Trump tax plans may affect business owners taxes

Trump tax plans may affect business owners taxes

(Wall Street Journal) – President Donald Trump’s plan to cut the tax rate to 15% for so-called pass-through businesses would be a radical change to the tax code.
The measure would apply to partnerships, S corporations, and limited liability companies that do not have to pay corporate-level taxes and instead “pass through” to owners a proportional share of income, losses or expenses that are now taxed at a top rate of 39.6%.
These businesses are global law or accounting firms, hedge funds, and private-equity funds in addition to small real-estate firms, car dealers, and manufacturers.
The appeal of becoming a pass-through business jumped after a 1986 U.S. tax overhaul set the top rate for individuals lower than the top rate for corporations. By 2011, more than half of business income was earned by pass-through entities.
Lowering the rate on pass-through income to 15% could enhance the appeal of these businesses. But it may also change taxpayers’ behavior, especially if the top rate on personal income is 37%.
“A large risk is that business owners will transform their wages or compensation income to avoid income, Medicare and even Social Security taxes,” said Michael Graetz, a former Treasury official under George H.W. Bush who now teaches at Columbia University’s law school.
Here’s how: Say a business owner has net income of $1 million a year from a partnership, plus substantial other income. Currently the top tax rate on the $1 million is 39.6%, or $396,000, whether the income is wages paid by the partnership or business income.
But if the rate on pass-through business income is cut to 15%, and the top rate on the owner’s compensation is 37%, some owners could try to lower their reported wages to bring their income-tax rate down.
The owner with $1 million could split that net income into a $50,000 salary and $950,000 in business income. The income tax bill would then drop by more than 59% to $161,000.
Policing such an issue would be difficult for the Internal Revenue Service because each case has to be considered individually, said Len Burman, co-founder of the Tax Policy Center in Washington.
“There is a long history of people taking advantage of rate differentials,” he said

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