Tax loophole in Trump’s plan would create windfall for the rich

Does Trump's tax plan favor the rich?
Does Trump's tax plan favor the rich?

When asked in April whether taxes should be raised for the wealthy, Republican presidential nominee Donald Trump told NBC's "TODAY," "I do." Yet his new tax plan includes three big windfalls for the wealthy, the least noticed of which may be the most important.

Much of the attention on Trump's tax plan, announced Monday, has focused on his raising the rate for top earners to 33 percent. While that's higher than the 25 percent he originally announced, it marks a reduction from the current 39.6 percent.

Trump would also eliminate the estate tax, saying that "American workers have paid taxes their whole lives, and they should not be taxed at death." Of course, the estate tax only kicks in for estates valued at $5.45 million for individuals and $10.9 million for couples, or roughly the wealthiest 0.2 percent of Americans.

Yet the biggest tax break for the wealthy would come from so-called pass-through income, or income that "passes through" a business to the individual returns of the business' owners. The Republican nominee says the cut is aimed at helping small business — and it will. But most of the benefits go to the very wealthy.

Currently, pass-through income is taxed at the individual rates, or a maximum 39.6 percent. Trump's proposal includes a 15 percent tax rate for owners of these businesses, which include sole proprietorships, S corporations, LLCs and other exotic structures used by the rich. That means the wealthiest business owners would get a huge boost from Trump's plan.

More than two-thirds of pass-through business income flows to the top 1 percent of tax filers, according to a new analysis by the Center on Budget and Policy Priorities. And most of that share goes to the richest of the rich. The top 400 earners in 2013 (the latest period available from the IRS) earned 20 percent of their income from pass-throughs, averaging more than $94 million each.

"This would take away one of the most progressive parts of the income tax," said Chuck Marr, director of federal tax policy at the CBPP, who co-authored the study with Chye-Ching Huang. "I'm surprised this hasn't gotten more attention."

Trump's plan could likewise result in many of the wealthy shifting their existing income to capitalize on these savings. When Kansas recently exempted all pass-through income from taxes, thousands of these entities popped up.

"History suggests that slashing the top rate on pass-through income to far below the top income and payroll tax rate ... would spur large-scale tax avoidance by expanding the incentive for high-income professionals to classify their income as business income instead of salary and wages," the report said.

Behind Trump's tax plan
Behind Trump's tax plan

Roberton Williams of the Tax Policy Center said high earners could easily recategorize themselves as "contractors" and lower their tax rate from 39.6 percent to 15 percent.

"There's no reason I couldn't do it," he said. "There is no real way for the IRS to police that, if people switched and called themselves contractors."

What's more, the CBPP said most of the pass-through companies are financial vehicles that contribute few jobs and little to the economy.

"Most of the partnership income that the top 1 percent of filers earn comes from finance and holding companies, not the sort of bricks-and-mortar businesses that the term 'small business' conjures," the report said.

When it comes to the wealthy, Trump touted his plan to eliminate the so-called carried interest loophole that allows hedge fund managers and private equity chiefs to have their earnings taxed as capital gains instead of income, to grab a lower 20 percent rate.

"Trump's saying to them, 'OK, you can't have the 20 percent rate, you're going to have to take 15 percent,'" Williams said. "I think the finance guys would be happy to take that."