New Senate Bill Would Overhaul Pass-Through Tax Deduction

Senate Finance Committee Chairman Ron Wyden, D-Ore., introduced legislation Tuesday to overhaul the pass-through deduction to ensure small businesses benefit as opposed to the wealthy, including a phase-out for households earning more than $400,000.

The Small Business Tax Fairness Act, Wyden said Tuesday on a call with reporters, would “expand middle-income business owners’ access to the pass-through deduction and remove complex calculations and limitations, while ensuring that the deduction goes to true small-business owners — not millionaires.”

With the 20% pass-through deduction created in the 2017 tax bill, “sixty-one percent of the monetary benefit of the pass-through deduction goes to the top 1% of households. The Small Business Tax Fairness Act would ensure the pass through deduction helps Main Street small business owners, not wealthy real estate investors,” Wyden said.

Most small businesses are organized as pass-throughs, he noted, but many pass-throughs are not small businesses.

Pass-through businesses account for 58% of all businesses with more than $50 million in receipts, a summary of the bill states. “While small business owners with incomes under $200,000 are 80% of taxpayers claiming the deduction in number, 52.4% of the federal government’s expenditure for the deduction pads the pockets of millionaires and billionaires,” the summary says.

Wyden explained that The Small Business Tax Fairness Act:

  • Phases out the deduction for households earning more than $400,000 in line with President Joe Biden’s tax plan;
  • Expands eligibility for middle-income business owners, such as services, by removing some restrictions on which industries qualify and which don’t; and
  • Simplifies the calculation to determine the deduction.

According to the Joint Committee on Taxation, Wyden explained, “the pass-through deduction for those making more than $500,000 per year is going to cost $36.9 billion in 2024. So our proposal eliminates the deduction for those making $500,000 per year for four years, but that comes to about $147 billion.”

While the expansion to “crucial small businesses” will come with some cost, he continued, “the costs for helping these small businesses like you’ve heard of in the budget picture are relatively modest.”

With the overhaul, “there’s opportunity here to pick up significant revenue while at the same time not raising taxes on Main Street small businesses,” Wyden said. “You’re going to hear a lot of baloney from some of these groups over on the far right [that] somehow this [proposal] is going to raise taxes on small businesses. Just not true. Our bill does not raise taxes on small Main Street businesses.”

Andy Friedman, founder and principal of The Washington Update, told ThinkAdvisor Tuesday in an email that the Tax Cut and Jobs Act of 2017 provides a deduction equal to 20% of business income for owners of certain businesses organized as pass-through entities (partnerships, LLCs, etc).

“The deduction is available regardless of the owner’s income,” Friedman explained. “The deduction typically is allowed for owners of non-service businesses” and “also is allowed for owners of service businesses, but only if certain additional requirements are met. These additional requirements often preclude owners of service businesses from claiming the deduction.”

Wyden’s bill, Friedman continued, “would make two changes to Section 199A. One change would eliminate the additional requirements for service businesses, so owners of service businesses may claim the deduction in the same manner as owners of non-service businesses. A second change would phase out the availability of the deduction for owners with income above $400K.”

Frank Clemente, executive director of Americans for Tax Fairness, stated on the call that with the bill, Wyden “is fixing one of the worst parts of the 2017 GOP tax law by actually limiting to small businesses what was falsely advertised at the outset as a small-business tax break. By excluding hedge fund managers and real estate speculators like former President [Donald] Trump, Wyden’s reform will probably raise more than $100 billion that can be used to support real neighborhood businesses and their working-family customers.”

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