Reuters reports that President Donald Trump and congressional Republicans are now tackling tax reform. Staffers are working straight through the August recess, with proposed legislation expected to be released in September.
Among the goodies expected in the new legislation: a lowering of the corporate income tax rate from its current level of 35 percent. President Donald Trump is seeking a reduction to 15 percent. Many Republicans in Congress are favoring a new 20 percent corporate rate.
Either cut, once enacted, would almost certainly trigger a feeding frenzy of tax avoidance. Here’s why: Tax avoidance planners seize on distortions in the tax law. One example: The current tax rate applicable to capital gains runs substantially lower than the rate for other income. So tax avoidance planners have developed strategies that cause non-capital gains income to be characterized as capital gains.
This particular distortion sits at the heart of the so-called carried interest loophole, the end run around taxes that lets ultra-rich hedge fund managers treat the income from their fund management work as investment income — and pay taxes on this income at the lower rate that applies to capital gains, while avoiding, at the same time, employment tax entirely.
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Under current law, individual income tax rates top out only slightly higher than corporate income tax rates, 39.6 percent for individual taxes as opposed to 35 percent on the corporate side. But this small gap doesn’t have much of an impact. Avoidance planners seldom try to convert what otherwise would be individual income into corporate income. Why bother? Corporate income, after all, faces another round of taxes once distributed out to shareholders as dividends.
So avoidance planers see no upside in the long run to lodging individual income in a taxable corporation. But that would change — and dramatically so– if Congress dropped the corporate income tax to half or less of the individual income tax…