Tax Reform for Small Businesses

Everyone agrees that changes are needed because current rules are too complex and too uncertain (with expiration dates of some breaks every year or two), and rates are too high. The Ways and Means Committee has issued a draft that addresses some of these problems.

The measures in the draft would reform and simplify a number of tax rules affecting small businesses and their workers. The draft also offers two approaches to modernize the way in which pass-through businesses (partnerships and S corporations) would be taxed at the federal level.

Proposals addressing complexity and permanency

The Committees wants to make permanent the Sec. 179 deduction (first-year expensing) for the purchase of equipment and certain other property at $250,000 (with a phase-out starting for purchases over $800,000). This change would apply starting January 1, 2014, when the dollar limit is set to drop from $500,000 this year to $25,000.

Other proposals:

  • Simplify and expand the use of the cash method of accounting after 2013.
  • Increase the write-off for start-up costs to $10,000 (instead of the current $5,000 limit). Costs over the limit could continue to be amortized over 15 years. A single rule would apply to sole proprietorships, partnerships, and corporations (rather than the separate rules that now apply) starting in 2014.
  • Change the due dates for business tax returns, with partnership returns due March 15, S corporations on March 31, C corporations and sole proprietorships on April 15. All filers would have a 6-month extension. Again, these changes would apply to tax years beginning after December 31, 2013.

Proposals addressing tax rules for pass-throughs
Currently, partnerships and S corporations have two distinct sets of rules for federal income tax purposes. The draft suggests two ways to change this.

  • Revisions to Subchapter S and Subchapter K (the part of the Internal Revenue Code for S corporations and partnerships, respectively). This option would simplify, modify, make permanent, or change a number of rules for S corporations and partnerships.
  • Create unified pass-through rules. This option would essentially end the current way in which these entities are taxed and, instead, treat them the same for federal income tax purposes, regardless of how they are organized at the state level.

Unaddressed issues
There remain many unanswered questions for these entities, key of which are the employment and self-employment taxes of partners and shareholders and the transition rules to facilitate a new tax regime for all pass-throughs if adopted.

Assessment of the draft
After reading the proposals, here are my views:

  • It’s clear that some of the tax problems of small businesses have been recognized (e.g., the ever-changing dollar limits on the Sec. 179 deduction and the filing deadlines burden on tax return preparers).
  • It’s also clear that the committee recognizes the need for transition rules should Congress want a new, unified tax regime for all types of pass-throughs.
  • The committee ducked the key issue: on what should Social Security and Medicare taxes for owners be based (essentially distributions or profits)?
  • The committee also didn’t address the tax rates that would apply on a unified tax regime. This question is particularly important in light of sentiment to drop the corporate tax rate. Should small business owners be paying federal income tax at as much as 39.6% when C corporations (including huge multinationals) may be paying 26%?

What do you think of these proposals?

The Committee is soliciting feedback on how to improve the proposals. If you want to express your views, send them to Chairman Dave Camp.

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