Mnuchin: Some Services Companies Won't Get 'Pass-Through' Tax Rate -- Update

Some services companies such as accounting firms won't get the benefit of lower tax rates Republicans are planning for other businesses, Treasury Secretary Steven Mnuchin said Tuesday.

Republicans want to cut the 35% corporate tax rate. They also want to lower rates on so-called pass-through businesses, which pay business taxes through the individual tax returns of their owners at individual tax rates, which currently reach as high as 39.6%.

Many pass-through businesses are small. They also include some of the largest law, accounting and investment firms, which Mr. Mnuchin suggested might not get the new lower rate on pass-through business income that Republicans are planning.

The idea is to create a special tax rate that is equal to or higher than the corporate tax rate but lower than the tax rate that applies to wages. That new rate would apply to pass-through business income but with boundaries to prevent it from being used by people whose income from service businesses closely resembles wages.

"If you're an accountant firm and that's clearly income, you'll be taxed an income rate, you won't be taxed a pass-through rate," Mr. Mnuchin said. "If you're a business that's creating manufacturing jobs, you're going to get the benefit of that rate because that's going to be passed through to help create jobs and better wages."

Mr. Mnuchin's remarks, at the Delivering Alpha conference in New York, offered new detail on how the administration and Congress may tailor new rules for partnerships, limited liability companies and other pass-through firms that account for a majority of U.S. business income.

A Treasury spokesman declined to provide additional detail.

Unlike corporations, whose taxable investors have to pay taxes on capital gains and dividends while the company itself pays corporate income tax, there is just one layer of tax on pass-through businesses.

Under a system like the one Mr. Mnuchin described, the owners of an accounting partnership would pay the individual tax rate on both their salaries and their partnership distributions. But the owners of a manufacturing partnership would pay the individual tax rate on their salaries and the special, lower rate on their profits.

The details are crucial, because they will help determine which businesses win and which lose from the tax plan Republicans aim to push through Congress this year.

At the National Federation of Independent Business, the influential trade group for small businesses and pass-throughs, "everybody's eyes kind of popped out" when they heard Mr. Mnuchin's comments, said Brad Close, senior vice president for advocacy.

"We just think that's bad government policy, for sure," he said. "It picks winners and losers based on industry type, and we just think that's a terrible way to go for tax reform."

It could be a challenge to define which companies get the lower tax rate Republicans are planning and which owners of companies would continue paying higher individual tax rates on their business income. Creating that distinction would cut against another Republican goal for the tax code: simplification. Possibly affected industries include law, engineering, medicine, finance, architecture and consulting.

"Trying to define a service business is challenging because all businesses use a combination of services, capital and entrepreneurship," said Steve Rosenthal, a tax lawyer and senior fellow at the Tax Policy Center in Washington. "Rigid lists are easy to exploit. As a former tax planner, that's what we did. You give us a bright line, and we make sure to fall on one side or the other."

Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee, said last week that policy makers want to lower the tax rates on corporations and pass-through businesses by the same percentage. If the corporate rate is reduced from 35% to the low 20s, that suggests a pass-through tax rate in the high 20s.

Mr. Brady told reporters Tuesday that no decisions had been made and that he wanted to generate a significant tax cut for pass-through businesses.

Mr. Rosenthal said he expected Congress and the administration would write a vague anti-abuse rule and leave the details to the Treasury Department and Internal Revenue Service to fight it out with taxpayers.

"This problem has been out there for a couple of years and nobody's come out with good solutions," he said.

Mr. Mnuchin also said the administration and GOP tax writers are "absolutely" open to making any tax law retroactive to Jan. 1, which would allow companies and individuals to take advantage of the new rules on income earned this year.

A retroactive tax cut would increase tax refunds on the returns that individuals file in early 2018, putting more money in consumers' hands. It would also reward individuals and businesses for decisions they already have made, undercutting the argument that the point of tax cuts is to enhance incentives for future decisions.

Policy makers from the administration and Congress, known collectively as the Big Six, have been working on their plan to rewrite the tax code for months, and are aiming to put out a more detailed blueprint in coming weeks, Mr. Mnuchin said late last month. The group met Tuesday afternoon and Mr. Mnuchin and White House economic adviser Gary Cohn also met with Republicans on the Senate Budget Committee.

Republicans need to pass a budget before they can use the fast-track process known as reconciliation to advance a tax bill without Democratic votes. But some GOP lawmakers, including House Freedom Caucus leader Rep. Mark Meadows (R., N.C.), are wary of advancing a budget without knowing more details about the tax plan, including the tax rates on individuals, corporations and pass-throughs and the rules for capital expenses and foreign income.

The Treasury secretary said Tuesday he is still "incredibly hopeful" that Congress will pass tax legislation by the end of the year.

Tuesday evening, President Donald Trump is set to host a bipartisan group of senators at the White House to talk about taxes.

Most Senate Democrats insist that a tax bill not add to budget deficits and not cut taxes for high-income households. Those conditions make it nearly impossible for the GOP to get the 60 votes needed to overcome a filibuster.

"Where we can work with the president, we will," said Senate Minority Leader Chuck Schumer (D., N.Y.). "But we're not going to abandon our principles."

But the White House is angling for some Democratic support, both as a way to rack up a bipartisan achievement and as a cushion against the challenges of using the reconciliation process that allows for a simple-majority vote in a Senate divided 52-48.

"We also learned this summer [in health care] that keeping 50 of 52 Republicans is not something that's reliable," Marc Short, the White House legislative director, said at a breakfast hosted by the Christian Science Monitor.

"We don't feel like we can assume we can get tax reform done strictly on a partisan basis, so it's wise for us, not just from a policy perspective, but from a vote count perspective, to try to reach out and earn the support of Democrats as well," he said.

Louise Radnofsky contributed to this article.

Write to Kate Davidson at kate.davidson@wsj.com and Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

September 12, 2017 17:34 ET (21:34 GMT)