The President’s new corporate tax proposal rate of 15% may actually prove to create tax shelters for US taxpayers that would extremely difficult for the IRS to detect or pierce. At issue is the proposed 35% top individual tax rate and the 15% corporate tax rate which would apply to income from “pass-through” entities as well as corporations. The majority of American businesses are pass-through entities. The company itself does not have to pay tax, but “passes-through” the profit (income) to the partners in partnership, members in an LLC or shareholders in a corporation. This income is presently taxed on their personal tax returns at the appropriate individual tax rate.
In this new tax scheme, the incentive would be to simply convert the maximum amount of their present income into “business income” dropping their potential rate from 35% to 15%. This saves them $2,000 on every $10,000 of income generated, not to mention the almost 3% savings of the Medicare tax they are currently paying on their personal wages.
When pushed for a comment on the matter, Treasury Secretary Steven Mnuchin committed to ensuring rules would be created to prevent people from using a pass-through entity to cut their tax bill by more than half. I thought the whole point was to simplify the tax code? All this would do is create blurred lines and a lot of muddy water the IRS will not be able to sort through.
There are no clear rules or laws for determining the fair market value of a business owner in terms of salary. So what is to stop managing members and shareholders from lowering their salary to a minimum and claiming the business profits or a return on their owner’s equity at the lower rate contained in the new corporate tax proposal unveiled this week?
How do we know this is what will happen? The new corporate tax proposal is much like the recent decision in Kansas to exempt all pass-through entities from income tax in 2012. What happened in Kansas? Revenues immediately plummeted. Substantially. The Kansas legislature has been struggling to replace that lost revenue ever since. The same will happen on a federal level.
“The pass-through carve out in Kansas is primarily incentivizing tax avoidance, not job creation” Scott Drenkard, director of state projects for the Tax Foundation, said in recent testimony to Congress.
Will the new corporate tax proposal actually create new tax shelter opportunities for the majority of American businesses? Who knows what will finally pass Congress and be enacted into code. What I can tell you is that Allen Barron is positioned to help our local, regional, national and international business clients to implement sound strategies to reduce their tax burden and increase retained earnings. If you are interested in learning more about domestic and international tax strategies we invite you to contact us or call 866-631-3470 for a free consultation.