The Small Business Tax Fairness Act
On July 20, 2021, Senate Finance Committee Chairman Ron Wyden (D-OR) introduced the Small Business Tax Fairness Act (S.2387). This proposal would make significant changes 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. We have supported legislation such as H.R. 1381 and S.480 that opposes any reductions or repeal of the 20-percent deduction for qualified business income under Section 199A, including phasing out the deduction above certain income thresholds.
Per the Legislative Small Business Council, which I am Treasurer, “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 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. 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. 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 do the following:
- Remove the special rules and limits applicable to specified service businesses so that the specified service businesses are eligible for the same deduction as other pass-through entities.
- Begin to phase out the deduction for taxpayers with taxable income over $400,000 with a full phase out for taxpayers with taxable income over $500,000. The $400,000 phase out is intended to comport with President Biden’s promise not to raise taxes on households with income under $400,000. These thresholds would be the same for both single and married taxpayers, thus placing married taxpayers at a disadvantage, and limiting the number of business owners eligible for the deduction.
- Senator Wyden stated that “while small business owners with incomes under $200,000 are 80 percent of taxpayers claiming the deduction 52.4 percent of the federal government’s expenditure for the deduction pads the pockets of millionaires and billionaires.”
- Require that, in order to claim the 199A deduction, married taxpayers must file joint returns.
- Modify and simplify the way that the 199A deduction amount is calculated. In 199A’s current form, the deduction is equal to the lesser of (i) the taxpayers “combined QBI amount” or (ii) 20% the taxpayer’s annual taxable income less net capital gains.
- Provide that the 199A deduction can only be claimed by “individuals” and expressly preclude trusts and estates from claiming the deduction.
- Notably, the Small Business Tax Fairness Act would not make 199A permanent or change its existing December 31, 2025 sunset date.