‘Tax reform’ plan virtually guarantees tomfoolery

Ihave weighed in, too many times, on my belief that we will not see tax reform in the near future. In this judgment, I use the term “tax reform” to refer to a reformation of the tax system.

I have also often stated do not be surprised if we see tax rate cuts called tax reform. Add to that rate cuts for corporations and “pass-through” entities that have some connection to “business.”

Politicians often say that tax reform comes with lower rates and with fewer rates. So, if a proposal would tax all income at 20 percent, that is taken as the very definition of reform and simplicity.

But politicians actually don’t like one rate. They like more than one rate so there can be some preferential rate for prescribed special types of income. And they like to have certain transactions that are not taxed. Well, OK, lobbyists like these things.

In 1986 we lowered tax rates, reduced the number of rates, and, shockingly, eliminated the long-standing tax rate preference for “net capital gains.” This change lasted three years.

Without a special rate applying to a special type of income (i.e., capital gains), a lot of questionable tax planning time was eliminated. The (considerable) time savings came from eliminating efforts to classify all gains as capital gains.

Why was it such an effort? Because tax policy history allowed us to pay half the tax on capital gains rather than ordinary income. Today tax advisers spend a lot of time trying to classify assets as capital assets so the gains can be taxed at a lower rate. A lot of time.

Now the Republican “tax reform plan” threatens to create a full schedule of new games to play. We have been told through recent elections that “pass-through” entities are how business is operated in the U.S.

A pass-through business is one operated through a partnership form, which includes a limited liability company, or an S corporation. These entity types are most certainly the ones that are dominating tax filings.

If these pass-through entities are the dominant form of business entity, then any “reform” directed at lowering tax rates for “business” would seem to need to also target income from pass-through entities.

But the pass-through income tends to be reported on the return of an individual. Lowering corporate tax rates does not affect individual rates. And the Republican plan seems to be more interested in lowering business rates.

The result of all this are suggestions to create a lower tax rate for individuals that would apply to business income of a pass-through entity.

Treasury tax experts are losing their hair worrying about how to design a tax plan that limits the special lower tax rate to business income of a pass-through.

Political spokespeople tell us that the tax-writing committees will work that all out, and there will be adequate safeguards to ensure that rascals do not attempt to apply this special lower rate to nonbusiness income.

There is, unfortunately, something called “accountant humor.” It consists of jokes that only accountants can understand.

The statement that there will be adequate safeguards to ensure that there will be no tomfoolery or shenanigans with application of a lower rate intended for business income of a pass-through to other sources of income would get a spokesperson a standing engagement at the Accountant Comedy Club.

The spokesperson could just keep repeating that statement, and the accountants will be rolling on the floor with tears in their eyes. My side hurts right now just typing the statement.

There is no clarity in the idea that business income will be taxed at a special rate, and non-business income, including service income, will not benefit from that special rate.

If a special lower tax rate applies to “business” income of a pass-through entity, then I can assure you that there will be a dramatic shift in the mix of reported income from non-business to business (but with no change in actual business activity).

Pass the Republican tax plan as is, with business income of passthrough entities taxed at a lower rate, and let the tomfoolery and shenanigans begin.