging Congress to also change rules that allow some businesses to take advantage of tax laws governing individuals.
The article cites testimony by Secretary of the Treasury Tim Geithner earlier this year in which he advocated “revisiting” long-standing rules allowing businesses to choose to be taxed as S corporations or partnerships. According to Geithner:
“Congress has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they’re treated as corporations for tax purposes or not.”
Combined with statements by Michael Mundaca (head of tax policy at Treasury) to business groups in recent days, the idea appears to be to force some partnerships and S corporations to pay taxes as C corporations, and use the additional revenue to help offset reforms (i.e. lower tax rates) for C corporations.
Bottom Line: The Obama Treasury Department is actively pursuing policies to impose corporate tax treatment on certain flow-through businesses as part of their corporate tax reform initiative.
Private and family businesses, be warned.
The President’s Budget and Corporate Reform Preview
As expected, the President’s budget didn’t offer any details on how he would reform the corporate tax code, but his budget did renew the call for corporate reform. According to the budget:
In an increasingly competitive global economy, we need to ensure that our country remains the most attractive place for entrepreneurship and business growth. As a first step toward reform, the President calls on the Congress to immediately begin work on reform that will close loopholes, lower the overall rate, and not add a dime to the deficit.
So budget-neutral corporate reform it is. But exactly how would that work?
Let’s start with the basics. Tax reform usually entails two components: broaden the base by eliminating specific tax deductions and credits, and use the additional revenue to reduce the overall tax rate.
Sounds great, but what about all of those non-corporate employers that use the same deductions and credits? Their tax rates (the individual tax rate schedule) are scheduled to go up in coming years, not down.
Further, not every business sector relies on the same credits or deductions, or to the same degree, so a budget-neutral reform means some sectors will win and some will lose.
Last month, former Treasury official Bob Carroll (now at Ernst & Young) and two colleagues penned a very interesting look into budget neutral tax reform and its impact on various business sectors. Here’s what they found:
“The biggest winners from using repeal of business tax expenditures to lower business tax rates to approximately 28 percent would be the retail and wholesale trade, information, transportation, finance and insurance,9 and services industries. Rate reduction would more than offset the loss of benefits from their tax expenditures.”
“Eliminating all business tax expenditures would disproportionately hit the manufacturing industry, especially those manufacturers with multinational operations. The tax rate would need to be lowered to roughly 26 percent to offset the tax increase from repealing the various tax expenditures that benefit the manufacturing industry.”
A key point: the above analysis assumes rates on flow-throughs are reduced right alongside C corporation rates. It also found that a revenue-neutral reform that reduced rates for all forms of business would bring the top rate down to 28 percent, not the 26 percent rate needed by manufacturers. (Hence the Administration’s push to disallow flow-through status for certain S corporations and others. They need the money.)
To determine the impact on S corporations, partnerships, and other flow- throughs, the S-Corp Association has asked Dr. Carroll to take another look at “corporate-only” reform, but this time assuming that only corporate rates are reduced, a la Chairman Rangel’s “”Mother” bill from 2007.
Dr. Carroll will have a chance to educate Congress on this issue Thursday when he testifies before the Ways and Means Subcommittee on Select Revenue. His testimony will be the beginning of a broad-based education campaign on the part of S-Corp and its allies.
Our message is simple: if you’re going to tackle tax reform, do it right and include both the corporate and individual tax codes. To do otherwise would mean picking winners and losers, and we know who the losers will be: manufacturers and the majority of employers in the country.
Tax reform should seek to make the entire U.S. economy more competitive, not just a subset of large corporations.