Tax Break

Tax Foundation: Kansas tax cut plays favorites

May 30, 2012

Kansas Governor Sam Brownback REUTERS/Dave Kaup

Kansas Governor Sam Brownback cut his state’s income taxes on May 22, bringing the highest rate down from 6.45 percent to 4.9 percent and doubling the standard deduction to $9,000 for both heads of household and married couples. Overall $800 million of taxes per year are being eliminated beginning in 2014.

The Tax Foundation, a Washington-based research firm that favors lower taxes, highlighted a potentially unintended consequence in its May 29 analysis of the new law: its changes to the way pass-through businesses are taxed, possibly encouraging businesses to adopt this structure.

Owners of pass-throughs declare profits from a business as income under the personal tax code, rather than filing as a corporation. Popular forms include LLCs, S corps, partnerships, farms and sole proprietorships.

According to the report, business owners traditionally would pay themselves a salary, which would be taxed as income, and then any profit above the businesses costs would be reported as business income on the owners’ returns, and again taxed at personal income tax rates.

The new law makes that second category of non-wage income exempt from taxes, with a goal of boosting investment and the creation of 22,900 new jobs.

The Tax Foundation argues that this rewards the pass-through structure over others, like C corporations, so business owners will likely restructure as pass-throughs even if there is no other business reason to do so besides saving on taxes:

Kansas is on the right track by broadening its tax base and lowering its rates, but should be cautious about favoring some businesses over others. A better path to encouraging economic growth is creating a tax environment that is not overly burdensome and treats all businesses well. Further, while tax reductions can have positive economic benefits, they will cost revenue and will ultimately have to be paid for either by cutting spending or increasing taxes elsewhere.

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