How things change in a day. On Monday, when word leaked of Trump's plan to cut corporate taxes to 15% at most, it seemed clear that many corporations wouldn't see a lot of effect. Two-thirds of active corporations in any given year pay no federal income tax, according to a U.S. General Accountability Office study from last year. Effective tax rates are already around 15%, even a little lower.

But one of the negotiation tactics Trump prefers is unpredictability. Monday's news didn't telegraph that of Tuesday.

Trump will reportedly propose a 15% rate on income from pass-through businesses. That will affect many entrepreneurs, significantly cutting the taxes they would need to personally pay.

A pass-through business is one in which income is treated on a personal taxable level rather than being taxed first as a corporation and then as either income or capital gains of the owners, depending on how they structure their compensation. (For example, owners might pay themselves a salary, taxed as ordinary income, and then take additional payments as dividends, which are taxed at the lower capital gains rates.)

Some examples of pass-through business structures are limited liability corporations, S-corporations, partnerships, and sole proprietorships. These also happen to be types of business organization that many entrepreneurs use to avoid the extra taxes and regulatory paperwork of a traditional C-corporation.

A 2015 working paper from the National Bureau of Economic Research presented research from the tax year 2011. (There is usually a significant lag between the close of a tax year and when data is available for analysis.) In that year, 54.2% of all business income went through such pass-through structures, compared to 20.7% in 1980.

If you're reading this and run a business or participate in one, chances are very good that you use a pass-through structure. The NBER paper noted that the average federal income tax rate on pass-through businesses was 19%. Under the Trump plan, you'd save a clear 4 percentage points automatically. In fact, a 15% rate is the second lowest marginal tax rate possible.

This would be a big pay day for many entrepreneurs and, without additional action, would also still allow the tax saving strategies that business owners regularly use, lowering the effective tax rate even more.

Personally, I think there are some big problems with the plan -- and, yes, I'm self-employed, have been for decades, and would personally benefit from the rate drop. At what point do we lower the tax base so much that we can't support common activity already necessary? Much of the country's infrastructure is in sore need of repair and upgrade. Federal research led to important advances in science and technology, including the Internet. Increasing deficit spending indefinitely seems unwise and there is a limit to how little we can spend as a nation. Taxes pay for all this.

All the discussion may be moot. Congress would have to pass this and given the likely impact on the budget, it would need support from both sides of the aisle.

Published on: Apr 26, 2017
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