WASHINGTON — Sen. Orrin Hatch defended a late provision he added to the GOP tax bill that could extend significant tax breaks to real estate companies, among others. The controversy threw a spotlight on one of the bill’s largest and most complicated tax provisions, one where even small tweaks can affect large swaths of the economy.
The Utah Republican’s statement came after a wave of speculation that the benefit had been added to secure a “yes” vote from Sen. Bob Corker, R-Tenn., a wealthy real estate investor who has strongly denied any role in crafting the provision. Hatch said it was a product of House and Senate negotiations and had nothing to do with Corker, who had been on the fence before announcing on Friday that he was backing the bill.
The measure’s inclusion highlights an ongoing concern in every version of the tax legislation up to this point: Which industries benefit from a major new tax break — and which ones are left behind.
These gaps stem largely from the bill’s tax cuts for pass-through entities, a type of private business in which owners pay taxes on their profits as individual income. Examples include limited liability companies, S corporations and partnerships. They’re subject to a different set of taxes than corporations, which are set to receive a simple cut to their tax rate.
Thanks to the particular rules surrounding pass-throughs, wealthy architecture firms are singled out for big gains in the final bill, for example, but not in the Senate legislation. A small-town family doctor might qualify for a tax break in the final bill, but not a thriving upscale dermatology practice, and both would have been left behind in the House bill. And real estate companies, like those owned by President Donald Trump and his family, fare better in final bill than they did in the Senate plan.
“This is a place in the bill where you see really big differences depending on your sector of the economy and whether you’re an employee or not,” David Kamin, a professor at New York University School of Law, told NBC News. “They are distinctions that, to my eye, are hard to justify.”
These fights aren’t likely to end with the bill’s passage either. A group of 13 tax experts, including Kamin, released a report warning that the large disparities between which businesses benefit from the final bill are likely to spark a new wave of tax avoidance strategies. Industries left out in the cold might try to spin off parts of their company to qualify or look to attach themselves to another company that meets the requirements.
The main problem confronting lawmakers is how to confine tax cuts for pass-through businesses to actual businesses. The tax benefits are so significant that they create a major incentive for individuals to reorganize as a pass-through in order to avoid paying income tax. This was a big problem in Kansas, where the state eliminated taxes on pass-through entities entirely.
Both the House and the Senate included provisions to limit the gains and prevent certain professions from taking advantage, but they were complicated and produced large disparities between those who qualified and those who did not.
The bill that passed the House would have lowered the top rate on pass-through income to 25 percent from 39.6 percent. The biggest gains would have gone to “passive” business owners, who play little role in the company they own, versus “active” business owners, who could pay the lower rate on just 30 percent of their income unless they showed they were especially capital-intensive. Further restrictions limited service businesses, like accounting and law firms, from using the lower rate at all.
The rules would block a baseball star from putting his multi-million dollar salary into an LLC and getting the lower rate. But they also meant a billionaire who inherited a real estate company would get a huge reduction in their tax bill while a tiny accounting business would be left out.
“In order to mitigate potential abuses they’ve placed some guardrails, but those guardrails inevitably involve picking some winners and losers in the economy,” said Scott Greenberg, an analyst at the nonpartisan Tax Foundation. “That’s unfortunately going to be inherent to the policy design.”
In the Senate’s case, their bill would have created a 23 percent deduction pass-through entities could use. Service businesses were allowed to take the deduction this time, but they were blocked from doing so at higher incomes, where new restrictions kicked in.
Past that threshold, the Senate bill required that qualifying businesses could only take the deduction on 50 percent of the wages they paid employees. Once again, the goal was to prevent wealthy people from reclassifying individual income without a real underlying company.
The final bill hewed closer to the Senate bill, settling on a 20 percent deduction. But in negotiations with the House, some of its restrictions loosened up. Architects and engineers, who were excluded at higher incomes from the Senate version, were added in by name.
And then there was the provision that set off alarm bells: The new bill offered an alternative way for larger businesses to claim the deduction by combining 25 percent of wages with 2.5 percent of depreciable assets. The change was especially beneficial to pass-through companies with few employees and lots of property, a combination that’s common to the real estate industry.
“It’s not specifically intended to benefit real estate, although the way they’ve designed the provision makes it particularly favorable to real estate,” Greenberg said.
Amid blowback from Democrats, Hatch argued that the provision was conceptually similar to the House. Both included some measure, albeit different ones, that benefited businesses with bigger capital investments.
While Congress is still debating which industries deserve the new pass-through benefits, it’s a safe bet that tax lawyers will be arguing with IRS officials over how to interpret the complicated provision well into the future should the bill become law.
“It doesn’t look like we’re going to run short of work,” said Don Susswein, a principal at RSM’s Washington National Tax.