When I Said Corporate Tax Reform, I Meant…

Wow. So, you bandy about a couple of phrases like “corporate tax reform” and you end up waking the sleeping giant…

The Obama administration has indicated, through U.S. Treasury Secretary Timothy Geithner, that it’s serious about corporate tax reform. And we’re not just talking about those rules governing multinational companies. That’s good, right?

Well, sort of. Now, the challenge is going to be what the heck actually constitutes a corporation. You see, on paper, it’s pretty easy: a corporation is defined by the rules of your state. But as a taxpayer, at the federal level, you have a number of options that determine your taxation. Wanna be a C corporation? An S corporation? An LLC taxed as a C? An LLC taxed as an S? An LLC taxed as a partnership? An LLC taxed as an individual? For the most part, these options are up to the taxpayer. And that’s making the idea of “corporate tax reform” just a bit more tricky.

Geithner believes it’s a huge issue, telling a Senate Finance Committee:

Congress has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they’re treated as corporations for tax purposes or not.

He’s not thinking about simply lowering rates or addressing repatriation. He’s clearly thinking about down to the root reform. That is a giant undertaking.

And it could get even bigger. Republicans in Congress have pointed out that if you tinker with those rules (especially on the pass-through side), you need to be prepared to deal with reform issues for individual taxpayers. This is, on its face, true since you can’t target one type of corporation only; those taxpayers will simply move their structures around to benefit from other rules.

Geithner seemed to imply that this might be best accomplished by forcing all corporations to be taxed as traditional corporations. That tends to result in the much reviled “double tax” scheme where corporations pay once on their profits and then shareholders pay again when they pull money from the corporation. That idea frightens small to medium-sized businesses which are likely to feel the most impact since they’re generally the ones which benefit the most from the current passthrough elections.

On a very basic level, what Geither is apparently suggesting – and what’s being bandied about in the tax world – is exactly what taxpayers have been asking for: a simpler tax structure. But as I’ve said before, we only want simple when it means fewer taxes. And despite assurances from the Obama administration that any tax reform would be “revenue neutral”, it’s likely to not be. Mathematically, I don’t see how you can talk about closing the tax gap with reform efforts and have it equal “revenue neutral.”

You and I don’t want to give up our home mortgage interest deduction, our tax favored retirement plans and our frequent tax credits. We say we want a simpler tax system but we really want to pay fewer taxes. So, too, do corporations. That’s going to make this notion of a complete tax reform a battle. Trust me on this.

The hearings on this issue begin on March 1. Stay tuned.