After the One Big Beautiful Bill Act (OBBB) extended a provision allowing many small business owners to deduct 20% of their qualified income, a group of Republicans are calling for a boosted, 23% deduction. Their proposal also contains a “fix” to allow more professionals to take advantage of the deduction.
Pass-Through Deduction Basics
The IRC § 199A deduction, also known as the pass-through deduction, is available for income that is “passed through” from certain businesses to their owners, and claimed by owners on their individual income tax returns. It was established under 2017 Tax Cuts and Jobs Act and extended by the OBBB.
Under § 199A, taxpayers can generally deduct 20% of qualified business income from a partnership, S corporation, or sole proprietorship. Taxpayers can also claim a 20% deduction for qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. Certain trusts and estates may also qualify for the § 199A deduction.
Generally, income derived from a specified service trade or business (SSTB) — such as a business performing health, legal, and accounting services — does not qualify for the § 199A deduction. However, an SSTB is treated as a qualified trade or business for taxpayers whose taxable income is under a threshold amount.
Owners of non-SSTBs with income over certain thresholds also face reduced deductions.
A Boosted Deduction
A recently introduced bill, the Small Business Tax Cut Act, H.R. 8415, would increase the § 199A deduction from 20% to 23%. Representative David Kustoff (R-TN), who is heading up the effort, explains that the goal is to lower taxes for small businesses, farmers, and independent professionals.
The bill also would adjust income-based limitations and phaseouts. Bill proponents say under current law, taxpayers are subject to a “sharp benefit cliff.” The aim of the adjustments is to “create a smoother, more predictable structure as businesses grow,” explains a press release.
In addition, the bill would treat SSTBs similarly to other types of businesses. Taxpayers with income at or below a new threshold could claim the full 23% deduction, even for income from an SSTB.
Cost Concerns
The proposal may sound familiar — the House version of the OBBB also would have raised the § 199A deduction to 23%. That proposal was tabled in the Senate, however.
Last year, some policy experts called out the high cost of the § 199A deduction, even without the House’s proposed boost. Extending the 20% deduction alone will cost more than $700 billion over 10 years according to a Congressional Budget Office estimate released in the wake of the OBBB. A 23% deduction along with threshold adjustments would come at an even higher cost.
Senator Steve Daines (R-MT) said the House’s proposal last year to raise the deduction from 20% to 23% “came as a little bit of a surprise.” Daines, speaking at an event last May, stressed that while he supports additional tax breaks for pass-throughs, what was most important for him was making the § 199A deduction permanent.
“All of the advocacy and desire was just to hold fast at 20%, but to make it permanent,” PwC’s Rohit Kumar told Checkpoint as the OBBB moved through Congress last June. “Going to 23% was expensive,” he added. “It was like over $100 billion of revenue over the 10-year period.”
NYU Tax Law Center’s Chye-Ching Huang had harsh comments on last year’s House proposal — which Kustoff’s bill is modeled on. Huang said the proposal “takes an inefficient, inequitable, and costly policy, and makes it more generous and more valuable to higher-income people, especially those in certain industries including lawyers and lobbyists.”
For more on the pass-through deduction phaseout for specified service trade or business income, see Checkpoint’s Federal Tax Coordinator 2d ¶ L-4311.
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