Q: Republicans want to cap the tax rate on business pass-through entities at 25%. What does this mean?

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Q: Republicans want to cap the tax rate on business pass-through entities at 25%. What does this mean?

A: Bottom line: this is another way for Republicans to cut taxes for the very wealthiest, while pretending it is for “small and family-owned businesses.” This aspect of their current tax plan comprises about a third of their desired corporate tax cuts, according to analysis from the non-partisan Tax Policy Center. Here's a 3-pack q&a to break this down.

What's a pass-through business? For US taxes, there are 4 main business types: C corporation, S corporation, partnership, and sole proprietorship. C corps pay regular corporate income tax on their profits, which are also taxed when they are paid out to individual owners (“double taxation” at the corporate and individual level). S Corps, partnerships (like most hedge funds), and sole proprietorships are pass-through entities that generally pay no corporate income tax—their paid out profits “pass-through” to the people who own the businesses, where they get taxed as income or capital gains (“single taxation” at the individual level).

How do Republicans want to cut taxes for pass-throughs? Republicans want pass-through income to be taxed at a maximum rate of 25%. This would then differ from other kinds of income, such as W-2 income, where high earners are subject to higher marginal tax rates.

How does this amplify income inequality? A comprehensive analysis of business taxes, by 5 economists at the US Treasury and 3 academic economists, found:

  • “The structure of business activity used to be relatively simple, with C-corporations—traditional corporations subject to the corporate income tax—earning the vast majority of business income. This is no longer the case. C-corporations now account for less than half of business income, with ‘pass-throughs’—businesses whose annual income is taxed at the owner-level—growing rapidly in importance.” (See chart above with pass-throughs shown in purple.)

  • “As is well-known, the top-1% income share doubled (from 10.0% to 20.1%) between 1980 and 2013. Less well-known is that 41% of that increase came in the form of higher pass-through business income.” (emphasis added)

  • The authors point out that certain industries take particular advantage of pass-through structures and pay especially low tax rates: "This fact is especially clear in our partnership tax rate estimates by industry, with finance and real estate subject to an average [tax] rate of only 14.7%.” (emphasis added)

-originally published in the 10/15/2017 newsletter

Stephanie Lee