On Nov. 3, ISRI joined nearly 100 trade associations and policy groups in a letter urging Congress to reject provisions of the Build Back Better Framework (the Framework) that would impose the Organization for Economic Cooperation and Development’s (OECD) highest marginal rates on family-owned businesses.
Released by the Biden Administration, the proposal would expand the 3.8% Net Investment Income Tax (NIIT) to all pass-through business income; impose a new surtax of up to 8% on all forms of income; and make permanent and expand the loss-limitation rules under Section 461 of the U.S. tax code. The White House estimates these measures would generate $650 billion over 10 years.
“ISRI signed onto the letter along with many, many other associations because this will adversely affect all small businesses,” says Billy Johnson, ISRI’s chief lobbyist. “This includes the recycling industry, farmers, and main street America like your local dentist or doctor.”
The letter expresses concern that the proposed tax rate hikes apply to businesses making less than the advertised levels. The new surtax imposes a 5% tax on a taxpayer’s modified adjusted gross income (MAGI) above $10 million, and an 8% tax above $25 million. The surcharge is much lower for estates and trusts: 5% in excess of $200,000 and 8% above $500,000.
“Increasing the tax rates goes against the idea that they won’t affect anyone making under $400,000 a year,” Johnson says. “[These provisions] will affect small businesses. For the recycling industry it’s essentially taking [away] money that the industry would otherwise use for further investment in new equipment, more fuel-efficient equipment, or technologically advanced equipment. [By] taxing it away you’re keeping them from buying more, hiring more, and investing more.”
The proposal aims to close a loophole that allows wealthy business owners to avoid paying both the Medicare employment tax and the NIIT. The loophole applies to pass-through businesses, typically S-corporations and/or limited partnerships. In pass-through businesses, income is passed to owners who pay personal income taxes on the income instead of getting taxed at the business level. With the current loophole, owners can cut their tax bills by classifying income as distributed profits instead of wages.
Under the proposal, all trade or business income of individuals with earnings over $400,000 (individual) or $500,000 (married couples) are subject to the 3.8% NIIT tax. This includes trade or business income earned by a non-grantor trust, which is currently exempt from the tax. The tax would apply to trust income over a relatively low threshold, currently $13,050.
The letter argues this would harm small businesses, because trusts are a common feature of succession planning.
“In most cases families use trusts for non-tax purposes, as they ease the transition of the business from one generation to the next by clarifying ownership and management roles and avoiding probate court,” the letter states. “Due to the prevalence of trusts, the higher tax rates included in the Framework would harm tens of thousands of modestly sized family businesses located across the country.”
Johnson notes that while the provisions are aimed at a particular investment class, they will end up drawing in and hurting more businesses including small and family-owned businesses. As a result, “larger companies could start buying out the smaller ones and that will lead to a rise in consolidation,” he says. “When similar major tax changes were introduced in 1987 and 2004, we saw a lot of consolidations where families were forced out. Big companies got bigger, and the smaller guys got squeezed out.” The letter argues that this is a particularly difficult time for family businesses that are confronting the COVID-19 pandemic, rising inflation, labor shortages, and supply-chain disruptions.
The House passed the Build Back Better Act on Nov. 19 and the Senate will take up the legislation during the budget reconciliation process. ISRI will keep its members updated on any changes or new additions to the bill as necessary.
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