Trump’s Tax Plan Unclear for Pass-Throughs

September 21, 2016

pic-taxes-fileOn Sept. 15, Republican presidential nominee Donald Trump released a recalibrated tax and economic plan that includes major revisions and clarifications of many of the business and individual proposals he included in the tax policy platform he unveiled last year – plus a new set of tax breaks specifically targeting families facing child care and elder care expenses.

Mr. Trump’s original tax reform plan was released in September 2015, and faced criticism from Democrats, as well as some Republicans, for being too costly and for targeting its tax reductions primarily at upper-income households. The nonpartisan Tax Policy Center estimated the plan could lose nearly $10 trillion in revenue over the next decade.

In an Aug. 8 2016 speech, Mr. Trump attempted to address some of those concerns by announcing that his tax platform now includes a top individual rate of 33 percent (with two other brackets at 12 and 25 percent), rather than the 25 percent top rate included in his original plan.

However, on Sept. 15, the Trump campaign release yet another fact sheet citing additional revisions of the plan that would reform the individual income tax code by lowering marginal tax rates on wages, investment, and business income. The latest version includes policy changes that have confused many—including NSBA—on exactly how he would tax small businesses under this broader tax reform plan. As described, the Trump plan, “will lower the business tax rate from 35 percent to 15 percent, and eliminate the corporate alternative minimum tax. This rate is available to all businesses, both big and small, that want to retain the profits within the business.”

Thus, the current state of the plan has led to multiple interpretations of the way that pass-through businesses would be taxed under the Trump plan. Since its release, some have argued that the phrasing indicates that the 15 percent rate is only applicable to businesses that choose to become C corporations. One indicator is that the sentence describes lowering the rate from 35 percent, which is the current rate for C corporations. A second factor is that it is available to businesses that want to retain the profits within the business, which is a property of C corporations.

Under the Trump plan, as in current law, after paying the 15 percent rate on retained earnings, such a business would then presumably be subject to an additional layer of tax on individual income. A 15 percent entity-level tax with a 20 percent tax on dividends comes out to a similar overall level of taxation as a 33 percent top individual rate. It is not immediately clear that pass-throughs would benefit from adding a second layer of taxation by opting for the 15 percent tax on their retained earnings.

After several days of confusion, on Sept. 21, his campaign announced some clarifications to his plan stating that it would allow all small businesses, partnerships and other unincorporated businesses to pay the same 15 percent rate he is offering big companies. Under his plan, they could elect to file their taxes as if they were incorporated. But for some – though not all – small businesses, that would subject them to the same second layer of taxation corporations pay when they distribute income to shareholders. The campaign went on to say that smaller firms would be exempt from that second tax, though larger ones would not, though they did not specify where it would draw the line. Small businesses would also have the option of continuing to pay their taxes through the individual side of the code, as they do today, if that is more advantageous for them, the campaign said. Therefore, under Trump’s plan, individual rates would range from 12 percent to 33 percent.

An evaluation by the Tax Foundation states that if you assume that the individual income tax rate on pass-through business income is the same as the rates on other individual income, the Trump tax plan would reduce federal tax revenue by $4.4 trillion over the next decade. But if the tax rate on this income is instead intended to be the same as the tax rate on corporate business income, the plan would then reduce federal revenue by $5.9 trillion.

Furthermore, the plan states that it would reduce marginal tax rates on labor and substantially reduce marginal tax rates on investment. As a result, the Tax Foundation estimates that the plan would boost long-run GDP, raise wages, and increase the equilibrium level of full-time equivalent jobs. Due to the larger economy and the broader tax base, the plan would reduce revenue by less on a dynamic basis: by $2.6 trillion over the next decade, if pass-through income is taxed as ordinary individual income, or by $3.9 trillion under the alternate assumption, where pass-through income is taxed purely at business rates.

For more information on Secretary Clinton’s small-business proposal, please click here.

NSBA strongly believes that allowing the smallest businesses to pay a much higher tax on their business income than a multinational, multi-billion dollar corporation undercuts any semblance to fairness. To promote economic growth, job creation, capital formation, and international competitiveness, fundamental tax reform is required. However, unless and until Congress agrees upon a replacement, NSBA believes that we must fix tax problems with the current tax code by developing simplification measures that are fair and fiscally responsible.