A. This proposed Social Capital Tax Credit could potentially be made available to non-corporate businesses and to corporations which pass the tax effect to another entity.
1. This tax credit could easily be made available to entities (such as some trusts and estates) which file their own tax returns and pay their own taxes on their income (as opposed to filing information returns where the tax effect is passed through to another entity or individual).
2. Making this proposed tax credit available to sole proprietorships and corporate and non-corporate entities which file information returns, such as S corporations and partnerships is more problematic.
a) The problem with making the proposed tax credit available to the sole proprietorship is in determining how much of the owner’s income is to be used in calculating the disparity of income ratio. How much of the business income is the compensation to the owner for services, and how much is related to the owner’s return on his or her investment in the business? It is potentially possible to develop some form of allocation, such as allocating a specified percentage of the business income to compensation for services or allocating the amount of income subject to self-employment taxes to compensation for services and the balance to return on investment, but any allocation method will be arbitrary.
b) In addition to the problem of determining how much of the owners’ income is to be used in calculating the disparity of income ratio, the problem with making the proposed tax credit available to corporate and non-corporate entities which file information returns and pass the tax effect to other individuals or entities is in determining the amount of the credit, since the credit is based on the amount of the tax after other deductions and credits, and this will be different for each individual or entity receiving the tax impact. However, it is possible to have the business report the tax credit percentage to the recipients, who would then apply that percentage to their own tax amount (after applying all other deductions and credits) related to the amount of the pass-through income to determine the amount of the social capital tax credit.
c) The simplest resolution would be to leave it to the business and its advisors to determine whether to incorporate or change its S-corporation election in order to take advantage of the proposed tax credit. Tax effect is a common consideration in choice of business entity decisions.
Richard E. Winder
Lindon J. Robison
Bryan K. Ritchie
Copyright 2012, Leadership Dynamics Research Institute