U.S. GOP tax lawmaker urges tighter U.S. partnership rules

WASHINGTON, March 12 Tue Mar 12, 2013 6:07pm EDT

WASHINGTON, March 12 (Reuters) - The top Republican tax writer in the U.S. House of Representatives on Tuesday proposed shaking up taxation of privately held businesses in ways that would tighten rules on partnerships, such as private equity and hedge funds.

House Ways and Means Committee Chairman Dave Camp laid out two options - one incremental; one more drastic - to revamp non-corporate business taxation, with the aim of reducing tax gaming and simplifying filing for hundreds of thousands of businesses.

Camp's plan addresses "pass-through" entities, the biggest of which are partnerships and S-corporations. Unlike publicly traded C-corporations, pass-throughs do not retain profits or distribute them as dividends. Rather, earnings pass through to the partners, who are taxed on them as personal income.

In general, Camp wants to streamline rules for S-corporations and tighten rules for partnerships, which have wide flexibility now in allocating profits and losses.

"We reduce the opportunity to play games in partnerships, while retaining some legitimate flexibility so that partners can participate in the business in different ways," said a top tax counsel for Camp who described the plan to reporters.

The Michigan lawmaker wants to pass tax reform legislation this year, but he faces deep divisions within his party and with Democrats, many of whom back raising revenue through reform.

PASS-THROUGH 101

Pass-throughs range from single owner shops to global private equity firms, hedge funds, law firms and accounting firms. The owners of pass-throughs file taxes through the individual tax code and the wealthiest among them now face a top tax rate of 39.6 percent.

By contrast, the top corporate income tax rate is 35 percent, though many large corporations pay far lower rates after using tax breaks.

An aide to Camp said the plan would impact hedge funds and private equity firms because of their use of "special allocation" rules to trim their tax bills.

Firms have been shifting from C-corp to pass-through status for years in part to avoid the corporate tax rate. Some of the Camp proposals could accelerate that trend.

One option that could cause pain for for some partnerships would require the firms themselves to pay a new withholding tax, which she said would be an administrative burden, according to tax attorney Linda Carlisle.

"That is very different from the ways things are now," Carlisle said. "That is now instead of me paying tax -- the partnership would be paying the tax for me."

Small businesses are a frequent sparring topic between the parties. Republicans oppose higher rates on wealthier individuals, while Democrats repeatedly have proposed raising the top tax rates paid by the wealthy.

Democrats won a key round in this fight in January with a deal ending the 'fiscal cliff' stand-off that raised the top tax rate on individual income above $400,000.

Camp's draft includes some relatively non-controversial measures, like making permanent a tax break for writing down the cost of equipment for certain business and easing rules to allow some businesses to use cash accounting.

The Obama administration has floated the idea of forcing large businesses now taxed as pass-throughs to file as corporations instead, something Republicans have resisted. "That is not something I am considering at this point," Camp said.

The draft is silent on "carried interest" earned by private equity and other fund managers that is now taxed at a lower capital gains rate, as opposed to the ordinary income tax rate.

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