GOP tax cut ap­plies to banks

They aren’t fi­nan­cial ser­vices firms, so own­ers qual­ify for new pass-through break, Trea­sury says.

Los Angeles Times - - BUSINESS - By Jim Puz­zanghera

WASH­ING­TON — It’s prac­ti­cally a dic­tio­nary def­i­ni­tion to say that banks pro­vide fi­nan­cial ser­vices. But when it comes to the new tax law, that’s not how the Trea­sury De­part­ment sees it.

Of­fi­cials there have de­cided that nearly 2,000 banks are not fi­nan­cial ser­vices firms and thus their own­ers qual­ify for a lower tax li­a­bil­ity un­der the $1.5tril­lion GOP tax-cut leg­is­la­tion that took ef­fect Jan. 1.

The de­ter­mi­na­tion, sought by the bank­ing in­dus­try, was one of dozens in 184 pages of pro­posed reg­u­la­tions is­sued this week by the Trea­sury’s In­ter­nal Rev­enue Ser­vice that will al­low high-in­come own­ers to claim a new tax de­duc­tion as part of an ex­pan­sive in­ter­pre­ta­tion of who gets the break de­signed for so-called pass-through busi­nesses.

Daniel Hemel, an as­sis­tant law pro­fes­sor at the Uni­ver­sity of Chicago, said the de­ter­mi­na­tion was a head­scratcher. “Most of us had thought that banks are fi­nan­cial ser­vices. The House Fi­nan­cial Ser­vices Com­mit­tee reg­u­lates banks. The Fi­nan­cial Ser­vices Roundtable rep­re­sents banks,” he said.

“It does lead to a bad head­line for Trea­sury and the IRS,” he said. “This so­called mid­dle-class tax break goes to those who own banks.”

The tax cuts for cor­po­ra­tions were straight­for­ward: The rate was slashed to 21% from 35%. But the cal­cu­la­tions are much more com­pli­cated for pass-through busi­nesses whose own­ers file through the in­di­vid­ual code. Those in­clude mom-and­pop op­er­a­tions, pri­vately held man­u­fac­tur­ers and large part­ner­ships such as law firms and hedge funds.

Un­der the tax law, those own­ers now get to deduct 20% of their busi­ness in­come if they make less than $315,000 for mar­ried cou­ples fil­ing jointly — no mat­ter what field they are in. The new de­duc­tion phases out at an in­come of $415,000 for cou­ples fil­ing jointly for some types of busi­nesses.

For other types of busi­nesses, the de­duc­tion doesn’t phase out at all. The reg­u­la­tions, re­leased Wed­nes­day, spec­i­fied which busi­nesses are ex­cluded

above the in­come thresh­old. In most cases, the reg­u­la­tions ex­pand the num­bers of high-in­come tax­pay­ers el­i­gi­ble for the 20% de­duc­tion.

“Pass-through busi­nesses play a crit­i­cal role in our econ­omy,” Trea­sury Sec­re­tary Steven T. Mnuchin said in re­leas­ing the pro­posed reg­u­la­tions. “This 20% de­duc­tion will lead to more in­vest­ment in U.S. com­pa­nies and higher wages for hard-work­ing Amer­i­cans.”

But that state­ment doesn’t com­port with an anal­y­sis by Congress’ non­par­ti­san Joint Com­mit­tee on Tax­a­tion, which es­ti­mated that the break would pro­vide the most ben­e­fit to wealthy tax­pay­ers. About 44% of the ben­e­fit this year would go to tax­pay­ers with an­nual in­comes of at least $1 mil­lion. That fig­ure rises to 52% in 2024.

The new reg­u­la­tions prob­a­bly ex­pand the ben­e­fit of the de­duc­tion to those high-in­come busi­ness own­ers.

“These new rules con­firm that the for­tu­nate few win and mom-and-pop shops lose un­der Trump’s tax law,” said Sen. Ron Wy­den (DOre.). “Tax plan­ners are al­ready scour­ing through the nearly 200 pages of reg­u­la­tions in search of new ways to keep wealthy clients from pay­ing their fair share.”

Bankers were among the big win­ners.

When Congress passed the tax cut leg­is­la­tion, it re­ferred to a pro­vi­sion in the In­ter­nal Rev­enue Code that listed types of busi­ness in­come that would be ex­cluded from the new tax break for high-in­come own­ers. Among those were busi­nesses in­volved in health, law, en­gi­neer­ing, per­form­ing arts, ath­let­ics and fi­nan­cial ser­vices, as well as “any trade or busi­ness where the prin­ci­pal as­set … is the rep­u­ta­tion or skill of one or more of its em­ploy­ees or own­ers.”

The bank­ing in­dus­try balked.

As of the end of last year, about 2,000 of the na­tion’s roughly 5,700 banks were pass-throughs. Known as sub­chap­ter S cor­po­ra­tions, those banks are set up like part­ner­ships and the banks’ share­hold­ers pay taxes on their in­come through the in­di­vid­ual tax code.

Most are small, with nearly two-thirds hav­ing as­sets of less than $200 mil­lion.

