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Bid to lower corporate tax rate stirs backlash from business

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(Bloomberg) — The latest plan in Congress to cut business tax rates faces a major obstacle: U.S. businesses.

Many Democrats and Republicans, including new House Ways and Means Committee Chairman Paul Ryan, agree that they will try to reduce the 35 percent corporate tax rate and curb business tax breaks to help pay for it. They’ll leave individual rates alone to avoid a politically charged fight.

The complication is that millions of U.S. businesses — from the largest hedge funds to neighborhood restaurants — don’t pay taxes through the corporate system. Instead, income and tax breaks appear on the individual returns of those businesses’ owners, in effect intertwining the corporate and individual parts of the tax code.

“If the only issue were the policy differences on corporate tax reform, Paul Ryan and the president could meet for tea and be done by dessert,” said Edward Kleinbard, a tax law professor at the University of Southern California.

Businesses not subject to corporate taxes are warning lawmakers that they may lose valued tax breaks without getting any benefit from a corporate rate cut. The politicians say they’re listening and trying to come up with a solution.

Treasury Secretary Jacob J. Lew today met with small- business trade associations to talk about the issue. In the hour-long meeting, Lew said he didn’t foresee a circumstance where small companies would pay for a corporate rate cut, according to Todd McCracken, president of the National Small Business Association.

‘Open Discussion’

“I was very encouraged,” said Keith Hall, president and chief executive officer of the National Association for the Self-Employed, who said it was the first time he had met with Lew. “It had the feel of an open discussion.”

The latest attempt to overhaul corporate taxes is a slimmed-down version of a four-year Republican campaign to revamp the entire U.S. code. It resulted in a 2014 proposal by Republican Dave Camp, then the Ways and Means chairman, that stalled without even coming to a vote in committee.

Lawmakers in both parties say they’re probably too far apart on individual taxes to reach the kind of big deal that Camp contemplated. President Barack Obama says high-income Americans should pay more; Republicans disagree.

After the November election that gave Republicans full control of Congress and elevated Ryan to chairman, Obama and Ryan said they would look for overlap on business taxes and plan to leave individual taxes largely untouched.

Not ‘Straightforward’

“There’s always an impression that less is easier than more,” said Ray Beeman, who helped write Camp’s tax plan and is now a principal at Ernst & Young LLP. “It’s probably not as straightforward as that.”

The U.S. business world is increasingly populated by what are known as pass-through businesses. They get their name because the income they receive isn’t taxed at the corporate level, but instead passes through to their owners’ tax returns.

The U.S. marginal tax rate on corporations is the highest in the industrialized world, encouraging companies to shift profits — and sometimes their addresses — overseas in search of lighter burdens.

In 1980, C corporations subject to the corporate income tax reported 75 percent of U.S. net income, according to the Internal Revenue Service. By 2007, that share had declined to 36 percent.

Business Activity

About one-third of all U.S. business activity is now conducted through pass-throughs, according to an analysis by the Tax Policy Center in Washington. They account for more than 9 percent of adjusted gross income on individual tax returns.

The pass-through businesses exploded in size in part because the top individual tax rates declined in the 1980s.

Form doesn’t necessarily correspond with size.

As a group, pass-throughs sometimes are described as “small business.” That’s not always the case. The group includes the largest law and accounting firms, hedge funds, private-equity firms and some large manufacturers.

Among the businesses are freelance writers, doctors’ offices, pipeline operators (such as Enterprise Products Partners LP) and accounting firms such as Ernst & Young.

That size and diversity create headaches for lawmakers. If they do too little to help such businesses, they hear from frustrated retailers and wholesalers who are in every congressional district. Yet every break for small businesses or pass-throughs makes it tougher to reduce the corporate rate or avoid a higher budget deficit.

‘Equal Influence’

“There’s a lot of sensitivity to small business,” said John Gimigliano, head of the tax legislative group at KPMG LLP in Washington and a former Republican Ways and Means Committee aide. “While any single one of them may not be able to influence at the same level as a big guy, as a group, they wield at least equal influence.”

The Obama administration’s approach is to focus on size, offering new tax breaks to small businesses to compensate for the loss of current ones, and contending that larger pass- throughs are increasingly avoiding corporate taxes.

“It’s important not to raise taxes on smaller businesses,” Mark Mazur, the top tax policy official at the Treasury Department, said on a PricewaterhouseCoopers LLP webcast last month. “And if you just think about this purely from a political lens, it’s not viable to have a tax cut for large multinational firms paid for by a tax increase on smaller businesses. There are probably less cynical reasons for getting to the same place.”

Capital Investments

Under the president’s 2012 framework for business taxation, small businesses would be able to write off up to $1 million in capital investments under an extension and expansion of what is now a temporary policy. Obama also proposed making it easier to use cash accounting, which can be simpler.

Special breaks for small business would make the tax plan less effective at promoting economic growth, said Alan Viard, a scholar at the American Enterprise Institute in Washington, which favors limited government.

“It leaves me somewhat nonplussed by really this whole reform endeavor, the way they’re framing it now,” he said.

The administration’s plan doesn’t go far enough, says Jade West, senior vice president for government relations at the National Association of Wholesaler-Distributors in Washington.

“There is no dollar figure you can put on expensing that solves the problem of an inequivalency in the rate,” she said.

Preserving Advantages

Kleinbard, former chief of staff of the congressional Joint Committee on Taxation, said he had little sympathy for pass- through businesses trying to preserve advantages they now hold.

“If you think the new corporate world is so great, incorporate,” he said.

The administration’s proposals are an “absolute non-starter,” said Brian Reardon, president of the S Corp Association, a group of pass-through companies whose board of directors includes an executive from Tabasco sauce maker McIllhenny Co.

“Main Street businesses have to be an equal partner in this,” he said. “And what that means is rate parity. It’s all about the rates.”

That isn’t simple to measure. The top rate for individuals and pass-throughs is now 39.6 percent, compared with the 35 percent top rate for corporations.

Second Layer

Some corporate income faces a second layer of taxes, however, when shareholders receive dividends or sell stock and receive capital gains. That income is taxed at a top rate of 23.8 percent.

In many cases, that second-level tax doesn’t apply to those exempt from U.S. taxes, such as retirement accounts, pension funds and foreign citizens.

Corporations pay higher taxes than pass-throughs — 38 percent vs.

 30 percent — when they make investments financed by equity, according to a Congressional Budget Office study released last month. The reverse is true on debt-financed investments, with corporations getting a 6 percent tax subsidy and pass-throughs paying an 8 percent effective tax rate.

Some lawmakers and groups are starting to circulate ideas.

Representative Devin Nunes of California, a senior Republican on Ways and Means, would impose a 25 percent cash flow tax on business income and allow businesses to immediately write off capital expenses. Accounting firm Grant Thornton LLP would create a “business equivalency rate,” which would apply to all business income regardless of whether it’s earned by a corporation.

Ryan, a Wisconsin Republican, hasn’t tipped his hand about his plans.

“We can’t leave the small business person hanging out there and not be a part of reform,” he said in a December interview.