United States

House Republicans release tax reform blueprint

TAX ALERT  | 

In a policy paper released on June 24, 2016, House Republicans announced a new ‘blueprint’ for tax reform. Of particular note are the proposed reforms for businesses operating as partnerships, limited liability companies, S corporations or sole proprietorships—as compared to C corporations.

Under the GOP proposal, income from proprietorships and pass-through entities would be taxed a maximum rate of 25 percent, lower than their proposed 33 percent top rate for ordinary income. By means of a 50 percent exclusion for certain investment income, the top effective tax rate for interest, dividends and capital gains would be one-half of 33 percent or 16.5 percent.  

In order to limit the 25 percent rate for pass-throughs and proprietorships to income that is not compensation for the personal services of an owner-operator, owner-operators would be required to be paid (or treated as if they had been paid) reasonable compensation taxed at ordinary income rates. This may be similar to the current law rules that require S corporations to pay (or be treated as paying) reasonable compensation to their owner-operators, for purposes of Social Security taxes.

While the proposed corporate rate would be 20 percent (lower than the rate on pass-throughs and proprietorships), the combination of a flat 20 percent corporate tax plus a maximum 16.5 percent individual tax on dividends or capital gains from the sale of corporate shares could amount to a combined tax rate on corporate income of 33.2 percent (i.e., 20 percent plus 16.5 percent on the remaining 80 percent). Thus, an approximate 8.2 percent rate differential would exist between the highest tax rate on business income of pass-through entities and the highest combined tax rate on business income of C corporations.

Interestingly, interest would no longer be tax-deductible for any business entity. However, investment interest would be taxed at the same preferential rate as capital gains or corporate dividends. The blueprint also compensates for the non-deductibility of interest by providing for immediate expensing of business investments, replacing the current system of depreciation and amortization for tangible property (such as equipment and buildings) and intangible assets (such as intellectual property). It is unclear how these new rules, if enacted, would affect new or existing entities and the choice of entity issue overall.

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