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Friday, January 13, 2012

Growth in Passthrough Entities and Terminology

A January 10, 2012 article in the Wall Street Journal caught my attention by the title - "More Firms Enjoy Tax-Free Status" by McKinnon. It explains the trend of the past few decades of the growth in passthrough entities and slight decline in the number of corporations. The graph included in this post is from the report the Joint Committee on Taxation presented to the Select Committee that was unable to find a way to reduce our growing deficits (JCX-49-11). The trend is a good reminder that taxpayers do respond to changes in the tax law. The key change was the Tax Reform Act of 1986 that dropped the top individual rate to 28% (it had been 50%) making it lower than the corporate rate that was dropped to 34% (it had been 46%).  Thus, it is likely that if Congress and President Obama succeed in lowering the corporate rate from 35% (where for 2011 and 2012 it matches the top individual rate),  the reverse may occur with some passthrough entities converting to C corporations (unless the double taxation feature of C corporations is an issue for them).

At one of the 2011 hearings on tax reform (I believe it was the 3/3/11 hearing on small businesses), the question was raised as to whether some large passthrough entities should be taxed as C corporations. That led to the introduction of S. Res. 88 calling for entitles to be able to chose their form.

  • The WSJ article title is too catchy - passthrough entities do pay taxes, that is, the owners pay taxes.
  • While there are a lot more passthrough entities than C corporations, the gross receipts picture is an opposite one.  Check my data page - here.
  • Why not talk about business tax reform rather than just corporate tax reform.  Or perhaps it should be business reform for large businesses such as those that are not sole proprietorships and have receipts over $500,000. After all, there are a lot of small businesses where the owners are not in the top tax brackets (because less than 2% of individuals are in the top tax brackets - see Tax Policy Center data).
  • How will we pay for lower tax rates?  Will the offsets hurt businesses, such as moving to slower depreciation methods and longer lives? (see 11/16/11 post on challenges of moving to even a 28% corporate tax rate).
What do you think about all of this?

1 comment:

Kenneth said...

Well written blog. I have a CPA and a masters in Tax and found this article to be full of helpful information. Regards, Ken