Last week, the U.S. House of Representatives passed their latest round of tax cuts dubbed, “Tax Reform 2.0.” This package makes permanent the middle income and small business tax cuts currently set to expire in 2026 — which is an important step towards parity in the tax treatment between corporations and small businesses.
As tax writers found out while drafting the Tax Cuts and Jobs Act (TCJA), seeking equality in the tax code is difficult because businesses come in all sizes and structures. Congress succeeded both in lowering taxes on all businesses and in providing a more level playing field, but some glaring areas of incongruence still need to be addressed.
The tax code distinguishes between corporate income and small business or “pass-through” income which flows through to the business owners’ individual income taxes. The tax cut for corporations last December reduced the corporate rate to 21 percent permanently. Small businesses received a new 20-percent deduction, which is not permanent and is set to expire in 2026.
The result according to a recent analysis by Ernst and Young is that corporations will continue to pay a lower effective rate than successful small businesses, even when factoring in corporate shareholder-level taxes on capital gains and dividends.
If the House’s Tax Reform 2.0 does not become law by 2026, private businesses will pay an effective 40-percent rate compared to a 30-percent effective rate for publicly held corporations. Clearly, there is more room for improvement in leveling the playing field as Congress continues to update the tax code each year.
The next serious effort to cut taxes will require offsets to fit within the Senate’s arcane budget reconciliation rules. One unique opportunity would level the playing field while raising revenue. Senate Finance Committee Chairman Orrin Hatch has inquired about the tax treatment of banks versus large credit unions (which effectively operate as banks).
A recent letter by Chairman Hatch expresses the Finance Committee’s concern that “the credit union industry is evolving in ways that take many credit unions further from their original tax-exempt purpose.” Chairman Hatch deserves credit for drawing attention to this problem.
Small credit unions serve an important role in communities. Family businesses depend on them. When a credit union folds, main street businesses are left with fewer options. Credit unions were originally granted a tax exemption to serve members of modest means, but their customer base no longer reflects this intent.
Now, credit unions serve mostly upper-income patrons and have fewer low-income members. They no longer serve a common bond based on locality or employment, but increasingly take anyone who walks in the door.
Nearly 75 percent of the credit union tax exemption’s foregone revenue goes to the 281 credit unions with over $1 billion in assets each, or less than 5 percent of the entire industry. The remaining 25 percent of the tax benefit goes to the other 5,504 credit unions with assets of less than $1 billion each — 95 percent of the industry.
In other words, the credit union giants are reaping almost all of the tax benefits originally intended to promote local community lending, including to family businesses.
There’s no need to change the tax treatment of the small, community credit unions family businesses like to partner with. But there is no reason why Congress should let a few hundred mega-credit unions leverage the lion’s share of the tax benefit to eat up their smaller credit union competitors. Small credit unions across the country are even speaking up about the incongruence in the industry.
“I agree with Senator Hatch that many larger credit unions operate in the same manner as taxable banks,” said a concerned credit union executive in Idaho. He continues: “I believe it’s time for them to convert to bank charters and be taxed like the ‘big boys,’ because the credit union movement doesn’t need them.”
Changing the tax-exempt status for the largest credit unions could raise up to $30 billion for the next round of tax cuts. Congress should start by requiring goliath credit unions to be subject to the same disclosure filings as banks.
Providing additional relief to small businesses through permanency in the tax code and syncing the tax treatment of banks and large credit unions are both changes worth pursuing as Congress continues to modernize the tax code.
Palmer Schoening is Chairman of the Family Business Coalition in Washington, D.C.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of The Daily Caller.