Tax change for S corps, LLPs 'would create havoc'

Investment advisory firms and small-business owners generally could be facing tax increases if the Obama administration's plans for corporate tax reform move forward. Last Tuesday, Treasury Secretary Timothy Geithner raised eyebrows at a Senate Finance Committee hearing by suggesting that the government reconsider the tax rules that allow businesses to be taxed as partnerships, S corporations and limited liability corporations. “Congress has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they're treated as corporations for tax purposes or not,” Mr. Geithner said in his oral testimony. His comments were reported by Bloomberg last Friday. Translation: The government should rethink the whole notion of S corporations, limited liability corporations and other so-called “pass-through” entities in which business income flows through to the entity's owners and is reported on individual tax returns. The original reason for such a structure was to avoid the double taxation — on income and on dividend distributions — that owners of C corporations face. According to David Tittsworth, executive director of the Investment Adviser Association, the number of advisory firms with a limited liability structure has proliferated dramatically over the past ten years. And Bill Rhys, tax counsel for the National Federation of Independent Business said that about 75% of small businesses in the country use a “pass-through” tax structure. “Anything to do with corporate tax reform will be a big deal for our membership,” Mr. Tittsworth said. “The details will be incredibly important.” So far there are very few. The government has articulated two basic ideas on corporate tax reform. The country needs it and whatever it is, it has to be revenue neutral. Many tax experts say that the elimination of tax expenditures or tax loopholes won't be enough to reduce the overall rates on C corporations significantly. It stands to reason that, whatever tax relief C corps get from a reform effort are likely to come from S corps and other pass-through entities. It will come either from higher individual income tax rates — the highest individual tax rates are set to raised to 39% starting in 2013 — or by forcing these entities to become C corporations. “S corporations have been around for fifty years,” said Neal Weber, a tax specialist with RSM McGladrey. “This would create havoc in tax planning.” A hearing on small business and taxation Thursday at the House Ways and Means Subcommittee on Select Revenue is likely to be crowded.