Republicans' plan to ditch healthcare to work on tax reform will be complicated by the fact that leaving Obamacare in place means keeping $700 billion in taxes, many of which are hated by some of the small businesses Republicans are trying to help.
Sen. Orrin Hatch and Rep. Kevin Brady, the top Republican taxwriters who will be tasked with writing the overhaul of the tax code, have said that they oppose the taxes and would prefer to see them eliminated in any scenario, but they have not said specifically if or how they might be repealed and their revenues replaced in tax reform.
The problem facing GOP lawmakers is that if they want to eliminate those $700 billion in taxes as part of tax reform without adding to the deficit, they would have to do so by eliminating a proportionate amount tax breaks, a possibility sure to invite fierce opposition from interests that benefit from those provisions in the tax code. Already, Republicans are on a collision course with the real estate industry and many others.
"It kind of creates a hole or a negative in trying to have a revenue-neutral tax reform bill," said Saul Rudo, the national head of tax planning at Katten Muchin Rosenman.
And one of the taxes in particular, a tax on investments for high-income earners, hits many of the small businesses that Republicans have been trying to create new provisions to help.
That would be the net investment income tax, a 3.8 percent tax surcharge on capital gains, interest and dividends for families making more than $250,000. Repealing the tax would cut revenue by $172 billion over 10 years, according to Congress' Joint Committee on Taxation.
Although the tax applies to individuals, it also falls on businesses that file through the individual side of the code, a category that Republicans are hoping to privilege with a new special tax rate.
"It hits a broad swath of family businesses," said Brian Reardon, president of the S Corporation Association.
S-Corporations are just one kind of so-called "pass-through" business, or a business in which income is reported on owners' individual tax returns. Along with sole proprietorships, partnerships and other forms of pass-throughs, they account for the majority of business income and employment in the U.S. Some are hedge funds or other big businesses, but many are the small businesses that have particular sway with their representatives.
Nonmanagement partners in S-Corporation businesses get hit with the 3.8 percent tax on the companies' earnings, Reardon noted. "It drains money from active businesses," he said.
Pass-throughs currently face a top tax rate of 44.6 percent at the federal level. That includes the top individual income tax rate of 39.6 percent as well as the 3.8 percent investment tax that the business' owners have to pay (it also reflects a 1.2 percentage point tax built in from another feature of the tax code: the Pease Limitation on itemized deductions).
Republicans want to get that rate down. The "Big Six" Republicans from Congress and the Trump administration working on tax reform have indicated that they want to create a special tax rate for pass-through businesses lower than the top individual rate. Trump officials have suggested that the rate should be the same as the envisioned corporate tax rate, at 15 percent.
The special rate proposal is an attempt to solve a problem that bedeviled and ultimately sank a bipartisan effort to lower the corporate tax rate in 2015. It would invite blowback from small-business groups to cut corporate tax rates without also lowering rates for pass-throughs.
Furthermore, the Republican motivations for tax reform are to lower taxes on investment and saving, which should encourage more of both and thus drive economic growth. Keeping in place an investment tax runs counter to that desire, noted Len Burman, a tax expert at the Tax Policy Center. "The difficulties are more political than analytical," he said, noting that Republicans could in theory simply reform the rest of the code while keeping the net investment income tax in place.