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  • Writer's pictureMallory Law Office

Tax Reform Could Distinguish Between Pass-Through Businesses

In April, the Trump Administration announced a broad outline for tax reform which included proposals to cut the top individual tax rate to 35% and reduce the top business tax rate to 15%.   This reduced business rate would also apply to “pass-through businesses” – the majority of U.S. businesses who report income on their owners’ tax returns rather than paying corporate income taxes.

However, Treasury Secretary Steven Mnuchin recently indicated that the reduced pass-through rate may not be available to service companies.

The idea is to create a special tax rate that is equal to or higher than the corporate tax rate but lower than the tax rate that applies to wages. That new rate would apply to pass-through business income but with boundaries to prevent it from being used by people whose income from service businesses closely resembles wages.

Under a system like the one Mr. Mnuchin described, the owners of an accounting partnership would pay the individual tax rate on both their salaries and their partnership distributions. But the owners of a manufacturing partnership would pay the individual tax rate on their salaries and the special, lower rate on their profits. It could be a challenge to define which companies get the lower tax rate Republicans are planning and which owners of companies would continue paying higher individual tax rates on their business income. Creating that distinction would cut against another Republican goal for the tax code: simplification. Possibly affected industries include law, engineering, medicine, finance, architecture and consulting.

Although many details are still lacking from the proposal, such a distinction – if included in the proposed legislation – could have a major impact on closely held businesses. The White House and Republican congressional leaders hope to reveal the full tax reform plan by the end of September.

For more information about how the latest tax reform plans could affect your business, please contact our office today.

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