Pass-Throughs Dominate Tax Reform Conversation

While lawmakers and the Obama administration both support simplifying an Internal Revenue Code described by one witness as “grotesque in its complexity,” lines in the sand are quickly being drawn on how it should be done. These lines were evident in a March 3 House Ways and Means Select Revenues Subcommittee hearing on small business and tax reform that focused on the burdens the Code places on small businesses and pass-through entities.


At the hearing, some members of the subcommittee sought to build a case against a suggestion to revisit the current taxation of pass-through entities. Treasury Secretary Timothy Geithner stirred controversy recently among the lawmakers and businesses when he suggested in testimony to the Senate Finance Committee that Congress should consider whether it makes sense … to allow certain businesses to choose whether they’re treated as corporations for tax purposes or not.”


Asked about the impact of requiring small businesses to be treated as C corporations, Patricia Thompson, chair of the AICPA Tax Executive Committee and the tax partner in a CPA firm in Rhode Island, said that it would hurt her clients tremendously under the current rules, but that it is too soon to predict its impact under a larger reform proposal. Ernst & Young partner Robert Carroll, a former Treasury official, labeled the concept “problematic. It would make the double-taxation problem bigger,” he said, referring to the tax on corporate income and the subsequent tax on dividends distributed to C corporations’ shareholders.


Thompson testified before the subcommittee on broader tax policy and process issues, particularly the impact of uncertainty on small businesses. She said the AICPA does not take a position on any specific tax reform proposals but champions tax simplification. The constant prospect of a change in tax laws makes it difficult for businesses to make long-term plans and make decisions, she observed.


The increasing number of temporary tax benefits compounds this problem, according to Thompson, and the goal behind an incentive is lost if taxpayers do not learn about it in time. For example, a tax incentive under the HIRE Act in 2010 (PL 111-147) was aimed at encouraging businesses to hire recently unemployed individuals. Yet, the law was not enacted until March and expired Dec. 31, giving employers limited time to learn about the credit and take advantage of it.  


Depreciation was another example given by Thompson where businesses need more predictability and less complexity. As the Code provides several kinds of depreciation with varying rates, “businesses have to maintain several different ‘books’ of depreciation and update them annually for each individual asset,” she explained.


The panel at a Senate hearing earlier in the week was unanimous in its warnings of the difficulty of reform, particularly reform that is revenue neutral. “It will be hard work,” said Mark Weinberger, one of five former Treasury officials who testified to the Senate Finance Committee. “Every poker game is revenue neutral,” he observed, as all the money leaves the table, “but it does not get distributed equally.”


Jonathan Talisman, who was assistant secretary of tax policy under President Bill Clinton, commented that the 1986 tax reform process was very difficult and took three years to complete.


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