23 01 2017

Tax Foundation Studies US Pass-Through Tax Reform

The Tax Foundation (TF) has issued a paper saying that "there is a strong case to be made for keeping the current system of taxing pass-through businesses" in the United States.

Pass-through entities, such as partnerships and S corporations, represent over 90 percent of businesses in the United States, and are currently taxed within the individual income tax code. It has been suggested that, within a future US tax reform framework, a cut in the US corporate tax rate should be extended to all businesses, including pass-through businesses.

TF noted that, although they are not subject to corporate income tax, pass-through entities can still face a substantial tax burden from federal, state, and local taxes. In most US states, it added, the top marginal tax rate on pass-through business income exceeds 47 percent.

However, it also pointed out that "proposals to create a new, lower rate on pass-through businesses would also raise several concerns. Lawmakers would have to justify why income from pass-through businesses should be subject to a lower tax rate than income from wages and salaries."

In addition, "taxing pass-through business income at a lower rate would make the US tax code less neutral, potentially leading individuals to invest in pass-through businesses based on tax considerations, rather than the economic merits."

It could also, TF added, "create practical difficulties for tax administration. Because such a policy creates strong incentives to categorize as much income as possible as pass-through business income, it would have the potential to lead to substantial tax avoidance unless accompanied by strong anti-abuse rules."

TF concluded that "lawmakers should keep in mind that the current system of taxing pass-through businesses is designed well, and they should be cautious about making fundamental changes to it."