Future Shock is Here: On Trump’s Pass-through Rate for Business Owners

Although the Trump administration hasn’t released any detailed tax overhaul plan, it has released a 1-page summary of principles outlining what they are aiming for, summarized here. In my comments below, I’ll focus on the pass-through rate for business and the lack of border taxes, but it’s worth reading through all the points to get a full picture of what the administration is has in mind.

 

  1. Corporate tax rate of 15%: The current federal rate is 35%
  2. Allows pass-through rate for business owners: Instead of self-owned businesses being taxed at the personal income rate, business owners would have incomes from operations taxed at the new 15% rate.
  3. No border-adjustment tax: Although favored by Speaker Paul Ryan and Kevin Brady, the chair of the Ways and Means Committee, the White House believes the tax does not “work in its current form.”
  4. A slight adjustment to individual tax rates: A change from 7 brackets to 3, with rates of 35%, 25%, and 10%. The top rate is 39.6% now.
  5. Doubling of the standard individual tax deduction: To $12,700 for individuals and  $25,400 for joint filers, double the current $6,350 for individuals and $12,700 for joint filers.
  6. A one-time repatriation tax: This would allow companies to bring back money from overseas to the US with a slightly lower, one-time tax.
  7. Elimination of the estate tax: No tax on assets being transferred through a will.
  8. Itemized tax deductions limited to charitable donations and mortgage payments: An attempt to close “loopholes” and offset the decrease in base tax rate for high income Americans.
  9. Repeal a 3.8% tax on net investment income: Currently levied on “individuals, estates and trusts” with higher than a certain threshold in investment income.
  10. Repeal the alternative minimum tax: A tax that requires some people who have large numbers of deductions to calculate their income tax under the normal tax rate and the alternative and pay the higher amount.
  11. No infrastructure spending: In spite of reports that the administration was considering including infrastructure spending in the plan.

 

Point 3 should be a big sigh of relief for importers, most of whom have been on the edge of their seats wondering if their margins would take a hit (or their prices would have to go up) if the current administration’s rumblings about tariffs were to become law. For now, at least, it appears that for importers, it’s business as usual.

 

Points 1 and 2 should be of great interest to all small business owners, many of whom operate as “pass-through” limited liability or S corporations. Pass-through entities include a variety of corporate structures, none of which pay federal income tax directly, but pass their earnings along to their owners, who in turn pay individual income tax on the money. If the above tax plan goes through, LLCs and S corps could potentially stop being pass-through businesses, report corporate rather than personal income and pay a flat 15% tax, which is significantly less than the 25% to 39.6% tax they currently pay as individuals. Naturally, high income individuals taxed at the high end of the rate schedule stand the most to gain, but this could also be an exceptional boon for small business owners across a broad range income levels.  

 

This potential new and interesting twist to the federal tax code also begs the question, why would anyone want to be an employee anymore? Why shouldn’t we all become LLCs or S corporations and put out a shingle for our services? A few hundred or thousand dollars invested in setting ourselves up as a business would pay for itself again and again, year after year.

 

In 1971, futurist  Alvin Toffler wrote in Future Shock that the future workplace would not be one of bureaucracies, but “ad-hocracies”of loose, impermanent associations between highly specialized individual contributors. Toffler swam decidedly against the tide of the mainstream who in the early 1970s saw an American future of only increasingly complex bureaucracy. Instead, he foresaw a more entrepreneurial work force and the dissolving of hierarchical institutions into interconnected resource networks.

 

Could it be that a radical change in the American tax code will usher in just what Toffler envisioned? It will be interesting to find out.