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Opposition Growing to Kansas Income Tax Policy for LLCs

Hundred Dollar bills (Photo by J. Schafer)

OVERLAND PARK, Kan. (AP) — Being a Kansas attorney for energy interests pays well, thank you very much.
So for James P. Zakoura it just feels wrong to pocket an extra $6,000 at tax time, though state law lets him, The Kansas City Star reports. "I'd give that up in a second," said the Overland Park lawyer, a six-figure earner for decades. "I don't need it." But Kansas does, he said.

Zakoura regrets that the state in which he was born and schooled has been gasping for extra revenue the past four years. That's why he's among a legion of well-off Kansans openly objecting to the state's so-called "LLC loophole." Passed by the Kansas Legislature in 2012 on the promise of creating jobs, the provision allows about 300,000 independent business owners to pay no state tax on the bulk, if not all, of their income.  

By Zakoura's tabulations — work done on his own in hopes that lawmakers repeal the policy — Kansas is forgoing tax revenues on $11 billion of annual business income (including his). He says that rescinding the exemption would raise at least $260 million in needed revenue year after year. Revenue officials dispute the $11 billion figure, placing it at about $7.5 billion. But even fans of the tax gift say the $260 million figure is near the mark.

Just last May state lawmakers faced a $290 million budget gap projected through June 2017. To close it they slashed funding for highways, higher education and other programs.

Kansas Senator Jim Denning was unsuccessful last spring trying to get the tax law changed. He, too, benefits from the exemption as co-owner of a small LLC that rents out space. Now as the Republican Denning seeks re-election, he's hearing from angry voters. "When I go door-to-door I meet salt-of-the-earth people saying the number 1 issue in Kansas is to close that LLC loophole," said Denning, of Overland Park. "It's running neck-and-neck with school funding." He said the electorate is thinking: "Everybody should pay their fair share of taxes when businesses are profiting. "But I'm hearing it, too, from successful business owners. They feel like freeloaders."

Despite all its complexity, the income tax exemption has become a hot button — especially as Kansas schools, roads, law enforcement and health care delivery endure the strains of budget belt-tightening.

Some voters awoke to the issue with reports that University of Kansas basketball coach Bill Self, the state's highest-paid employee, avoids paying Kansas income taxes on most of his nearly $3 million income. He shelters a chunk of assets in an LLC.

"In 22 years of holding public office I've never seen a more aware electorate in Kansas than I'm seeing this year," said Democratic state Senator David Haley of Kansas City, Kansas. "No matter your politics, there seems a universal disdain for this loophole."

Universal confusion as well, says the Kansas Chamber of Commerce. It defends the no-tax policy as a means of spurring business activity.

"The first question I ask people is, what is the loophole that is supposedly the problem?" said chamber president and chief executive Mike O'Neal, who was speaker of the Kansas House when the tax cuts passed. "To me 'loophole' suggests someone is scamming the system."

No, O'Neal said, the law's intent never was sneaky: "We'd like to be a zero income-tax state."

Governor Sam Brownback has said he wants Kansas to keep making that possible for self-employed people, family-owned operations, partnerships and those income earners in an increasingly popular category called the LLC — limited liability company.

He told The Star last week: "The data shows we're getting a lot of people moving into the state because of the small business tax exemption and we're getting people moving, a number from Missouri, into Kansas."

But the governor also has said he believes the tax policy should be reviewed at least every five years to determine if adjustments need to be made, said his spokeswoman, Eileen Hawley. And 2017 would be five years. "He will work with the Legislature when it returns in January," Hawley added.

O'Neal said most LLC owners welcome the lifting of state taxes on business income.

But others who benefit are saying, "Thanks but no thanks." A few dozen of them, including lawyer Zakoura, stated as much in testimony to a Kansas House committee in March.

They're asking:

  • Where's the fairness in letting business owners skirt taxes on income — often called "pass-through" earnings — when their employees get no such break?
  • Why in an era of yearly fiscal emergencies would Kansas turn away a quarter-billion in potential revenues?
  • How can supporters of the LLC exemption argue that it creates jobs when, for the typical small business owner, the savings is less than $1,000 a year, according to one study?

That's hardly enough to pay just a month's worth of minimum wage.

— And how did the state's farmers get a pass on paying Kansas income taxes, even in profitable years?

You may be surprised at who's asking.

