The push for corporate tax reform is gaining momentum on Capitol Hill but most proposals to reduce the U.S. corporate tax rate could have unintended, adverse consequences for small businesses cautions the Kogod Tax Center, a new research institute at American University. The center has devised a proposal for comprehensive business tax reform that would ensure small business owners receive needed tax relief—and is urging policymakers to consider the proposal.
“If corporate tax reform moves forward in this way, small businesses will end up with an increased tax burden,” said David J. Kautter, managing director of the Kogod Tax Center, of the majority of proposals to reform the corporate tax rate. “That makes little sense if we are interested in growing jobs and enhancing the competitiveness of our economy.”
In his article appearing in Monday’s Bureau of National Affairs’ (BNA) Daily Tax Report and Daily Report for Executives, Kautter explains that the majority of U.S small businesses are structured as unincorporated “flow-through entities”—their business income is channeled directly to individual owners and is therefore subject only to individual tax rates, not corporate tax rates.
Corporate Tax Reform Pitfalls
Most corporate tax reform proposals rely on eliminating a range of “tax expenditures”—deductions, preferences, and credits that benefit all types of businesses. By reducing these tax expenditures, policymakers can increase the amount of business income subject to tax and then lower tax rates for corporations without adding to the deficit. Under most proposals, small, unincorporated businesses would suffer losing access to many tax deductions, preferences, and credits.
“The effect could be chilling to small business growth and innovation,” said Kautter. “If we eliminate business deductions for all businesses, including those that are not corporations, but only reduce corporate tax rates, we could hurt a lot of smaller businesses on Main Street in the process.”
Tax Center Solution
The Kogod Tax Center’s straight forward solution to what Kautter calls “the flow-through problem” calls for Congress to eliminate business deductions, credits, and preferences, and apply the same reduced corporate rate—a business rate—to all businesses, regardless of organizational form.
According to Kautter, this would be relatively simple to administer. Income from flow-throughs already appears on separate schedule—Schedules C and E—on individual tax returns. Under this proposal, a flow-through owner would simply add their income on those two schedules together and subject the total to the reduced business tax rate reschedule.
Kautter explains the proposal’s goal is to help “level the playing field for corporations and unincorporated businesses—without forcing Congress to deal with the massive task of individual tax reform.” He says that, if done right, this plan could also ease tax compliance and increase simplicity and fairness, which ultimately, could provide small businesses with the relief they need to compete and thrive.
Based at American University, the Kogod Tax Center is an independent, nonpartisan research institute focused on encouraging balanced, productive analysis and dialogue, and developing solutions with respect to tax compliance, tax planning, and tax policy matters affecting small businesses, entrepreneurs and middle-income taxpayers.