Who Should Get A Rate Cut In Tax Reform?

Annette Nellen

For the past few years, the focus of federal tax reform has been on reducing the corporate statutory rate from 35% down to 25% (H.R. 1 (113rd Congress, Camp)), 20% (House Republican blueprint of June 2016) or 15% (Trump 1-pager). The rationale for a corporate rate cut is that ever since we last reduced the top corporate rate from 46% to 34% with the Tax Reform Act of 1986, other industrialized countries did the same (in 1993 the rate was increased to 35%). You can see from this OECD data that most countries have a lower rate, although France is at 34.43%.

Most businesses don’t operate as C corporations. Instead, they operate as sole proprietors, partnerships, LLCs and S corporations. For these entities, the income mostly is taxed at the individual tax rates where the top rate is 39.6% although less than half of one percent of individuals are in that top bracket. According to a recent report from the Joint Committee on Taxation (JCT), for 2016, it is estimated that only 6% of individual returns report income of $200,000 or more. For married taxpayers filing jointly, at $200,000 of taxable income, about $45,000 of that income is taxed at 28%. They would need to have over $233,350 in 2016 to get to a 33% marginal tax rate, over $415,700 to get to a 35% marginal rate and over $470,700 to reach a 39.6% marginal rate.  If their income consists of capital gain income, it is taxed at 0% and 15% and doesn’t reach 20% until income exceeds $470,700. Basically, very few individuals are at today’s top individual rates although many who are have a lot of income.

Should only C corporations get a rate cut? I don’t think so.  If the goal of lowering rates is to improve competitiveness, than it makes sense to lower rates for all entities. Also, if only the C corporation rate is lowered, some other types of entities might find it advantageous to convert to the C corp form despite double taxation of corporate income (once by the corporation and again by the shareholders when a dividend it issued).

Recently, Treasury Secretary Mnuchin stated that accounting firms would not get a lower rate even if the rate is reduced for non-C corp entities. He implied that only firms creating manufacturing jobs would justify a rate cut. (Bloomberg, “Trump Officials Temper Expectation of 15% Corporate Tax Rate,” by Mohsin and Sink, 9/12/17.) Wow! The government produces lots of data, but I’m concerned that not many policy makers look at it.  According to the Bureau of Labor Statistics, accounting jobs are growing faster than for other industries – at an 11% rate. And these are good paying, interesting jobs that are key to business growth overall. In contrast, jobs for fabricators and assemblers are declining by 1%.

Barry Melancon, President and CEO, has a blog post on Secretary Mnuchin’s comments and the justification for lowering all business tax rates as part of reform – check it out. Also see this AICPA testimony for the Senate Finance Committee’s hearing of 9/19/17 on business tax reform.

Note: For the rate cut for non-C corporations, the owners must first pay themselves reasonable compensation to be taxed at individual rates + payroll taxes. The remaining income would be taxed at a lower top rate than other individual income though.

Have a question?

Contact Annette 

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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3 comments on “Who Should Get A Rate Cut In Tax Reform?

  • I agree with corp rate reduction to be more consistent with other countries.
    As to changing flow-thru taxation, one need to devise a fair system to divide the
    Income on cost of capital and earned/compensation income, but this really only
    Applies to those with income below the SS level.
    Partnership, S corporation, at risk and basis rules are quite appropriate and fair when properly
    The NIT should not be repealed if OBAMA is repealed and then all income of the
    wealthy should be classified as either or and taxed accordingly.
    Corp rates are high world wide but US individual rates are not so I really believe that
    the top rates should be increases, look at the breakdown of wealth in the 60s and 70s
    when top individual rates were 50% on earned income and 70% on passive.

  • If there is a rate cut, then I would expect special treatment of most tax situations to be eliminated. There is no need for most incentives and special tax breaks if the overall tax rate is reduced.
    This would parallel cutting out many itemized deductions available to individual taxpayers if the standard deduction is increased.

  • Michael H Jacoson

    The problem is two-fold. First corporations know how to adjust their end of the line (via bonuses and increased payroll to the executives), and have COGS and other adjustments that they can make;

    Then comes that factor that the individual tax rate is an adjustment that can help or hinder both Corporate earnings, as well as other income factors. It is not an accident that every time that the individual rate rises, there is a coordinating decline in purchasing. As a tax preparer, I always wonder why a person who receives a 2% increase in income may find themselves with an increase in their tax rate by simply moving from one margin to another. If we are going to be fair, how about simply eliminating most of the deductions (keep the dependency deduction) and have a fixed rate for individuals that they will be taxed at, with limited deductions. Not only will it make it easier for Treasury to estimate the amount of income that the government will receive, but will provide taxpayers a way of estimating their yearly income. I will bet that the increase in purchasing would make both industry and company executives and owners very happy.

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