Family Businesses Worry the Tax Overhaul Will Hurt Them

Family-owned businesses including grocery stores, craft shops, small manufacturers and others are worried tax legislation in Congress could leave them at a disadvantage to big corporations and other competitors.

At issue for these businesses is their structure as trusts, established to preserve an enterprise for succeeding generations, protect against estate taxes or a divorcing spouse or other claimants who might try to seize a stake. Some family-owned firms say the Senate version of the tax bill holds risks for them because it excludes trusts from a new tax deduction.

Family-owned businesses are a slice of the universe of "pass through" companies -- partnerships, limited liability companies and S Corporations -- that pay taxes through individual rather than corporate returns. Trusts in this category of business include Hobby Lobby, the arts and crafts chain founded by billionaire David Green, and Love's Travel Stop. They also include such small businesses as grocery stores, packaging makers, wholesalers and beer distributors.

Tax writers in the Senate crafted the bill in a way that prevents trusts and estates that operate businesses from reaping the benefits of new low business tax rates. Republican tax writers haven't explained their motives, but the move could save billions.

"If they are really left out of this, that in my opinion would be a problem," said Ed McCaffery, who teaches tax law at the University of Southern California's law school.

The issue isn't about the tax levied at death on large estates that Republicans are trying to reduce. It's about the income taxes due when a trust or an estate owns a business.

Trusts can vary in form, and the tax treatment is complicated. But for a certain type of trust known as an "electing small business trust" created by a 1996 law, or ESBT, the consequences of the tax bill could be profound if the Senate version of the tax bill becomes law.

Earnings generated by such trusts are taxed as ordinary income -- even if that income is retained with the company to be reinvested later. Every dollar of income is taxed at the top marginal rate, currently 39.6%, but 38.5% under the Senate bill. The Senate bill creates a new rule for pass-through businesses that gives those that qualify up to a 23% deduction on their tax rate. Trusts wouldn't get that deduction.

In contrast, other qualifying pass-through businesses would receive a top tax rate of just under 30%, when factoring in the new deduction. The tax rate applied to corporations would drop to 20% under both House and Senate tax bills. In other words, businesses held in trust would have to pay taxes of from 10 to 20 percentage points more than other types of companies.

"This is potentially devastating to myself and others," said Deborah Jacob, the chairman of MJS Packaging, which employs more than 100 people to design, make and distribute packaging and containers.

Ms. Jacob would like to keep the Livonia, Michigan, company going to hand it down to a new generation, but "it takes a lot of hard work" and "it's going to be made almost impossible given the uneven playing field that's being presented."

Bigger companies are also worried about being put at risk. "It does put us at a competitive disadvantage," said Jon Cargill, the chief financial officer of Hobby Lobby.

The subject came up at a closed-door lunch among Senate Republicans last week.

"We've singled them out to be mistreated," complained Sen. Ron Johnson (R., Wis.), about the motives of tax writers. "We couldn't offer that kind of discount to everybody so let's cut out trusts because they're an easy one to pick off -- we always hear about trust babies."

Mr. Johnson plans to press for trusts to be entitled to the same treatment as any other pass-through when a conference committee resolves differences between House and Senate bills. He added that Republican tax writers were constrained by their commitment to keep the cost of the bill at $1.5 trillion over a decade before accounting for economic growth, meaning not everybody could get a break.

Rewriting the portion of the tax bill that deals with pass-through entities is one of the biggest hurdles remaining for Republican lawmakers, who have passed versions of sweeping tax legislation through both chambers, with no Democratic support. It isn't clear how much it would cost to treat trust-owned businesses the same as other similar pass-through entities, but the cost might not be cheap.

"It's not a tiny sliver," Laura Howell-Smith, a managing director in the Washington DC tax office of Deloitte Tax LLP when asked about how many trusts were set up as electing small business trusts. She estimates that more than half of all partnerships and S Corporations would be adversely affected if trusts and estates are excluded from receiving a deduction available to other qualified pass-through entities under the Senate bill.

"When the government starts picking winners and losers, that starts to be a real challenge for us," said Rob Bartels, president and chief executive of Martin's Super Markets Inc. in South Bend, Indiana, a 70-year-old business with 23 stores that employs about 3500 people in Indiana and Michigan.

Martin's has faced competition against behemoths like Whole Foods Market, CVS Health Corp., Costco Wholesale Corp. and Dollar General -- all corporations whose tax rates would drop to 20%.

Write to Siobhan Hughes at

(END) Dow Jones Newswires

December 07, 2017 05:44 ET (10:44 GMT)