Passthrough Taxation

Proposals for tax reform raise a number of significant questions for the future and operation of passthrough entities such as limited partnerships, LLCs treated as partnerships, and S Corporations. April 24, 2017
Businesses in the United States are most commonly formed as passthrough entities for tax purposes (such as limited partnerships, LLCs treated as partnerships, and S corporations). Such entities account for over 60 percent of net business income in the United States. Under current law, the income of passthroughs is generally not subject to tax at the entity level, and the partners or shareholders are required to take into account allocations of income from the passthrough entity. Accordingly, the income of the passthrough entity may be subject to tax at the individual income tax rates, which at the highest level are greater than the corporate tax rate. So the retained business income of passthrough entities is sometimes subject to a higher effective rate of tax than the retained business income of corporations.

Both President Trump’s proposals and the Blueprint offer that the “business income” of passthrough entities would be subject to a lower rate of tax, which would be the same as or close to the proposed corporate tax rate. The Blueprint proposes a cap on the tax on business income of a passthrough entity at 25 percent. President Trump has proposed allowing passthroughs to elect being taxed either at the proposed 15 percent corporate rate or at the tax rates applicable to individual taxpayers.

How these proposals are intended to interact with the general business entity tax reform is not clear.