Washington’s tax-reform effort has hit its first roadblock.
President Obama and key congressional Republican leaders have said for weeks that they are working on deal to reform business taxes that would lower rates and broaden the tax base by eliminating credits and deductions. The two sides are too far apart on individual tax rates for an overall deal, but Republicans have said they could settle for reforming the business side now and aim for the individual side in 2017.
But this week the small businesses whose support would be crucial for such a deal signaled that they are far from committed.
“Congress should not consider an approach that would disadvantage businesses that employ two-thirds of American workers, create more jobs and pay more in taxes,” members of the Coalition for Fair Effective Tax Rates wrote the Republican chairmen of the House and Senate tax-writing committees.
The group represents 71 national associations, including the National Federation of Independent Business, the International Franchise Association and many others.
Those groups include many businesses that are organized under the tax code not as businesses but as “pass-throughs” filing on the individual side, such as partnerships, sole proprietorships and S corporations.
Pass-throughs account for the majority of employment, including self-employment, and earn more income than C corporations do. In 2012, pass-throughs accounted for nearly $840 billion in net income, according to the Tax Policy Center. The majority of pass-through businesses are very small, in some cases dormant, but they also can be large companies.
Such companies are at particular risk in a business tax reform deal, because they could be put at a disadvantage to corporations if the statutory corporate rate is lowered from its current 35 percent. The top individual tax rate is 39.6 percent, and some pass-throughs face significantly higher state rates.
The Obama administration and Republican leaders have been working on ways to equalize the tax treatment of corporations and non-corporations without lowering the individual rate, which was set at its current level during the bruising negotiations that led up to the fiscal cliff deal at the end of 2012.
“We’re trying to see if there’s a way of finding common ground on business tax reform that includes pass-throughs, that’s very important to people like myself,” House Ways and Means Committee Chairman Paul Ryan said in late March.
Some Republican members have been skeptical of tax reform that doesn’t include lowering the individual rate for that reason.
On Monday, the Wisconsin Republican and his Senate counterpart, Republican Orrin Hatch of Utah, sent a letter to small business groups asking for ideas on how to accommodate pass-throughs.
In their letter, the Coalition for Fair Effective Tax Rates responded that “[a]s a practical reality no combination of credits, deductions or exclusions will bring about tax rate parity and produce a fair, simple, transparent and pro-growth tax code.”
Furthermore, the group accused Ryan and Hatch of endorsing the “president’s approach to tax reform,” namely working on business-only tax reform, which it said was “contrary to the aim of true tax reform.”
“We have received significant positive feedback and look forward to working with those who want to help achieve tax reform that helps American small businesses,” a spokesman for Ryan said.
Although Republican tax writers as well as White House aides have been saying that they are working behind the scenes on business-only tax reform, the small business group said that they were surprised to hear about it in the letters sent out by Ryan and Hatch.
“The members of our coalition seemed to be surprised,” said Jack Mozloom, a spokesman for the National Federation of Independent Business, a group that claims 350,000 small business owner members. Most members of the federation are organized as pass-throughs, he said.
In the past, Treasury Secretary Jack Lew has suggested that pass-through businesses could simply incorporate if they are placed at a disadvantage by corporate tax reform.
“The president’s people are strongly resistant to dealing with the individual side of the tax code,” Mozloom said.
