August 12, 2020

In Tax Overhaul Debate, It’s Large vs. Small Companies

Some of the biggest and most powerful companies in the United States are fighting for a cut in the official corporate tax rate, arguing that it is necessary to allow them to compete more effectively in the global market. But the nation’s millions of small businesses fear they will be the ones paying for it.

“We are in favor of comprehensive tax reform that includes both corporate and personal tax, but we are not happy with anything that raises the rate for us,” said Chris Whitcomb, the tax counsel for the National Federation of Independent Business, the leading small business lobbying and advocacy group, representing about 350,000 members.

The conflict, which in some ways is even larger than the controversial issue of how to properly tax multinational corporations on their global profits, arises because the vast majority of American businesses, including some large, well-known companies and prominent Wall Street firms, actually do not pay corporate taxes at all.

Beginning in earnest in the 1980s, millions of businesses shed their traditional corporate status to become what are known as pass-through companies. That led to a boon for business, but was a drain on the Treasury.

But what began as a typical Washington dispute between big and small business has been transformed into a fierce lobbying battle that pits some of the richest firms in the country against one another. Some big pass-throughs “are trying to conflate themselves with smaller pass-throughs,” said one official working on tax reform in Washington — so much so that they could be accused of “small business identity theft.”

Business executives have long complained that a traditional corporation’s profits are taxed twice, first at the corporate level, and then again on the dividends received by shareholders. Pass-throughs, by contrast, are allowed to distribute their profits directly to their owners and investors, who then pay federal taxes on their personal income tax schedule.

This arrangement, previously used almost exclusively by partnerships, very small businesses and the self-employed, proved especially attractive after the major 1986 tax overhaul, which cut personal rates below corporate ones. That spurred a vast migration to pass-through status, a shift that has continued up to the present day.

Of the 34 million business tax returns filed in 2009, the most recent data available, 32 million were pass-throughs, representing about 70 percent of net business income, compared with about one-quarter in 1980.

“Most businesses are pass-throughs,” said Eric Toder, institute fellow at the Urban Institute in Washington. “They dominate the business landscape.”

Companies that switched said the simpler, generally lower single-tax rules gave them a leg up and helped them grow.

McGregor Metalworking Companies, a family-owned business in Ohio and South Carolina, had 80 employees when it converted in 1986 and now has a work force of 370.

“It has been a real force for reinvestment,” said Dan McGregor, 69, chairman of the company, which has seven shareholders.

Even though the top personal income tax rate of 39.6 percent once again exceeds the maximum corporate rate of 35 percent, the pass-through arrangement remains attractive to companies like McGregor Metalworking, analysts say, by avoiding double taxation. And it is even more appealing to firms that are able to treat some of their income as long-term capital gains, which are taxed at no more than 20 percent.

In the 1990s, the introduction of “check the box” tax return procedures sped the growth of pass-through businesses. Other rule changes, allowing companies with more shareholders to qualify and affording investors increased protection against personal liability for their business’s debts, made pass-throughs even more popular — and not only among smaller companies.

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