On July 20, 2021, Senate Finance Committee Chairman Ron Wyden (D-OR) introduced the Small Business Tax Fairness Act (S.2387). This proposal would usher in significant changes, most detrimental, to the current 20% deduction for qualified business income for pass-through entities (also known as the 199A deduction).
The 199A deduction arose from the 2017 Tax Cuts and Jobs Act (TCJA) and was intended to give some parity on tax rates between C Corps and the pass-through entities. Unlike the TCJA’s provisions for C-corporations, which are permanent, the 199A deduction will sunset at the end of 2025. Since its introduction, TIA has been advocating for Congress to improve upon, and make permanent, the 199A deduction.
In short, the 199A deduction provides a deduction equal to 20% of “qualified business income” (QBI) from a pass-through entity – sole proprietorships, partnerships, LLCs (that have elected to be treated as partnerships for tax purposes) and Sub-S corps. Besides its temporary status, the biggest shortcoming with 199A is that it includes special (less advantageous) rules for “specified service business” providing a phased out deduction that is only available if the taxpayer’s taxable income is below a certain threshold that is adjusted annually for inflation (in 2021 the thresholds are $429,800 or less for married filing jointly, $214,925 or less for married filing separately, or $214,900 or less for single filers and the full deduction is available if income is $329,800 or less for married filing jointly, $164,925 or less for married filing separately or $164,900 or less for single filers). A “specified service business includes any trade or business described in Internal Revenue Code Section 1202(e)(3)(A) which includes health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing, investment management, trading or dealing in securities, commodities, etc. or where the principal asset of such trade or business is the “reputation or skill of one or more of its employees.” In a last minute deal when the law was passed, engineering and architecture was removed from this definition for purposes of 199A. For pass-through entities that are not specified service businesses, the 199A deduction is available regardless of the taxpayer’s taxable income but may be subject to limits based on the business’ W-2 wages or capital. The 199A deduction is currently available to trusts and estates. Of course, the rules governing 199A and how to calculate the amount of the deduction are far more complicated than this brief summary.
If enacted as proposed, Senator Wyden’s Small Business Tax Fairness Act would, among other more minor or technical changes, do the following:
Notably, the Small Business Tax Fairness Act would not make 199A permanent or change its existing December 31, 2025 sunset date.
The principles set forth in the Small Business Tax Fairness Act were not included in President Biden’s latest budget proposal. However, during the 2020 campaign, Biden did state his support for limiting or eliminating the 199A deduction for high income taxpayers and it is very possible that some of all of the provisions in this proposal may make their way into the upcoming “social infrastructure” bill. This is particularly true because this bill would be a short-term revenue raiser with the Tax Foundation estimating that it would raise $114 billion in four year period before 199A is set to sunset.
TIA will continue to monitor this bill and advocate to make 199A permanent, to eliminate the distinction for specified service businesses and to increase any proposed phase out thresholds.