Business groups hope to sink tax hike on pass-through entities

Business coalitions are scrambling to sink a last-minute, state income tax hike on the owners of small and mid-sized businesses, arguing it would weaken job growth and erode public trust.

The Connecticut Society of Certified Professional Accountants and the Connecticut Business and Industry Association both urged Gov. Ned Lamont and Democratic legislative leaders to drop the proposal, which would generate an estimated $50 million per year from so-called pass-through entities — limited liability corporations and other businesses that don’t pay the state corporation tax. Instead, the business earnings “pass through” to the owners, who then pay personal income taxes on them.

“These are not businesses that are making a lot of money,” said Bonnie Stewart, executive director of the society of CPAs, who noted the pass-throughs are still adjusting to a new taxing arrangement adopted last May. “We’re disappointed that the state continues its practice of giving and then taking away. This new proposal perpetuates the reputation the state has for inconsistency where tax policy is concerned.”

“This directly impacts Connecticut’s small businesses, the engine of the state’s economy,” CBIA President and CEO Joseph F. Brennan wrote in a newsletter posted online Thursday, adding that it “erodes” public trust. “It is a last minute change that had no public hearing and no opportunity for small businesses to speak out.”

The tax hike was proposed as part of a tentative, two year $43 billion budget deal struck by Lamont and legislators that attempts to close a projected $3 billion deficit.

Sen. John Fonfara, D-Hartford, co-chairman of the Finance, Revenue and Bonding Committee, said Connecticut businesses still would benefit tremendously from the entity tax arrangement, which was enacted last spring to help business owners work around the new $10,000 cap on state and local tax (SALT) deductions within the federal income tax system.

Here’s how it works:

For years, many small businesses paid up to 6.99 percent on their business earnings through the state income tax. Now their businesses also pay a 6.99 percent entity tax on the same earnings.

At first glance it appears to be double taxation, but it’s not.

Connecticut now allows these owners to reduce their personal, state income tax payments by 93 percent of the amount their businesses paid in entity taxes. This means that when the time comes to pay federal taxes, individuals face a $10,000 cap on the state tax payments they can deduct — but businesses do not.

These businesses can deduct their new state entity tax payments and secure big federal tax breaks — larger than the extra state taxes their owners had to pay — and state government also gains revenue in the process.

If this isn’t confusing enough already, Lamont and state lawmakers want to change things.

Instead of being able to reduce their personal state income tax obligation by 93 percent of the business entity taxes they paid, owners would only be able to reduce the bill by 87.5 percent. So, as the credit drops, these owners’ personal state income tax bill will rise.

Maribel La Luz, Lamont’s communications director, said even with that change, “individuals with LLCs are able to keep more of their money than they would have had the state not acted to protect them from the SALT cap last year.”

La Luz added that business groups are spreading “incorrect rhetoric that does not meaningfully contribute to a productive dialogue about how we get our state’s economy growing and working for everyone.”

But Stewart said businesses already were bracing for more tax instability. 

The Internal Revenue Service has warned it is reviewing SALT cap workarounds in several states, and could invalidate them.

Raising taxes by $50 million and changing a complex policy just one year after adoption could discourage owners from adding jobs, expanding product lines or services, or from purchasing new equipment, she said.

“People are just going to wait for one shoe to drop, then another shoe, then another,” Stewart added.

Rep. Chris Davis of Ellington, ranking House Republican on the finance committee and an opponent of the tax hike, called the plan” incredibly premature” and noted state tax officials still can’t say definitely how many Connecticut businesses are paying the entity tax.

Farmington CPA Robert Lickwar said “some of my clients have already begun to chime in. They can’t believe they [state officials] are going this route. I think it also discourages new businesses from locating here.”