On February 22, 2012 the Obama Administration today released “The President’s Framework for Business Tax Reform.” Among the items discussed is the tax treatment of large pass-through entities.
The “Framework” does not contain specific proposals, but discusses in depth five principles to be followed in reforming the business tax code::
- Eliminate dozens of tax loopholes and subsidies, broaden the base and cut the corporate tax rate to spur growth in America
- Strengthen American manufacturing and innovation
- Strengthen the international tax system, including establishing a new minimum tax on foreign earnings, to encourage domestic investment
- Simplify and cut taxes for America’s small businesses
- Restore fiscal responsibility and not add a dime to the deficit
The discussion under principle 1 contains a section on pass-through entities, which states that the ability of large entities to use pass-through tax treatment distorts choices of organizational form and places corporations at a competitive disadvantage. It recommends as one way of broadening the corporate base, “establishing greater parity between large corporations and large non-corporate counterparts.”
The document does not advocate a specific way of establishing such parity, but refers the reader to the 2005 report of President Bush’s Advisory Panel on Tax Reform, which recommended that all large businesses pay one layer of tax at the entity level, and the ideas discussed by the President’s Economic Recovery Advisory Board in 2010, which did specifically discuss PTPs (and gave both pros and cons for taxing them).
The specific language relating to pass-through entities is as follows:
Page 7
(iii) Distorting the form of businesses
Business may be organized under a variety of different forms, including C-corporations, S-corporations, partnerships, and sole-proprietorships. These organizational forms offer varying legal, regulatory, and tax treatments. The primary difference in tax treatment between C-corporations, on the one hand, and S-corporations, partnerships, and sole-proprietorships, on the other, is applicability of the corporate income tax. C-corporations are subject to the corporate tax, while pass-through entities are not. (These other entities are known as “pass through” because profits pass through to the individual without being taxed at the entity level.)
“The combined effect of this varying tax treatment has contributed to a lower effective tax rate for pass-through entities relative to C-corporations. The effective marginal tax rate on new investment by C-corporations is now 32.3 percent, while the effective marginal tax rate on new investment by pass-through businesses 26.4 percent.[footnote omitted]
“As a result, large companies are increasingly avoiding corporate tax liability by organizing themselves as pass-through businesses. Pass-through businesses represented less than one quarter of net business income in 1980, but more than 70 percent of net business income in 2008—the most recent year for which data are available (see Table 4).[footnote omitted]While the pattern from year-to-year can be volatile, the overall trend is clear.
The ability of large pass-through entities to take advantage of preferential tax treatment has placed businesses organizing as C-corporations at a disadvantage. By allowing large pass-through entities preferential treatment, the tax code distorts choices of organizational form, which can lead to losses in economic efficiency; business managers should make choices about organizational form based on criteria other than tax treatment.”[footnote omitted]
Page 9-10
Reform the corporate tax base to invest savings in cutting the tax rate and reducing harmful distortions. This Framework lays out a menu of options that should be under consideration in reform. At least several of these would be necessary to get the rate down to 28 percent:
- Establishing greater parity between large corporations and large non-corporate counterparts. Establishing greater parity between large corporations and their large non-corporate counterparts should be considered as a way to help improve equity, reduce distortions in how businesses organize themselves, and finance lower tax rates. A variety of ways to do this have been proposed, including ones discussed in the 2005 report of President Bush’s Advisory Panel on Tax Reform,[footnote omitted] and in reform options developed by President Obama’s Economic Recovery Advisory Board in 2010. [footnote omitted] It is essential that any changes in this area should not affect small businesses.
Click here for a copy of the entire document.
Click here for NAPTP’s statement with regard to the President’s Framework for Business Tax Reform.