Small Business Tax Credit Restoration Plan Draws Opposition

Gov. Ned Lamont’s proposal to return more than $60 million to Connecticut small businesses is facing opposition from some lawmakers. 

The governor’s budget recommendations included full restoration of the pass-through entity tax credit, implemented in 2018 to offset federal tax changes.

Restoring the credit—which impacts more than 123,000 small business—is one of CBIA’s 2023 Transform Connecticut policy solutions.

The 2017 federal Tax Cuts and Jobs Act imposed a $10,000 cap on deductions for state and local taxes, a major hit for small businesses organized as partnerships, S corporations, and LLCs.

The following year, Connecticut was the first state in the country to implement a pass-through entity tax and corresponding tax credit to offset the impact of those federal changes.

However, lawmakers reduced the credit from 93.01% to 87.5% to help address holes in the 2019 state budget.

Penalizing Small Businesses

A few state lawmakers expressed opposition to the bill during the Finance, Revenue, and Bonding Committee‘s April 3 public hearing on two grounds. 

Had the state not taken action back in 2018, one lawmaker suggested, businesses today would be financially far worse off—therefore, the state should be allowed to keep more of the credit.

That argument ignores the fact that the pass-through entity tax was implemented to help offset federal tax changes that unfairly penalized small employers.

Just two of the 28 states with a pass-through entity tax keep a portion of the corresponding credit: Massachusetts and Connecticut.

By reducing the matching credit a year later, Connecticut lawmakers also unfairly penalized small businesses.

Today, Connecticut is experiencing record budget surpluses, so shouldn’t we go back to doing the right thing for those small businesses and help them better compete?

Twenty-eight other states followed Connecticut’s lead by passing a pass-through entity tax credit as a result of the federal tax changes—yet just two opted to keep a portion of the corresponding credit for themselves: Massachusetts and Connecticut. 

Tax Policy

Second, there is a misperception that pass-through entity businesses are not shouldering the same tax liability as businesses organized as corporations.

While is some degree of truth to this, the numbers don’t tell the full story.

Corporations in the state pay a 7.5% corporate tax, while shareholders also pay taxes on their dividends or distributions. If there are no distributions, shareholders do not pay taxes. 

Pass-throughs typically pay their taxes via the personal income tax, with a top rate of 6.99%.

With the 6% reduction in the pass-through entity credit in 2019, small businesses are effectively taxed at 12.99%.

However, with the 6.4% reduction in the pass-through entity credit, those small businesses are effectively taxed at 12.99%.

In addition, other expenses are paid coming directly from the income of owners, including payroll, unemployment, social security, and other taxes and insurance.

Unlike corporations, pass-through entities are also taxed on income that is invested back in the business.

In other words, they are taxed for doing exactly what we want them to do—grow their footprint here. 

Connecticut remains a costly place to live and run a business. The budget holes that existed back in 2018 no longer exist, and lawmakers should be doing more to help Connecticut’s smallest businesses. 

---

For more information, contact CBIA’s Eric Gjede (860.480.1784) | @egjede.