LeEtta Felter of Olathe is co-owner with her husband of several LLCs, including a small farming operation. She even used one of their LLCs — a car dealership — to stage a rally for Brownback when he sought re-election in 2014. She wishes she hadn't. Felter, who sits on the Olathe school board, says her tax freebie harms the state far more than it boosts her bottom line. "I feel I owe the state of Kansas a little bit of an apology for helping (Brownback) get re-elected," Felter said. As a school board member she wants secure funding of education. She worries that children's programs will be further squeezed of state help. And she deals with teachers who see the effects of strained budgets while paying their share of income taxes. Beyond those concerns, Felter argues that the LLC loophole works against entrepreneurs taking investment risks to launch startups: They can't claim losses as they could before tax reform. So Felter and her husband wind up paying more in taxes if their businesses don't profit in a given year.

Johnson County lawyer Dan Doyle came clean in a 2014 interview with The Star. "I'm making out like a bandit, and it's completely unfair," he told columnist Barbara Shelly. At the law firm where Doyle and 15 partners worked, the attorneys' Kansas income-tax liability became shielded by the LLC umbrella. He said it saved him $5,000 to $10,000 a year in state taxes. Meanwhile, lower-salary paralegals and staffers without an ownership stake paid their required income tax. Doyle wasn't joking when he said he planned to spend his savings on a family vacation to Cancun.

Some online readers were incredulous. They posted comments such as, "His choice to go to Cancun only reveals his character, not a faulty tax plan." Hire office help, critics cried. Spruce up the firm, one said, or introduce workplace programs to make employees happier and healthier. Doyle said his partnership would consider those things with or without a tax gift. What he never saw was job creation. Reached by the newspaper this month, Doyle said he recently formed his own practice as an LLC. No net job growth resulted from that transition, either. "Some thought I was crazy back then for even saying anything. But it was true," he said. "Others were glad I spoke out." Doyle said he still reaps $5,000 to $10,000 in tax savings, all cash. As for that windfall producing new jobs, "who are you going to hire for $5,000 to $10,000 a year?" he asked. "What's the purpose? It's really to give people like me more walking-around money."

Kansas farmers also qualify for the zero-tax provision on income they don't file as wages. And fifth-generation farmer Donn Teske isn't cheering about it. It is not that Teske loves income taxes. Who really does? (And those allowed an exemption legally could report all their income on a W-2 and pay taxes on it to help out the state. But who would?) As president of the Kansas Farmers Union, which favors progressive tax policies, Teske wonders how he benefits overall from an income-tax exemption when his property and sales taxes shoot up to cover the shortfall. Farmers call the triad of income taxes, property taxes and sales taxes a three-legged stool. The stool requires balance, Teske said: "You take one leg out (the income-tax obligation) and it messes everything else up."

State Senator Denning voted for the 2012 tax reforms. But he said revenue officials at the time provided estimates on the number of qualifying businesses that were far below those that wound up exempted.

The Kansas Farm Bureau was equally surprised. "We never asked that farmers be thrown into this," said Warren Parker, the bureau's director of policy communication. "That decision happened under the (statehouse) dome. "Now, like anybody else, we're not going to stand up and say, 'Hi, we want to pay more taxes.' But our focus will always be on keeping property taxes low."

The LLC income-tax exemption still has plenty of defenders.

"The overall policy is a good policy" even if it may need some tweaking, said Shawnee businessman Kevin Tubbesing, past chairman of the National Federation of Independent Business in Kansas.

The state Department of Revenue says total tax collections are increasing. And not all business owners who file for exemptions get an entirely free ride. They pay Kansas income taxes on capital gains, stock dividends, payments guaranteed to partners when the company formed, and on any W-2 wages declared outside their business earnings.

Revenue Secretary Nick Jordan said more than 20,000 small businesses have started up in Kansas since the tax law took effect.

But Zakoura, the Overland Park lawyer, won't rest until fairness is restored. This "passion," he said, has nothing do with any of his clients' interests: "It's just something I took up on my own." It's not about his politics, he insists. Though a registered Democrat, he says he has contributed to the campaigns of state candidates of all stripes, including Brownback.  

Just this month the revenue department responded to Zakoura's open-records request for the number of tax filers who used the exemption in 2014, the latest tax year in which such information is known.

The state's answer intrigued him: 299,000.

That's up from the estimated 191,000 filers who were expected to benefit when the law was passed. But it's down from the 333,000 who actually took advantage of tax exemptions in 2013, the year it took effect.

"You'd expect the number of filers would increase," he said. "That it's shrinking tells me the law isn't having its intended effect" of bolstering business activity and employment.

So why does he care, with six grand more in his own pocket when he files taxes?

"Why look at this law and not 100 others?" Zakoura asked.

"I think the answer is that it's patently unfair to everyone else who has to pay income taxes in Kansas."


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