New proposed legislation by the chairman of the Senate Finance Committee would expand the pass-through deduction under Internal Revenue Code Section 199A and might be of some help to plan advisors, but it also would curtail the deduction for so-called upper-income clients.
The Small Business Tax Fairness Act introduced by Sen. Ron Wyden (D-OR), who is chairman of the powerful tax-writing Finance Committee, would expand eligibility for what the Senator describes as “middle-income services business owners” by removing restrictions on which industries qualify and which do not.
Wyden notes that the current limitations cause “tremendous confusion” for taxpayers trying to figure out if they are a “specified service trade or business,” and that his bill would eliminate this red tape.
The bill would also simplify the calculations that pass-through businesses use to determine their deduction. Here, Wyden notes that the deduction’s multiple caps and thresholds make calculating the deduction and determining eligibility unnecessarily complicated.
As such, the bill would establish one, sometimes significantly higher, income threshold for determining whether a taxpayer gets the deduction (the phase out would start at $400,000 for all individuals) and one simple definition of qualified business income that applies to all taxpayers. Small business owners would no longer have to calculate their deduction using formulas and limitations based on W-2 wages and qualified investments, according to a summary of the legislation.
Give and Take
That said, as a way to cover the cost of expanding the deduction and to help finance other priorities, the proposal would eliminate the ability of certain taxpayers to take the deduction (such as trusts and estates and married taxpayers filing separately) and phase out the deduction for more taxpayers.
To that end, the Chairman notes that, while most small businesses are organized as pass-through businesses, many pass-through businesses are not small, noting that pass-through businesses account for 58% of all businesses with more than $50 million in receipts.
“This bill is a win-win. It’s going to make the policy more fair and less complex for middle-class business owners, while also raising billions for priorities like child care, education and health care,” Sen. Wyden said in a statement.
With House and Senate Democrats, preparing to act on a trillion-dollar infrastructure package later this fall, look for this proposal, or something similar, to emerge from the Senate Finance Committee as part of the Senate bill.
Enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA), Internal Revenue Code Section 199A provides a deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S Corporation, trust or estate engaged in domestic trades or businesses. The deduction is currently set to expire in 2026 unless it is extended by Congress.
The deduction is generally equal to the lesser of 20% of an eligible taxpayer’s qualified business income plus 20% of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20% of taxable income minus net capital gains.
The deduction is generally available to eligible taxpayers whose 2021 taxable income falls below $329,800 for joint returns (with a phase-in range up to $429,800), $164,925 for married filing separately (with a phase-in range up to $214,925) and $164,900 for single and head of household taxpayers (with a phase-in range up to $214,900). These limits are currently indexed for inflation.
For taxpayers making more than the income threshold, the deduction may be limited by the amount of W-2 wages and qualified property of the business or entirely eliminated if the taxpayer is engaged in a specified service trade or business (SSTB).
Among other things, an SSTB includes, for example, a trade or business involving the performance of services in the fields of accounting, actuarial science, consulting, financial services, investing and investment management, or trading or dealing in certain assets.
The SSTB exception does not apply for taxpayers with taxable income at or below the threshold amount and is phased in for taxpayers with taxable income within the phase-in range. For taxpayers with taxable income above the phase-in range, no deduction is permitted with respect to any SSTB.
Additionally, income from a trade or business conducted by a C corporation or a trade or business of performing services as an employee will not qualify for the deduction.