Sep 9th 2013
By Ken Berry
The more Congress tries to simplify the tax code, the more complicated things seem to get. At least that's what the American Institute of CPAs (AICPA) believes about a proposal to consolidate the myriad of tax rules for pass-through entities.
Tax reform is certainly in the air. As part of a collaborative effort, the heads of the two main tax-writing committees in Congress, Dave Camp (R-MI) of the House Ways and Means Committee and Max Baucus (D-MT) of the Senate Finance Committee, have been crisscrossing the country seeking input from the taxpaying public. Calls for significant reform are echoing on both sides of the aisle as well as in the Oval Office.
One of the first official tax reform drafts was released by Camp's committee in July. Commonly referred to as "Option 2," it includes several recommendations for revamping the tax rules applicable to small businesses. Under Option 2, for instance, the current Subchapter S (S-corporation taxation) and Subchapter K (partnership taxation) regimes are replaced by a single, unified regime. But the AICPA objected to this proposal in a letter dated July 30, 2013, that was sent to the committee.
Notably, the AICPA believes that the Option 2 "one-size-fits-all" approach for taxing pass-through entities isn't in the public's best interest. Therefore, it doesn't support Option 2.
"We understand that one of the objectives of proposing a single passthrough regime was to simplify the tax rules. However, in our opinion, the single regime that was developed in the Proposal does not provide the needed simplification," reads the letter. "Option 2 removes an entity choice for tax reporting purposes. However, fewer choices does not always result in overall and continued simplification for taxpayers."
In the AICPA's opinion, Option 2 creates rigid rules reflecting the complexities of the current partnership regime without the flexibilities of that regime. The AICPA also believes that the change prevents tax-free distributions of appreciated property from pass-through entities. In addition, the AICPA says that transitioning from the current Subchapter K and Subchapter S regimes into a single regime would result in significant complexity and corresponding costs.
The letter further states, "We strongly believe that the Subchapter S and Subchapter K rules should not be eliminated from the Code. Taxpayers need the simplicity of operating as S Corporations and the flexibilities allowed by partnerships with the ability to make allocations depending on their various and differing circumstances. Taxpayers benefit by having the choice of subjecting themselves to Subchapter K or Subchapter S. The Code should continue to include both forms as viable options for the business and investment communities."
Finally, according to the AICPA, if taxpayers desire a simpler taxing regime, they can choose to form a simple partnership with pro rata allocations, or they can opt to be taxed as an S corporation and forego basis and ownership flexibility. If taxpayers prefer more complex allocations so that various participants' (e.g., investor, manager, entrepreneur) economic goals are achieved, they may select the current partnership regime.
Bottom line: The AICPA's position is that a reduction in the number of pass-through regimes doesn't provide simplicity. It does, however, applaud the committee's efforts.
It was Abraham Lincoln who famously said, "You can please some of the people all of the time, you can please all of the people some of the time, but you can't please all of the people all of the time." Undoubtedly, if tax reform ever occurs, it won't be embraced by the entire tax community.
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- Tax Reform: Listen, Do You Want to Know a Secret?