May 5th, 2011

Senate Finance Committee Chairman Max Baucus (D-Mont.) said May 4 that taxing large passthrough entities as if they were corporations may be a necessary part of any corporate tax reform effort.

To get the corporate tax rate down to 26 percent—as many tax experts have recommended—would require that all business tax expenditures be repealed, including deferral, and the research and development tax credit. Eliminating all business-related tax expenditures is not going to be an option, Baucus said, so “some have thought of taxing passthroughs as corporations after they’ve earned a certain income because so much business income these days is through passthroughs, not traditional C corporations,” Baucus said.

He noted that the change to the tax treatment for certain passthroughs would have to be considered in order to be able to bring corporate tax rates “low enough to make a difference.”

Baucus did not hint at what income level passthrough entities should be taxed as corporations, or even whether he would endorse such a plan, but said it is an idea that should be considered.

Corporate Revenue Reductions Noted

Michael Graetz, a tax expert and law professor at Columbia Law School, testified to the Finance Committee in March that passthrough entities, such as S corporations and partnerships that have revenues in excess of $50 million per year should be taxed more like C corporations. The Obama administration is expected to offer a proposal in the coming weeks to tax passthrough entities at a similar threshold.

Graetz said about 40 percent of U.S. business net income comes from passthrough entities, a substantially larger share than in 1990. As a result of the shift, corporate revenues will be reduced by about $140 billion by 2015, Graetz said.

“The 0.2 percent of partnerships that had revenues greater than $50 million accounted for nearly 60 percent of all partnership income that year. Unless one needs access to the market for public capital, it is foolish not to organize a business entity to be taxed as a partnership rather than a corporation,” Graetz said. He added that “creating greater parity between large corporate and passthrough businesses would be a valuable step to take.”