One of the principal election promises of the Republican Party in 2016 US presidential election campaign was US tax reform. After several months of work, both houses of the US Congress, the House of Representatives and the Senate, arrived at an agreement and consolidated their respective tax reform bills into one bill.
The House of Representatives tax reform bill passed this month is focused on reducing the tax burden of small business owners. The tax code passed by the House of Representatives proposes a 25% tax rate (down from 39.6%) for small business owners who report profits as income in their individual tax returns. While still above the proposed 20% tax rate for corporations, the bill on its face appears to provide tax relief to small business owners. But will it really? That depends on how a particular small business owner makes his or her money.
Many small businesses earn passive income, either through royalties and licensing fees or by owning an interest in a pass-through entity. A pass-through entity is a common business structure such as Limited Liability Company or a Limited Partnership that is disregarded by the Internal Revenue Service; it does not pay tax on its income, the entity’s income is taxed solely and directly in the hands of the entity’s owners. Businesses that earn passive income will not benefit from this tax cut.
Since many business owners earn passive income through their current small business structures, the consolidated tax reform bill will not provide them with a real tax break. Small active businesses such as ones that provide goods and services will benefit from the tax cut proposed in the tax reform bill.
What we may see if the current legislation becomes law is that many small business owners may choose to restructure their businesses away from pass through entities in order to avoid possible additional income tax exposure. One should speak to a qualified tax attorney regarding the possible alternative structures for small businesses in light of the new law.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.