Pass-Through Tax Implications

Aug. 1, 2012
More than a Passing Phase

In my previous column for this fine publication, I touched upon the pending “Taxmageddon” that could be awaiting the United States at the end of the year if Congress and the president fail to act. To briefly recap, unless action is taken, we will face $500 billion in tax hikes in 2013, which figures out to a whopping $3,800 per taxpayer on average. In fact, many believe we are already feeling the tremors of the pending doom and have been urging tax reform to combat the fiscal cliff that the Congressional Budget Office says we are headed for.

While I am a supporter of tax reform, I want to throw out a warning, especially to the many folks in the HVACR distribution industry who operate as pass-through entities: Be wary of any “tax reform” that limits itself to just the corporate tax code. Quite simply, corporate-only tax reform is not the wholesale change we need and could negatively impact small businesses.

Let's first look at why we need tax reform. I believe that small businesses are the most important economic driver in this country. When small businesses are succeeding, the United States economy typically flourishes. Unfortunately, the tax code is so complicated that small businesses spend nearly 1.8 billion work hours complying with it at a cost of about $19 billion annually. That tells me that we are making small business owners take valuable time and resources away from their businesses because our tax code is too darn big and complicated.

Now that we agree hopefully that the tax code is too cumbersome and that it needs fixing, we can go about looking for solutions. First, the relatively easy one, corporate tax reform. It's pretty well-known that the U.S. corporate tax rate is the highest in the industrialized world and the belief that it needs to be lowered is one of the few things that President Obama and congressional Republicans agree on. There is some disagreement over how much to lower it and which deductions need to be eliminated, but by and large it shouldn't be too difficult to compromise and get a deal done on the corporate side of things.

Where things get tricky is tax reform for pass-though entities or businesses that pay taxes at the individual tax rate. “Taxmageddon” would see a tax increase on the individual rates and hit small businesses particularly hard, taking away vital capital that businesses need to operate. The President and Congressional Democrats believe that the top rate for many pass-through entities should be raised AND tax deductions eliminated. House Republicans also believe that many deductions should be eliminated but think this should be offset by lowering the overall tax rate.

Many in Washington said that given the circumstances, we should go ahead and fix the corporate rate and return later to fix the problem for pass-through businesses. Small businesses should be wary of this as a proposition. According to the National Federation of Independent Businesses, corporate-only tax reform would place an additional burden of 8 percent per year on pass-through businesses (and this number is not inclusive of the pending 2013 tax hikes). This is not a situation that would benefit small businesses or the economy.

This fall, you will hear the candidates talk about their plans for the economy. They will undoubtedly reference the high corporate tax rate in our country and the need for reform; however, remember that tax reform for some businesses and not for all businesses is not “reform,” it's the status quo. Real reform is the type that benefits all businesses, large and small, and helps our economy grow across all sectors.

Jon Melchi is HARDI's director of government affairs. Contact him at 614/345-HEAT (4328) or [email protected].