You have to feel for the House tax writers.  They spent months putting together a plan to reform the tax code and now all anybody wants to talk about is Brexit and Section 385.  That’s too bad, because the plan outline released last week is pretty good.

You can read the whole outline here, plus there’s been lots of discussion among the tax experts on how it would help to simplify tax collections while encouraging more business investment and job creation:

From the S-Corp perspective, the headline is the plan would make progress on all three of the key “pass-through principles” we’ve been championing since 2011 – that is, it takes a comprehensive approach to reform, it reduces both the corporate and pass-through rates to more reasonable and similar levels, and it makes progress on reducing the harmful double tax imposed on corporations.  It also gets rid of the dreaded estate tax, which hits private companies much more acutely than publicly-owned ones.

And while some folks are concerned about the fact that the initial tax on C corporation income is 20 percent while the pass-through tax rate is 25, the simple fact is that the tax imposed on successful S corporations and partnerships will be almost 20 points lower under this plan than it is under current law.  That’s a huge rate cut and one that would be welcomed by S corporations across the country.  As Tax Notes reported yesterday:

At the briefing, House Republican taxwriters insisted that their plan offers parity for the various types of businesses, with a 25 percent rate for small business and passthrough income and a 20 percent rate for C corporation income.

Double taxation on corporations’ paid dividends accounts for their lower rate under the plan, Nunes said.

“It’s not based on small or large. It’s based on how you’re legally set up. I could be a one-man C-corp and get a 20 percent rate,” Nunes said. “Because of the double taxation on C-corp is why it’s necessary to have a little lower rate than the individual. But any company can create an LLC or C-corp no matter what size you are.” The blueprint labels the two rates as applying to “small businesses” and “large businesses,” respectively.

Brady emphasized that the GOP plan’s rate for small businesses is a dramatic drop from the current tax structure.

“Don’t let that myth continue. You know right now that our passthroughs are paying the top rate of 44.6 percent as individuals, not just 39.6 percent. That’s the dramatic cut to 25 percent,” Brady said.

Regarding next steps, the Committee views this white paper as a discussion draft and is soliciting comments from stakeholders.  We like the broad parameters outlined last week, but there are lots of details that go unexplored. For example, the 25 percent rate on pass-through businesses is structured as a rate cap rather than a separate tax rate schedule.  That approach may work similar to a top rate in principle, but in practice it seems to be susceptible to being limited either by size or by industry (see our comments on the Buchanan bill).  The authors of this plan need to resist the temptation to limit the pass-through rate in any way, and treat it just the same as the top rate on corporations.

We intend to comment further on this and other key aspects of the blueprint.  There’s lots here to like, and much more that needs to be clarified.  Our goal will be to ensure that the plan continues to be something Main Street can support as it moves through the process.


House R’s and D’s Weigh In on 385

Speaking of Section 385, in separate letters to Treasury Democrats and Republicans on the Ways and Means Committee have communicated their respective concerns about the pending regulations.

First, eleven Ways and Means Democrats sent a letter to Secretary Lew last week that applauded his agency’s efforts to crack down on inversions and base erosion practices, but also raised concerns that the proposed regulations implementing Section 385 go too far:

However, there may be a number of unforeseen circumstances in which the regulations could adversely affect ordinary course business transactions between related parties in the absence of tax avoidance motives.  It has been raised that certain business sectors, including financial services, insurance, and utilities, may encounter industry-specific challenges to implementing these regulations due to various regulatory requirements unique to those industries.  We also have been informed that there are broader concerns related to various internal cash management practices, such as cash pooling, and appreciate that Treasury is continuing to examine the effect of the proposed regulations on those practices.  For these and other limited circumstances, we ask that you give careful consideration to whether exceptions or special rules, including transition rules, are appropriate.  

Next, all the Republicans on the Committee signed a letter to Secretary Lew today that takes a much more aggressive and critical tone regarding the rule.  As the letter notes:

We believe any finalization of the proposed regulations in present form will have a profound and detrimental impact on business operations nationwide. If not significantly altered, they will undoubtedly reduce overall investment and economic activity to the detriment of the United States and its business community. Since the release of these proposed 385 regulations, strong concerns have been raised with our offices by constituent companies and business groups representing every economic sector and industry in the United States. …

Furthermore, the proposed regulations represent a dramatic departure from current policy and practice, overturning more than a half century of well-established jurisprudence based upon analysis of an instrument’s actual substance …  the proposed regulations are broadly applicable to a wide array of ordinary business transactions, creating unacceptably high levels of uncertainty and adverse collateral consequences for non-tax motivated business activity.

So, in addition to the broad concerns raised by the business community to date (here and here), we now have bipartisan concerns raised by Republicans and Democrats alike regarding the 385 rule.  Let’s hope Treasury is in listening mode.