As tax reform rapidly continues to take shape, with both the House and the Senate passing its own version of a bill, pass-through businesses are starting to learn how these proposals could impact their organizations if and when the legislation is passed. Although both bills contain similar language on how C-corporations will be taxed, they are still far apart on how pass-through businesses will be treated.
One issue concerns family-owned businesses that have trusts within their structure. Many family-owned businesses are structured this way to provide estate planning opportunities and preserve their family legacy in the business for the next generation. Under the Senate's version of the tax bill, trusts would be excluded from the new pass-through deduction of 23 percent. This could mean a significant competitive disadvantage for these family-owned businesses.
Under current law, some trusts that own pass-through businesses (i.e. S-corporations, Partnerships, and Limited Liability Companies) are taxed at ordinary tax rates as high as 39.6 percent. Under the Senate's version of the tax bill, qualifying pass-through businesses will be provided a new deduction of 23 percent on their pass-through income before the new top tax rate of 38.5 percent is applied to this income. This would help lower the pass-through owner's effective tax rate and get them closer to being on par with the new C-corporation rate of 20 percent. However, the Senate bill as it is currently written will exclude trusts and estates from this deduction. Therefore, some businesses that are held in trust would have to pay significantly higher taxes compared to other types of businesses that would qualify for this deduction.
It is not clear why Republican tax writers have excluded trusts and estates from this deduction, although the exclusion could save millions of dollars in tax revenue. It is also unclear whether this would apply to all trusts, or certain types of trusts that pay the tax at the trust level (i.e., Electing Small Business Trusts). This would need to be clarified if this section of the Senate bill survives the reconciliation process.
Select members of the House and Senate have been appointed to a joint committee to begin the reconciliation process between the two bills. Committee members from the tri-state area are Senator Pat Toomey (R-PA), Senator Robert Menendez (D-NJ), and Senator Tom Carper (D-DE). The goal of the committee is to agree on one bill to be sent to Congress for approval and, ultimately, to the President for his signature.
It is a good time to discuss this issue with your advisor. This issue could have a major impact on your business if you have trust owners. If you have concerns about how this provision will affect your business, there is a short window of opportunity for you to express them to the committee members and/or your Congressional representatives, who can be reached at the email addresses listed on their respective websites.
If you have any questions or would like to discuss this subject further please do not hesitate to contact a member of Kreischer Miller’s Tax Strategies group at 215.441.4600.
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