IS A PUZZLEMENT

As you all know by now, in the wee hours of Saturday morning the Senate approved its version of the “Tax Cuts and Jobs Act” by a vote of 51 to 49.  The Republicans were actually able to finally pass a bill in both the House and the Senate, despite the handicap of having arrogant idiot Donald T Rump in the White House!

FYI - see my post on "Making One Bill Out of Two" at TWTP.

This bill is not as good as the Republicans claim it is, and not as disastrous as the Democrats insist it is.  There is both good and bad in both the House and Senate versions of the bill.  

What is bad with ANY legislation at ANY time is rushing it through without proper intelligent review, research and discussion merely so the idiot in the White House, and the Republican Party, can claim a legislative victory (Trump really doesn’t give a rodent’s hind quarters what is actually in the bill – he just wants Congress to pass ANY bill so he looks good).  The “Affordable Care Act”, aka Obamacare, was similarly rushed through, with nobody actually reading in full the actual bill, to get an early victory for Obama – and, while like the tax reform bill it was based on a good concept, the actual legislation that passed was a mucking fess.

It is obvious that, despite what Trump tweeted in self-congratulation, the tax cuts for working families and the middle class in the bill is certainly not MASSIVE.  And let’s be perfectly clear - self-absorbed Trump truly gets a MASSIVE tax cut in this bill.

I look forward to seeing the final legislation that the conference committee will come up with.

One thing that has always confused me in both versions is the need to reduce the maximum tax rate on “pass-through” business income, which includes income reported by a sole proprietor on Schedule C.

Am I not seeing something?

Under current law corporations pay a maximum of 35% on corporate income, and when this income is passed to shareholders as dividends they pay a maximum of 20% in income tax and 3.8% in NIIT on the dividends. So, the income of a “C” corporation CAN be taxed at a maximum federal rate of 58.8%.

Pass-through business income is currently taxed at the business owners’ individual tax rate. It is not subject to NIIT. So, under current law the maximum federal tax on, for example, “S” corporation income is 39.6%. When you consider the phase-out of items affected by AGI the actual effective maximum rate may be a bit higher – but nowhere near 58.8% The purpose of pass-through treatment is to avoid the double-taxation of corporate income.

Partnership and sole proprietor income is also subject to the self-employment tax, but the W-2 salaries of corporate owners is subject to FICA tax. So this is not included in the above comparison.

So why does there need to be a reduction to the federal tax rate of pass-through business income?

All pass-through entities are not equal.  Owners of sub-S corporations must be paid a W-2 salary, taxed as a W-2 salary; the amount that is passed through on the K-1 is in full the equivalent of corporate dividends.  The “pass-through” income of sole proprietors and general partners is a combination of wage-equivalents and dividend-equivalents, but is currently taxed in full at ordinary income rates and subject in full to the self-employment tax.  And the deductions for health insurance and pension contributions for the self-employed sole proprietor and general partner do not reduce net earnings subject to the self-employment tax; they are treated as adjustments to income on the Form 1040.  These items are not subject to FICA tax for a corporate owner-employee.  It is the in the application of the self-employment tax that inequities exist. 

If nothing else, the pass-through rate changes add additional and unnecessary complexity to the mucking fess that is the Internal Revenue Code, and more unnecessary work and agita for us at tax time.

I would very much like to hear from fellow tax professionals on this issue.  You can send a comment to this blog or email me at rdftaxpro@yahoo.com.

TAFN