The Obama administration is seeking to widen the scope of its proposal to overhaul the corporate tax code, urging Congress to also change rules that allow some businesses to take advantage of tax laws governing individuals.
U.S. Treasury Secretary Timothy Geithner told the Senate Finance Committee Feb. 15 that Congress should “revisit” long-standing rules that give businesses a choice of paying taxes as a corporation or through a structure such as a partnership through which they can report business income on individual tax returns.
The recommendation, which Geithner repeated in a meeting with reporters this week at Bloomberg News in Washington, would affect income earned by the nation’s largest law firms, investment partnerships and so-called S corporations. It would more than double, to about $3 trillion, the amount of business income potentially affected by tax-law changes.
“Congress has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they’re treated as corporations for tax purposes or not,” Geithner told Senate Finance Committee members. Later in his testimony he said: “You have to look at business taxes outside the corporate sector if you’re going to do something sensible here.”
Obama called for a rewrite of business tax rules in his State of the Union address on Jan. 25 and in his fiscal 2012 budget proposal released Feb. 14. The House Ways and Means Committee, led by Michigan Republican Representative David Camp, has held one hearing on revamping the nation’s tax system and plans more.
Senate Finance Committee Chairman Max Baucus, a Montana Democrat, has said that the first in a series of hearings on rewriting the tax code will be held March 1.
Geithner’s suggestion confronts complaints by congressional Republicans, including Camp, who say the administration’s earlier focus on rewriting only the corporate code ignores how other types of businesses are taxed. Camp has said Congress should also examine the individual tax code because it affects so many businesses.
A spokesman for Camp, Sage Eastman, said a tax code rewrite should also simplify rules for individual taxpayers.
“You’ve left out in the cold individual Americans and their families who are dealing with massive levels of complexity and compliance costs both in terms of hours to comply and actual dollars to comply,” Eastman said. “It still falls short of the comprehensive reform that we need.”
U.S. businesses can pay taxes as a corporation, with a top 35 percent rate, or through structures that allow profits and losses to be reported on owners’ personal tax forms. The top marginal rate for individuals is also 35 percent. It is scheduled to rise to 39.6 percent in 2013.
Of 32.1 million U.S. businesses in 2007, 5.9 million opted to file under the corporate code, with total taxes paid of just under $1.4 trillion, according to the most recent data available from the Internal Revenue Service. About 7 million partnerships and so-called S corporations earned $484 billion and $976 billion, respectively. The rest of the businesses were sole proprietorships that collectively earned $335 billion.
To some degree, an examination of both forms of business taxation is unavoidable. Many business tax breaks, such as accelerated write-offs for equipment, benefit both types of filers. Eliminating a break in exchange for lowering the corporate tax rate would lead to debate about whether non-corporate businesses should be able to claim the deduction.
In an interview this week with reporters in Washington, Geithner indicated that the question about maintaining multiple tax classifications is more fundamental.
“What’s a little unique about our system relative to other countries is we do give a lot of businesses the choice of how their income should be taxed,” he told reporters. He also said the administration’s oft-repeated condition that an overhaul must raise as much revenue from corporations as is now collected applies to all forms of businesses.
“When we say revenue-neutral,” Geithner said, “we try to mean it sort of generally across business income, not just corporate.”
Pamela Olson, a tax partner at the law firm of Skadden, Arps, Slate, Meagher & Flom LLP in Washington and a former assistant secretary for tax policy at the Treasury Department, said policy makers have long studied “the huge gap between corporate and pass-throughs.”
“Congress may be forced to choose between eliminating the double tax on corporate income or requiring all businesses to pay a corporate-level tax,” she said.
Neal Weber, managing director of the Washington national tax office of RSM McGladrey Inc., said that including non-corporate businesses in talks about a corporate code rewrite would alarm his clients, many of which are small and medium-sized businesses.
“It strikes me that Secretary Geithner’s proposal to potentially force businesses to be taxed as corporations runs contrary to the administration’s objectives,” he said. “Most small to mid-sized businesses in the U.S. are structured as pass-through entities in order to avoid double taxation.”