Now that historic tax reform is done, it’s time for Congress, the Treasury Department and the IRS to work through the details of implementing the new law. For Main Street employers, the stakes couldn’t be higher. As the dust settles, it is becoming clear that there is unfinished business when it comes to tax parity for American employers.
Main Street businesses are organized as pass-throughs, which make up 95 percent of all American businesses, and thus they employ the majority of U.S. workers. Because income should be taxed once and only once, pass-throughs make perfect sense as a preferred way to organize a business.
{mosads}The pass-through is a unique American innovation, making it possible for businesses of all shapes and sizes to start, grow and thrive. They are an essential part of keeping family businesses in the family. This makes it vitally important for the newly revised tax code to support Main Street employers and not work against them.
The new law gave C corporations a dramatically lower tax rate of 21 percent. Pass-through businesses, on the other hand, didn’t get a lower rate. Rather, they got a deduction that is challenging the skills and knowledge of the best tax professionals.
But because of the broad brush of new enforcement rules, most Main Street businesses won’t get the full deduction. Those rules limit access to the deduction based on income, industry, employment and investment. Too much of one or too little of another, and you don’t get it. For those businesses that are able to take the new deduction, they will still pay a top tax rate that is 40 percent higher than the new corporate rate. That’s not tax parity.
This disparity is made worse by the new law’s treatment of state and local income taxes. It permits all C corporations to deduct state and local taxes as a cost of doing business, but denies that deduction for Main Street employers if the state doesn’t levy those taxes at the business level. So family businesses in high-tax states face even higher taxes.
Finally, the deduction for Main Street employers expires in 2026, while the tax rate relief for C corporations is permanent. For most employers, this sunset makes effective planning and investing today nearly impossible even as it puts them at risk of large tax hikes in the not too distant future. While public companies are able to spend their tax cuts on bonuses, pass-through businesses are having to consult their tax advisors.
A coalition of Main Street businesses I am part of is committed to improving the new law by focusing on three key areas. First, we will work with Congress and the administration to ensure the new deduction applies broadly, and benefits bone fide Main Street businesses with real payrolls and real profits. Guidance from the Treasury Department and the IRS will be essential to getting this right, especially for what constitutes “qualified business income.”
Second, we will seek to restore parity by allowing pass-through businesses to fully deduct their state and local income taxes, just like all C corporations. This effort will take place at both the federal and the state level. Some states already permit pass-through businesses to pay their income taxes at the entity level, which under the new law means they can deduct those taxes as a business expense. More states should follow suit.
Third, we will begin work now with Main Street allies to make permanent a workable and sustainable pass-through deduction. After the last “fiscal cliff,” tax rates went up on Main Street employers and the estate tax was revived. With another cliff already on the horizon, we need to begin working now to avoid another and potentially larger tax hike.
While the corporate reforms in the new tax law are positive and pro-growth, the treatment of pass-through businesses still remains a work in progress. We need a tax system where employers on Main Street have tax parity with those traded on Wall Street. The three steps outlined above will help move us closer to that important goal.
Chris Smith is executive director of Parity for Main Street Employers, a coalition of national trade groups representing American businesses.