House Looks at Tightening Pass-Through Rules

Lawmakers are concerned that large companies may take advantage of a cut in the pass-through tax rate for small businesses.
Matthew HellerJuly 14, 2017

Republican lawmakers appear to be leaning toward coupling a cut in pass-through business tax rates intended for small businesses with rules that would prevent large companies from taking advantage of pass-through treatment.

At a hearing on tax reform, Rep. Peter Roskam (R-Ill.), who is chairman of the House Ways and Means subcommittee on tax policy, said the top marginal tax rate on small businesses needs to be reduced from 44.6% to 25%.

“This means more money to hire employees, and this means more money to grow your business,” he said.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

But Roskam also appeared sensitive to Democrats’ concerns that any reform should avoid cutting rates for large businesses by allowing big companies to take advantage of the pass-through rate. “Message received,” he said. “We need to understand that so that it can’t be manipulated.”

Most businesses in the U.S. are not subject to the corporate income tax but “pass” their income “through” to their owners, who report the business income on their individual income tax returns. These companies include partnerships, S corporations, most LLCs, and self-employed individuals.

But some large businesses are also set up as pass-throughs, including hedge funds, private equity firms, real estate developers, and major law firms, whose partners often pay a top rate of 39.6% on their earnings.

“Not all those that benefit from pass-throughs are genuinely small businesses,” Rep. Lloyd Doggett (D-Texas), the ranking Democrat on the tax policy subcommittee, said at the hearing. “Many of them are connected to Wall Street, to some of the wealthiest people in the country.”

Chye-Ching Huang, deputy director of federal tax policy at the Center on Budget and Policy Priorities, expressed similar concerns about a rate cut for pass-through businesses.

“In reality, it would mostly help wealthy filers — such as hedge fund managers, investment bankers, and real estate investors — as well as high earners who engage in tax avoidance by converting their salaries to pass-through income,” he said. “Few typical Main Street small businesses would see a benefit.”