By Les Raatz

Republicans are still expected to come up with significant changes in income taxation. The latest proposed significant change is to reduce the maximum marginal federal tax rate on corporations to 20% from its current essential rate of 35%, to lower it to be closer to the rate on business worldwide, and therefore enhance competitiveness of US companies internationally.  However the latest talk is that the maximum federal individual rate of 39.6% might not be reduced to 35%, as had previously been touted.

This top rate issue for individuals is not simple. The Trump administration has acknowledged that to be fair to individual business owners, so-called “pass-through” business entities (companies that are taxed directly to the individual business owner, like S Corporations, most LLCs, and partnerships) should also be taxed at or near the anticipated lower corporate rate.  But as this is thought through, there are many dissonant consequences.  An executive of a regular C Corporation potentially would be taxed on her compensation at the 39.6% rate, whereas the owner of a pass-through could be taxed at the new 20% rate for same kind of work.

Also, are the professionals at accounting firms, law firms and medical practices, many of which are pass-throughs, able to avail themselves of the 20% rate? Pass-through service firms, notably accounting firms, have recently been by cited by Treasury Secretary Mnuchin as businesses that will not benefit from the lower rate.  The Wall Street Journal surmises other professional service firms would be targeted in this manner should such tax legislation pass.  Alternatively, there may be some kind of splitting of pass-through income. For example, 50% may be taxed at regular individual rates and the rest at the new business rate.

Whether or not individual rates decline significantly, in the end there may not be great benefit for many. The original Trump proposal would pay for corporate (and pass-through) rate reduction by eliminating the itemized deductions for state and local taxes, like property tax and state and local income tax. Some have even suggested further limiting mortgage interest deductions.

This all a work in progress.

One final note: It seems that the 3.8% Net Investment Income Tax (a/k/a NIIT or Obamacare Tax) enacted with the Patient Protection and Affordable Care Act will not be repealed, regardless of how or whether the current bills in Congress progress.  However, for many pass-through business owners, the structures of businesses may be able to be modified to avoid significant self-employment tax and the NIIT.

If you have any questions, please contact Les Raatz in the Phoenix office at 602-285-5022.