More Vitriol Aimed at Obama’s Tax Plan

Proposed changes to the tax code could spur S corporations and limited-liability companies to abandon their coveted &doublequot;pass-through&double...
Sarah JohnsonMarch 7, 2012

At a congressional hearing today, Mark Smetana, CFO of Eby-Brown Co., a privately held distributor, tried to persuade lawmakers that “pass-through” companies like his shouldn’t be effectively penalized for their tax status while larger companies fatten up on an overhauled tax code.

He noted a recent Ernst & Young report that found pass-through businesses — small and midsize entities organized as limited-liability companies or S corporations — pay 44% of federal business income taxes, even though they generate only 36% of business net income. “The recent framework for business tax reform released jointly by the Obama Administration and the Department of Treasury strongly implies that those organized as pass-through entities are advantaged in the current tax code over corporations,” Smetana said. “This is simply not the case.”

Smetana testified along with several tax experts at a House Ways and Means Committee hearing that the latest tax-reform proposal, introduced by the Obama Administration last month, will create a disadvantage for pass-through entities. The plan would lower the top corporate tax rate to 28% for most C corporations (manufacturing companies would have an even lower rate of 25%) and eliminate some tax incentives. Pass-through entities would lose the same incentives, but their tax rates would not go down.

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S corporations have multiplied since the mid-1980s, the last time major corporate tax reform was enacted. Only 22% of companies held that status in 1985, and now three-fourths do, according to Dewey Martin, a member of the National Federation of Independent Business. Such companies avoid double taxation — both the entity and its shareholders are taxed on their earnings — whereas S corporations’ taxable earnings are “passed through” to business owners, who are subsequently taxed.

Released on February 22, President Obama’s plan claims that “large companies are increasingly avoiding corporate tax liability by organizing themselves as pass-through businesses.” If his proposal prevails (though that’s unlikely during this election year), companies may once again reconsider their structures.

Smetana said that if passed, the proposal — which would also eliminate last-in, first-out inventory accounting ­— would result in his company retaining only about 40 cents of every dollar earned, versus 60 cents now. That “would reduce our ability to fund and invest in the business,” he said, and would put a strain on Eby-Brown’s cash flow.