Pass-Through Entity Taxation: A Tempest in the Tax Reform Teapot

Source: Bret Wells, University of Houston Law Center, No. 2014-A-76, September 15, 2014

From the abstract:
Pass-through entities represent a major conceptual challenge for policy-makers today. But, pass-through entities did not occupy its dominant position with respect to growth-oriented small businesses prior to 1986, and the exponential growth in the importance of pass-through entity taxation since 1986 creates an impressive backdrop for the current business tax reform discussion. However, if tax reform proceeds along the path where corporate tax rates are significantly lower than individual tax rates, then small business taxpayers will be provided with a compelling economic incentive to exit pass-through entity structures in favor of C corporate entities. Tax reform that creates a monumental paradigm shift in the business planning premises of closely-held businesses will bring about transformative reactive tax planning on the part of the business community. Consequently, before enacting such a significant paradigm shift, Congress should clearly articulate the policy goals of this tax rate paradigm so that taxpayers will know which attempts to utilize C corporation vehicles as a mechanism to avoid the higher individual tax rate are acceptable and which such attempts cross the line. Where to draw the line is the historic challenge of the pre-1980 paradigm, but this reality has been shielded from our view due to the inverted rate structure that has existed since 1986.