How Trump's Business-Tax Proposals Could Apply to You

Article Highlights:

• Corporations: Top Tax Rate Reduced From 35% To 15%
• Pass-Through Businesses: Top Tax Rate Reduced From 39.6% to 15%
• Partnerships & Sole Proprietorships
• S-Corporations
• Pass-Through Businesses With State LLC Protection

This is the third in a series of articles related to President Trump's tax reform outline. Click here to read the first summary of the Trump Tax Reform.

As part of his tax plan, Trump would cut the top rate on corporate taxable income from 35% to 15%. So as not to discriminate against small businesses, he would also cut the top tax rate on pass-through businesses from 39.6% (the current top marginal rate for individuals) to 15%.

The term “pass-through business” refers to business entities whose income or losses are reported directly on the business owners’ individual 1040 returns, as opposed to the business itself being taxed, as is the case with C-corporations. Pass-through entities include partnerships that issue K-1s, which report each owner’s share of the business’s income or losses; these figures are transferred to each owner’s 1040. Self-employed taxpayers who report their income on Schedule C are also considered pass-through entities, as business profit or loss is included on these individuals’ 1040s.

This means that partners and self-employed individuals would enjoy a much lower maximum income tax rate of 15% on their earnings than would employees, who would still be subject to rates as high a 39.6% (or 35%, using Trump’s proposed top marginal tax rate). Although the IRS uses stringent definitions of “self-employed” and “employed,” if this provision passes, it could lead to some creative tax planning in which people who are currently treated as employees would be treated as self-employed so that they could take advantage of the lower tax rates; this would be especially true for those in higher marginal brackets.

S-corporations are also pass-through entities. An S-corporation has no more than 100 stockholders, and it elects to be treated as a small business. It is unclear how this proposal would apply to an S-corporation based on the limited details provided in the proposal. This is especially true because distributions (K-1s) from an S-corporation are treated as investment income, and it is doubtful that the final plan would allow a maximum 15% tax on S-corporation investment income. At the same time, working stockholders are required to take a reasonable salary; this is treated as employee income and is taxed at marginal rates of up to 39.6% (or 35% using Trump’s proposed top marginal tax rate). It looks like we will have wait and see on this one.

A corporation affords some liability protection, so if the 15% rate does not apply or only partially applies to S-corporations, partnerships and sole proprietorships with state LLC liability protection may become the favored business entities for small businesses.

Trump’s proposal also includes a one-time repatriation tax on corporate offshore earnings. The exact rate was not mentioned; it would be negotiated in Congress.

Not a lot of tax planning can be accomplished at this point, but if you have questions related to a business entity, please give this office a call.