A new tax bill was introduced last quarter in the senate by Senator Susan Collins of Maine (R) and Senator Bill Nelson of Florida (D) called The Main Street Fairness Act. The bill seeks to provide federal tax parity between pass-through businesses (such as S-Corps, LLC’s and Partnerships) and C-corporations. It would essentially guarantee the tax rate for small businesses is never higher than that of a large corporation. This is a bipartisan bill, which is an encouraging sign of increased support for much-needed tax reform.
As is the case for most Liberatore CPA clients, most small businesses are organized as “pass-through entities” and profits are passed-through to the business owner(s). They are then taxed at an individual tax basis on the individual income tax returns (the form 1040 in this case).
Under current law, the top individual tax rate is 39.6%, while corporations pay a much lower corporate tax rate of 35%. This makes an already uneven playing field even less competitive, as corporations tend to have more access to funds and other resources.
The Main Street Fairness Act would prevent these pass-through companies from being taxed at a higher rate than C-corporations. Instead, income from pass-through businesses would be treated like corporations’ income.
The bill comes on the heels of increased focus on tax reform in Washington. Recently President Trump’s proposal on tax reform was presented by Treasury Secretary Steven Mnuchin and Gary Cohn, Director of National Economic Council, that seeks to reduce the corporate tax rate even further from 35% down to 15%. Congress is also working to pass tax-reform legislation. A version of the senators’ bill was previously introduced in the House of Representatives by Vern Buchanan (FL). House Republicans’ “Better Way Tax Reform Blueprint” that was introduced last summer, states that it builds on concepts from the small-business bill, according to Accounting Today. The tax-reform blueprint aims to lower taxes across the board, but it does not seem to provide for tax parity between small businesses and corporations. The blueprint aims to lower the top tax rate for individuals to 33%, the top tax rate for pass-through businesses to 25%, and the top rate for corporations to 20%.
Philip L. Liberatore CPA Observation
The proposal could potentially yield a significant tax savings for small business owners. At present, only income below $37,950 a year is currently taxed at 15% or less. Income earned through the pass-through entity would be able to benefit of the lower corporate tax rate. This specifically refers to an individual’s distributive share of “active business income” from a pass-through entity (excluding his or her “reasonable compensation” from providing services to such entity), where the top rate would be equivalent to the Corporate tax rate. It is encouraging to see bipartisan support building for much needed tax reform that could be a monumental shift for small-businesses nationwide.
In the senator’s joint statement, Senator Susan Collins said “small businesses employ more than half of all workers and have generated approximately two-thirds of our country’s net new jobs since the 1970s. Unfortunately, our nation’s small businesses face a higher tax burden that affects their ability to compete with large firms in the marketplace. Our legislation will help keep small businesses strong by ensuring that they do not pay a higher tax rate than large companies.” Collins further noted, “Keeping small businesses healthy keeps Americans employed and the economy strong.”
According to the same joint statement, small businesses generate half of the U.S. GDP, 54% of all U.S. sales, 41% of private sector payroll, and one-third of the country’s export value.
As is the way of doing business in Washington, legislation can take a long time to become law. We’ll follow the ongoing efforts in Washington aimed at tax reform legislation and alert you when it hits any big milestones. If you feel strongly about this legislation, make sure to reach out to your senators and representatives and make certain your voice is heard.