Wyden Urges a Closer Look at Passthrough Businesses During Debate on Tax Overhaul

By Marc Heller | March 14, 2014 09:21PM ET

Sen. Wyden (D-Ore.) says small passthrough businesses don't receive enough attention in talk of tax changes.

Likely Impact March 14 (BNA) -- How to treat small businesses is a big question for lawmakers seeking to overhaul the U.S. tax code—and one that Senate Finance Committee Chairman Ron Wyden (D-Ore.) says isn't getting enough attention.

Wyden, at a March 13 hearing on concerns of middle-income taxpayers, said that passthrough businesses, which aren't taxed through the corporate side of the Internal Revenue Code, need more consideration as Congress weighs sweeping tax changes. Yet lawmakers remain divided over how best to address their concerns.

Lobbyists and business advocates told Bloomberg BNA they don't yet see an approach to passthrough entities that has the momentum to pass Congress, any more than a broad tax overhaul has. Ideas range from integrating the corporate and individual sides of the tax code to carving out specific treatment for businesses so their income won't be subject to higher individual tax rates.

“As we go into tax reform, it's always about C corporations,” Wyden said. Somehow, he said, small businesses such as barbers and cleaners are left out of the debate even though small businesses often drive economic growth.

Focus on Small Business

Far too often, conversations about tax reform focus on the big businesses, the big, successful businesses, and ignore the rest. But economic growth, and the jobs that follow, so often flow from our small businesses,” he said. “So as this committee continues to consider the best ways, again on a bipartisan basis, to fix this broken tax code, let's ensure that young startups and green-shoot entrepreneurs have the opportunity to succeed.”

Wyden said he hoped to work with the National Federation of Independent Business, which was represented on the hearing witness panel, toward crafting a solution.

At issue is how to lower the top tax rates for businesses on both the corporate and individual sides of the tax code, especially if the tax changes Congress ultimately approves cut corporate rates without a corresponding reduction in individual rates. The top corporate rate is 35 percent and the top individual rate is 39.6 percent.

Wyden has previously introduced legislation to cut the top corporate rate to 24 percent, while setting individual rates in three brackets at 15 percent, 25 percent and 35 percent. Those levels were in legislation he sponsored with Sen. Dan Coats (R-Ind.), before Congress raised the top individual rate in early 2013.

Short on Specifics

Wyden didn't say at the hearing how he would achieve a lighter tax burden on businesses that are taxed through the individual side of the code. A spokesman didn't respond to an e-mail seeking elaboration.

In the House, Ways and Means Committee Chairman Dave Camp (R-Mich.) proposed matching top rates of 25 percent on each side of the tax code and has said he thinks any tax overhaul must address both because of the nature of passthroughs.

His plan is more complex, however, with a 10 percent surtax on households with more than $400,000 in annual income. Manufacturing income would be exempt from this surtax.

Majority of Businesses

The NFIB, on its website, calls for keeping tax rates low and making taxes simpler. As many as 75 percent of small businesses are structured as passthroughs, such as S corporations, partnerships and limited liability companies, the NFIB said.

While the concept of integrating individual and corporate taxes has been studied often, Congress has shown little taste for action, mainly because corporations worry they would have to make larger dividend payouts, said John Buckley, a former chief tax counsel for the Ways and Means Committee who until recently taught tax law at Georgetown University.

In addition, Buckley told Bloomberg BNA, passthroughs already enjoy some favorable treatment under the tax code as it is framed now, including being subject to just one level of tax.

CBO Outlines Options

The tax integration is about more than small businesses. Corporate tax integration addresses double taxation, first at the corporate level and then at the shareholder level.

Partial integration could address distortions between how businesses are taxed on either side of the code, the Congressional Budget Office said in a December 2012 report (235 DTR G-9, 12/7/12). The Congressional Research Service also delved into the question in a February report on the corporate income tax system (33 DTR G-5, 2/19/14).

Integrating the tax code would encourage more businesses to organize as passthroughs, lower federal revenues and reduce effective tax rates, the CBO said. It would also reduce two biases of the tax code: toward retaining earnings instead of distributing them, and toward debt financing because of the deduction taxpayers may take for the interest they pay creditors, according to the CBO report.

Integrating the two sides of the tax code would eliminate the conflict between C corporations and other types of business, said Brian Reardon, executive director of the S Corporation Association, which lobbies for tax policies favorable to such businesses.

“To the extent that he can pursue that, that would be terrific,” Reardon told Bloomberg BNA March 14.

Congress could also limit the use of passthrough organizations, which would probably raise effective rates on business investment, the CBO said. Or lawmakers could create a new entity-level tax that unifies taxes on business, the report said.

Lower Rate on Manufacturers

Lawmakers and the Obama administration have floated various ideas for business-related tax rates. President Barack Obama proposed a reduced tax rate of 25 percent for manufacturers, an idea that has received lukewarm support. The National Association of Manufacturers has said tax rates should generally be uniform across industries.

Sens. Susan Collins (R-Maine) and Claire McCaskill (D-Mo.) in 2011 proposed a small-business carveout in connection with a surtax on households with annual incomes of more than $1 million. To spare passthrough entities the surcharge, they proposed to separate active business income from passive business income, tracking the passive activity rules of tax code Section 469.

Passive investors would pay the higher rate, while owner-operators who actively participate would be protected from the surtax, which they proposed in the Jobs Creation Act (S. 1960). The bill didn't advance in the Finance Committee.

The National Small Business Association prefers comprehensive changes on both sides of the tax code and would be open to a corporate-only tax overhaul only if it didn't make the code more complicated, said Molly Brogan Day, the group's vice president of public affairs.

“If you're going to launch a big corporate reform, why not do all of it?” Day said.

To contact the reporter on this story: Marc Heller in Washington at This email address is being protected from spambots. You need JavaScript enabled to view it.This email address is being protected from spambots. You need JavaScript enabled to view it.

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Source: Bloomberg BNA

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