Wyden Proposes Changes to Pass-Through Deduction

July 21, 2021

Senate Finance Committee Chairman Ron Wyden (D-Ore.) released a bill—the Small Business Tax Fairness Act—that would make changes to the 20 percent deduction that is available under Section 199A for partnerships, LLCs, and other entities taxed only at the individual owner level that was created by the 2017 Tax Cuts and Jobs Act (TCJA). Sen. Wyden’s plan is expected to phase-out the deduction for those making $400,000 or more but retain, clarify and potentially expand it for some small businesses.

The TCJA created the 20-percent deduction for income from non-corporate businesses known as pass-throughs, which pay taxes through the individual code on their owners’ returns. There are both large and small businesses organized as pass-throughs.

Sen. Wyden has raised several issues with the deduction. He has highlighted a 2018 estimate from the Joint Committee on Taxation (JCT) finding that much of the benefit of the deduction would go to high-income households. According to Sen. Wyden …“Half the benefit of the pass-through deduction goes to millionaires, and because the benefit is so skewed toward the top, many Main Street small business owners are excluded.” “The mega-millionaires get to write off 20 percent of their income while middle-class accountants are cut out. This makes no sense, and my bill would overhaul the deduction to ensure its benefitting Main Street small businesses.” 

He also noted that the deduction is currently designed so that business owners in some industries can benefit more from the tax break than business owners in other fields. Wyden’s bill would expand eligibility for the full deduction to businesses and professions not currently eligible for the entire break, though the phase out would limit the benefit for those in the high-end of earners claiming the deduction. Owners of service businesses, such as law and accounting firms, face restrictions on the deduction that apply for 2021 to single filers with income of above $164,900 and married couples with income above $329,800. 

Sen. Wyden’s bill would phase out the deduction for individuals making above $400,000 in annual business income and disappear entirely at the $500,000 mark while also removing industry-related rules about eligibility. With these threshold changes, it would sharply limit the number of businesses eligible for the deduction to those defined by the committee as more “traditional” small businesses. Specifically, under the revised tax plan, complicated categories and calculations to determine which partnerships, limited liability companies and other pass-through businesses qualify would be eliminated, opening the deduction potentially to more businesses.

It would also streamline how the deduction amount is calculated. Wyden’s bill would aim to simplify the baseline deduction by using a filer’s individual taxable income as the basis, and allow a 20 percent deduction of their income from that business. The current pass-through benefit involves a more complicated calculation comparing 20 percent of the business income against 20 percent of the owner’s taxable ordinary income, excluding long-term capital gains.

“Chair Wyden has long been an advocate for easing tax complexity on small business, and this proposal would simplify the complex calculation required to take the 20 percent deduction,” stated NSBA President and CEO Todd McCracken. “Unfortunately, the proposal falls short of parity and permanency—two major issues that plague small-business owners uniquely. The deduction for the self-employed was implemented to create greater parity between incorporated and unincorporated businesses at a time when corporate tax rates were being dramatically cut. While there may be better ways to achieve that parity than the current deduction, arbitrarily eliminating the deduction at a certain income level is not that way.”

Please click here to read NSBA’s full statement on the bill.

The committee did not specify how much the income cap would save the Treasury, but according to some it could be substantial — without greatly reducing the number of businesses claiming the deduction. By the committee’s estimate, small-business owners with incomes under $200,000 have made up 80 percent of taxpayers who claimed the deduction, but 52.4 percent of the revenue lost to the Treasury went to millionaires and billionaires. The JCT estimated that tax savings under the existing break for taxpayers earning more than $500,000 would total around $36.9 billion in 2024 alone.

The proposal comes after Senate Democrats reached an agreement on a $3.5 trillion budget plan, and it comes as some Democrats are discussing how to pay for their spending priorities. The budget deal would facilitate spending in areas such as health care, education, and clean-energy investments and would be paid for through means that include unspecified tax increases on high-income households and corporations.

Changes to the pass-through deduction could be an appealing way for Democrats to raise revenue. However, Republicans are likely to argue that an overhaul of the tax break would amount to a tax increase on small businesses.