Article courtesy of STEP:
The corporate tax reductions in US president Donald Trump’s tax reform plan could prompt large numbers of US individuals to incorporate, in order to take advantage of the proposed pass-through provisions.
The plan’s 15 per cent tax rate on pass-through business income would apply to sole proprietorships, partnerships and so-called ‘S corporations’ – small businesses and private equity investors that organise themselves as partnerships or limited-liability companies.
Under current law, such businesses pass their earnings and deductions untaxed through to their owners, who pay an income tax rate of up to a maximum of 39.6 per cent. The Trump plan of 15 per cent pass-through tax, much lower than either the current 35 per cent corporate rate or the 39.6 per cent pass-through rate, would thus give them a strong incentive to incorporate, as is reported to have happened in the state of Kansas after it exempted pass-through businesses from state income tax in 2012.
As yet, though, details of Trump’s proposals are sketchy. For example, it is not clear whether the pass-through rate would be available to all pass-through businesses, or whether service businesses such as law firms, accounting firms and investment firms, and ‘large’ pass-throughs would be excluded, says law firm Proskauer Rose. It is also unclear whether ‘reasonable’ salaries would be deemed paid at the maximum individual rates.
Though the pass-through provision could cost the US Treasury hundreds of billions of dollars, it would be partly balanced by the abolition of many tax reliefs currently granted on corporate and individual income, or for certain special interest groups. It is still likely to attract strong opposition from Democrats in the US Congress, and some Republicans, as it will mainly benefit high-earning business owners.