If passed in anything close to its current form, the unified framework for tax reform announced today would easily be the most far-reaching tax reform since 1986. But the tax blueprint raises more questions than answers. For example, the framework calls for a new 25% rate for small and family-owned businesses.
Will this rate be available for independent contractors working exclusively (or nearly exclusively) for a single client or customer? My best guess is no, but it remains to be seen. Otherwise, small businesses and employees should start studying how they might qualify as independent contractors!
Partners and Guaranteed Payments
What about partners that only receive “guaranteed payments”? A guaranteed payment is a promise to pay a fixed dollar amount rather than a percentage of profits. Partners receiving guaranteed payments are in many respects in a similar economic position as employees. (Although instead of being subject to wage withholding, they pay self-employment tax and quarterly estimated taxes.) If the special rate extends to guaranteed payments, employees will naturally request partner status.
What will mark the outer limits of a “small” business? Expect taxpayers to come up with clever ways to divide business enterprises and organizations into smaller units to fit into this exception!
The push to be a “partner” may clash with the desire to qualify as a “small” business. If the size of a business depends on the amount of its profits after deducting wages, but not deducting guaranteed payments and distributions paid to partners, then business owners will want to limit the shift from employee to partners. Every employee that becomes a partner will lower the amount of wage deduction and increase the amount of profits.
The blueprint also promises the same rate for “family-owned” businesses. Will businesses be punished if they bring in unrelated partners with special expertise? Will selling to financial sponsors and private equity funds result in a tax hike because the business is no longer family-owned? That seems harsh but it will be up to Congress to create the parameters.