Policy 106 – Pass-Throughs

Policy 106


One Sentence Argument

The new Republican tax code’s tax cut for pass-through businesses is just another way for politicians to help their donors use accounting tricks to avoid taxes – only 10% of people claiming pass-through income are small business employers, and half conduct no business activity at all.

Issue Breakdown

We’ve heard “small businesses are the backbone of our economy” from politicians so often that it’s become almost a cliche, but in many ways, it’s very true. Most businesses – about 95% according the Brookings Institution – are not classified as what we normally think of as corporations, or “C-corporations,” but are instead registered as “pass-throughs.”

Instead of paying the corporate tax rate as C-corporations do, pass-through businesses allow their income to “pass through” to their owners to be taxed at the personal income tax rate instead of the corporate tax rate. It’s essentially counted as if all of the earnings of the business are actually personal income for the business owner.

The Republican tax bill allows pass-through owners to deduct 20% of their business income from their taxes. So say you ran a pass-through that brought in $1 million in income. Rather than pay taxes on all $1 million, you only have to pay taxes on $800,000 of it. That’s a huge break for the owners of these pass-throughs.

Helping Create Jobs, or Profits?

The Republicans gave this cut to pass-throughs in the name of helping small businesses and creating jobs, but does cutting pass-through rates really help small businesses create jobs? It’s a hard question to answer, because like squares and rectangles, virtually every small business is a pass-through, but not every pass-through is a small business.

In fact, according to the Department of Treasury, less than half of all people who claim pass-through business income actually conduct normal business activity at all. Of those who do, the vast majority are self-employed, with no employees. Only 10% of people claiming pass-through income were actually small business employers.

Many pass-throughs are just legal frameworks that the ultra-wealthy use to avoid taxes. They’re not really businesses, they’re just pieces of paper that say this rich person is working as a business and not an individual, and should therefore be taxed like one. Many millionaires and billionaires (our president included) earn most of their money through pass-through income, meaning that rather than helping small businesses, the new 20% deduction is just giving some of the rich an even bigger tax cut.

This isn’t an accident.

Giving rich “business owners” a tax cut wasn’t a necessary price to pay to give real small businesses tax relief. There are dozens of other mechanisms in the tax code that could be changed or added to give small businesses a tax cut (or added incentive to hire additional workers) without giving billions to the rich, but Congressional Republicans needed to give their wealthy donors a reward for their campaign contributions.

Further Reading:


NEXT: Policy 107 – EITC and Work Requirements →