- Chair of Senate Finance Committee introduces legislation that would make major revisions to pass-through deduction for small business owners
- Deduction would be phased out starting at households earning $400,000 and not available to those earning $500,000 or more
- Measure also seeks to expand eligibility for the deduction and simplify its calculations
Summary by Dirk Langeveld
The chair of the Senate Finance Committee has introduced legislation to revision the pass-through deduction for small business owners, saying the current framework is skewed toward higher owners and excludes many companies.
The Small Business Tax Fairness Act, introduced by Senator Ron Wyden (D-Ore.), would make changes to the qualified business income deduction. This deduction was established under a Republican-led tax overhaul in 2017 and is currently set to expire in 2025.
The deduction allows certain businesses (such as sole proprietorships, partnerships, limited liability companies, and S corporations) to write off up to 20 percent of their net income. This full deduction is currently only available to individuals earning less than $164,900 and married couples earning less than $329,800, but partial deductions are available for higher earners.
In line with President Joe Biden’s pledge to not raise taxes on those making less than $400,000 a year, Wyden’s proposal would phase out the deduction starting at households earning more than that figure and eliminate it for those earning $500,000 or more.
Both small and large businesses use pass-through models, but Wyden argues that larger, more profitable enterprises are more likely to benefit from the deduction. In a one-page summary of the legislation, he says that 80 percent of those claiming the deduction earn less than $200,000 a year, but that 52.4 percent of federal expenditures resulting from the deduction go to millionaires and billionaires.
“While it’s true that most small businesses are organized as pass-throughs, many pass-throughs are not small businesses,” says Wyden. “In fact, pass-through businesses account for 58 percent of all businesses with more than $50 million in receipts.”
The Joint Committee on Taxation estimates that $147 billion would be generated over four years by eliminating the deduction at the $500,000 income level.
Eligibility and calculations
The legislation also expands the eligibility for the deduction, as some business types are ineligible to claim the deduction above a certain income level. These include service trades such as law firms, financial services companies, and health care as well as businesses involved in accounting, entertainment, sports, and consulting.
Wyden described these as “arbitrary industry carve outs and limitations, and also criticized the calculations involved in the deduction as needlessly complex. He said that by incorporating multiple caps and thresholds, the deduction creates more confusion for small businesses and may lock out some eligible companies.
The legislation would establish one threshold to determine if a business is eligible for the deduction and a simple definition of qualified business income applicable to all taxpayers. It would also eliminate the current method of having small business owners calculate their deduction using formulas and limitations based on W2 wages paid and qualified investments.
The proposal received some pushback from Republicans and business groups, who said it will harm the ability of businesses to hire workers and make investments during the recovery from the COVID-19 pandemic. Kevin Kuhlman, vice president of federal government relations at the National Federation of Independent Business, described the measure as “the wrong plan at the wrong time.”
Todd McCracken, CEO and president of the National Small Business Association, complimented Wyden’s effort to simplify tax rules by revising calculations but said the proposal fell short in other ways.
“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,” said McCracken. “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.”