August 24, 2018

Tax Reform: Pass-Through Businesses

Partner Up - Tax Reform: Unfair Restrictions on Law Firms

Law Firms Excluded

Both the House and Senate tax reform bills include significant tax reductions for various “pass-through” businesses, including partnerships, Subchapter S corporations, and sole proprietorships. However, the pass-through rate reduction in the House bill would generally not apply to law firms and many other types of professional service businesses. Unlike the House bill, the Senate measure would provide the deduction to all types of pass-through businesses, including professional service businesses, but professional service providers could only claim the deduction if their taxable income does not exceed $500,000 for married individuals filing jointly or $250,000 for other individuals.

On December 13, ABA President Hilarie Bass sent a letter to the House and Senate conferees for H.R. 1, the “Tax Cuts and Jobs Act,” urging them include in the final legislation the Senate’s version of pass-through business tax relief. The ABA’s letter also urged the conferees to apply the tax relief to all pass-through entities—including law firms and all other types of professional service businesses—on an equal, non-discriminatory basis.

Call Congress Today: 

(202) 224-3121

"I oppose discriminatory provisions in the tax bills that exclude or limit law firms from receiving tax reductions as pass-through businesses."

Tax Reform: Pass-Through
Talking Points

  • House and Senate leaders are currently working to finalize tax reform legislation with a goal of passing the bill and sending it to President Trump for his signature before Christmas.
  • To accomplish this, they must reconcile a House and a Senate bill, both of which would reduce taxes on most non-service pass-through businesses but would unfairly deny the tax reduction for many law firms, accounting firms, and other types of professional service providers.
  • Law firms and many other types of professional service businesses create a large number of good paying jobs. In addition to directly employing many professionals and support staff, professional service providers also help stimulate job creation in the local community and throughout the nation by purchasing goods and services from numerous other businesses.
  • Because professional service businesses provide just as many benefits to our economy and contribute just as much to the nation’s goal of creating jobs and competitive wages as other pass-through businesses, professional service businesses should receive the same tax reductions and other benefits as all other types of pass-through entities.
  • Without the benefit of a fair and consistent pass-through tax reduction, the incentive to start or grow a professional business would be diminished. Accordingly, in any adjustments in the tax code, Congress should provide parity for all pass-through entities, regardless of their line of business, in order to achieve a fairer, simpler, and more competitive tax code.
  • The tax code should not drive taxpayers’ decisions on how to form their businesses. Under the principle of neutrality, Congress should minimize the effect of the tax law on a taxpayer’s decision, and encourage businesses to make decisions motivated by economic and business factors, not such superficial factors as which business form will receive the most tax benefits.
  • There is a long-standing principle in tax law that similarly-situated taxpayers should be treated similarly. Applying this principle to the taxation of pass-through business would require that all pass-through businesses—including law firms and other professional service providers—receive the same tax treatment.
  • In today’s economy, professional and personal service pass-throughs increasingly compete on an international level with businesses organized as corporations. They require a significant investment in tangible and intangible assets subject to economic risks, and rely on the contributions of salaried, non-equity professionals to generate a significant portion of their revenue. Artificially denying professional service providers the same tax rates and reductions available to other pass-through businesses would unfairly penalize these businesses for operating as pass-through entities.
  • For all these reasons, all pass-through businesses should be treated equally, and law firms and other professional service businesses should not be unfairly excluded from the provisions in the House and Senate bills that reduce taxes on pass-through entities. 

More About Tax Reform Pass-Throughs

What is a pass-through entity?

Pass-throughs are legal entities where income “passes through” to investors or owners, who then must report the income or loss on their own individual income tax returns. Common types of pass throughs include partnerships, Subchapter S corporations, limited liability companies, and sole proprietorships. A pass through is the preferred type of business entity for most small and new businesses, and the vast majority of law firms are organized as pass-throughs. Currently, pass-through entities generate more than 50% of business income reported to the Internal Revenue Service.

How are law firms treated unfairly in proposed tax reform legislation?

On November 16, 2017, the House passed its comprehensive tax reform bill, H.R. 1, titled the “Tax Cuts and Jobs Act,” which includes significant tax reductions for various pass-through businesses.

Under the House bill, many pass-through businesses would be taxed at a maximum rate of 25 percent on qualified business income, but any portion of the taxpayer’s net business income not deemed to be qualified business income would be treated as compensation subject to the taxpayer’s ordinary individual income tax rates. In addition, a reduced 9 percent pass-through rate would be phased in over five years for small pass-through entities based on certain income thresholds. However, the pass-through rate reduction in the House bill would generally not apply to law firms and many other types of professional services businesses, including those engaged in the fields of health, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.

On December 2, 2017, the Senate passed its own version of the Tax Cuts and Jobs Act. The Senate bill would reduce taxes on pass-through businesses by creating a 23 percent deduction for the non-wage portion of the pass-through income, effectively resulting in a top rate of 29.6 percent in the absence of other limitations. Unlike the House bill, the Senate measure would provide the deduction to all types of pass-through businesses, including professional service businesses, but professional service providers could only claim the deduction if their taxable income does not exceed $500,000 for married individuals filing jointly or $250,000 for other individuals.

On December 13, 2017, ABA President Hilarie Bass sent a letter to the House-Senate conferees urging them to adopt the Senate’s version of the pass-through tax relief. The ABA’s letter also urged the conferees to apply the tax relief to all pass-through entities—including law firms and all other types of professional service businesses—on an equal and non-discriminatory basis.