In April, three in­dus­try trade groups — the Amer­i­can Bankers Assn., the In­de­pen­dent Com­mu­nity Bankers of Amer­ica and the Sub­chap­ter S Bank Assn. — wrote to the Trea­sury De­part­ment urg­ing that banks not be in­cluded in the fi­nan­cial ser­vices cat­e­gory.

They ar­gued that banks al­ready are highly reg­u­lated and that Congress opted not to ref­er­ence an­other pro­vi­sion of the In­ter­nal Rev­enue Code that specif­i­cally refers to bank­ing. The groups said that af­ter ex­ten­sive dis­cus­sion with law­mak­ers and staff last year about the mat­ter, “we were as­sured re­peat­edly that S Banks would qual­ify” for the passthrough tax break.

The reg­u­la­tions re­leased Wed­nes­day, which will be the sub­ject of an Oct. 16 pub­lic hear­ing be­fore be­com­ing fi­nal, sided with the bank­ing in­dus­try view.

They said Trea­sury and IRS of­fi­cials agreed “fi­nan­cial ser­vices should be more nar­rowly in­ter­preted.” The reg­u­la­tions de­fine fi­nan­cial ser­vices as those per­formed by fi­nan­cial ad­vi­sors and in­vest­ment bankers, not tra­di­tional bank­ing ser­vices such as “tak­ing de­posits or mak­ing loans.”

“This does a lit­tle bit of vi­o­lence to the English lan­guage and it does a lit­tle bit of vi­o­lence to rev­enue col­lec­tion,” Hemel said of the in­ter­pre­ta­tion of fi­nan­cial ser­vices. “It will cost the Trea­sury prob­a­bly bil­lions of dol­lars over the course of a decade.”

He couldn’t es­ti­mate a pre­cise fig­ure, but the Joint Com­mit­tee on Tax­a­tion es­ti­mated in De­cem­ber that the pass-through de­duc­tion over­all would re­duce fed­eral tax rev­enue by $415 bil­lion through 2027.

Steven Rosenthal, a se­nior fel­low at the non­par­ti­san Tax Pol­icy Cen­ter, said the reg­u­la­tions showed “Mnuchin wanted to be Santa Claus in Au­gust.”

“This just high­lights the ar­bi­trari­ness of the whole ex­er­cise,” said Rosenthal, who had ex­pected banks would be ex­cluded from fi­nan­cial ser­vices in the reg­u­la­tions. “For Re­pub­li­cans who are sup­posed to be freemar­ket ad­vo­cates to ar­bi­trar­ily cre­ate win­ners and losers de­pend­ing on whether you like some types of busi­nesses is crazy to me.”

The reg­u­la­tions also clar­i­fied how some of the other ex­cluded fields would be treated.

In health, peo­ple who di­rectly pro­vide med­i­cal ser­vices, such as physi­cians, den­tists, phys­i­cal ther­a­pists and ve­teri­nar­i­ans, are not al­lowed to claim the tax break above the in­come thresh­olds. But those who don’t di­rectly pro­vide med­i­cal ser­vices, such as the own­ers of health clubs or spas, are al­lowed to claim the break above the thresh­olds.

Be­fore the tax law, the IRS code cat­e­go­rized some pass-through busi­nesses as hav­ing as their prin­ci­pal as­set the rep­u­ta­tion or skill of one or more of its em­ploy­ees. The tax cut added the own­ers of those busi­nesses to that pro­vi­sion.

How­ever, Trea­sury and IRS of­fi­cials opted to nar­rowly in­ter­pret the pro­vi­sion, lim­it­ing it to busi­nesses that re­ceive en­dorse­ment in­come, li­cense an owner’s or em­ployee’s im­age, voice or other iden­ti­fy­ing sym­bols, or re­ceive ap­pear­ance fees for those peo­ple.

“If a restau­rant’s big sell­ing point is a celebrity chef, does that mean that its trade and busi­ness is the skill and rep­u­ta­tion of one or more of its own­ers or em­ploy­ees?” Hemel said. “The IRS ba­si­cally took the po­si­tion that, ex­cept in un­usual cir­cum­stances, we will not con­sider you to be a skill or rep­u­ta­tion busi­ness un­less you fall into one of a few spe­cific statu­tory cat­e­gories.”

So a restau­rant run by a celebrity chef ap­pears to be el­i­gi­ble for the break, Hemel said. The same would be true for ho­tels owned or man­aged by Pres­i­dent Trump that bear his name.

“Ar­guably Trump’s D.C. ho­tel’s prin­ci­pal as­set is that its owned by the pres­i­dent of the United States,” Hemel said. “The IRS ba­si­cally said we’re not go­ing to make that ar­gu­ment.”

‘This just high­lights the ar­bi­trari­ness of the whole ex­er­cise.’ — Steven Rosenthal, Tax Pol­icy Cen­ter

Jim Lo Scalzo EPA/Shut­ter­stock

PRES­I­DENT TRUMP signed the $1.5-tril­lion Re­pub­li­can tax-cut leg­is­la­tion that took ef­fect Jan. 1

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