199a Deduction – Pass-Through Business
The One, Big, Beautiful Bill includes multiple tax provisions which will impact state- and local-level taxA Tax is a mandatory payment collected by local, State, and National governments from individuals and businesses to cover costs of general government goods, services, and activities.
systems, and subnational revenue. The SALT deduction is currently capped at $40,000 per household. Under the proposed legislation, this cap will be increased to $40,000 if married couples have incomes below $500,000, and then gradually reduced to $10,000 at higher income levels. The OBBB also extends several Tax Cuts and Jobs Act of 2017 (TCJA) changes to individual and corporate brackets, deductions, and credits, affecting state tax policy either directly (e.g., when states conform to the federal tax code) or indirectly (e.g., through behavioral responses of taxpayers), along with certain new pay-fors and restrictions.
The TCJA established a temporary 20 percent deduction for qualified business income (the QBI deduction, also known as the Section 199A deduction) for certain sole proprietorships, partnerships, S corporations, and some trusts and estates through the end of 2025. The OBBB proposes that the QBI deduction be made permanent in 2026 and increased to 23 percent, along with other changes to the phase-in process of previous limitations. Pass-through businesses must also demonstrate that they are “qualifying entity” meaning that at least 75 percent of their gross revenues are derived from qualified trades or businesses to qualify for the updated QBI. The TCJA exclusion is retained in the OBBB modified form for pass-through entities classified in specified service trades and businesses (SSTB). These businesses include those providing services in accounting, health care, law, consulting, financial services, investment management, athletics, and the performing arts, among other specialized fields.
Qualified pass-through businesses benefit substantially from the deduction, though they–along with SSTBs ineligible for the deduction–were also subject to the TCJA’s $10,000 SALT cap. With the introduction of the cap many states adopted workarounds that allowed SSTBs, and other pass-through businesses to bypass the cap. This is typically done by paying state-level tax on pass-through entities (PTET), which can be deducted at the federal level. (per IRS notice 2020-75). According to the AICPA 36 states have PTETs. The PTET rates vary depending on the specific qualifications for owners of pass through entities, the PTET election rules and the allowed credits for other state’s PTETs. However, the general PTET is usually a top marginal rate
individual taxAn individual tax is a tax levied by the government on wages, salaries, investment income, or any other form of income that an individual or household earns. The U.S. has a progressive income-tax system where rates increase as income increases. The Federal Income Tax was created in 1913, with the ratification 16th Amendment. Individual income taxes, which are only 100 years old but are the biggest source of tax revenue for the United States, have been around since 1913.
When paying state taxes at the entity level, owners can typically claim a tax credit. A tax credit is a provision that reduces a taxpayer’s final tax bill dollar-for-dollar. Owners who elect to pay state tax at the entity-level can usually claim a taxcredit. A tax credit is a provision which reduces a taxpayer’s final tax bill dollar-for-dollar. Tax credits are different from deductions and exclusions, which reduce the taxpayer’s final tax bill by dollar for dollar.
–often refundable –on their individual state return. PTETs can provide other benefits to businesses, beyond avoiding SALT deduction caps. For example, they may offer a better net benefit than a tax deductibility. A tax deduction allows taxpayers the ability to subtract certain deductible items and other items from their income to reduce the amount of tax that is due. Some deductions are available for all taxpayers while others are only for those who itemize. Most business expenses are immediately and fully deductible, but some, such as capital investment and R&D, must be deducted over a period of time.
A manager’s amendment reflects what was understood to be lawmakers’ intention to curtail the benefit for SSTBs (including those eligible for the QBI deduction because they remain below the income threshold), not all businesses. However, a subsequent manager’s amendment reflects what was understood to be lawmakers’ intention to curtail the benefit for SSTBs (including those eligible for the QBI deduction because they remain below the income threshold), not all businesses.Consequently, some pass-through businesses will get the dual benefit of an even higher QBI deduction of 23 percent and continued ability to take advantage of PTETs, while others are denied the benefit of the QBI deduction (a continuation of the status quo) while also losing the ability to deduct their state and local taxes above the cap–even if it’s a higher cap.The SALT deduction cap represents good policy, and the lack of a deduction does not yield
double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.
. These PTETs, for all their shortcomings and all the questions they raised, were a patch to restore this treatment. These PTETs, for all their shortcomings and all the questions they raised, were a patch to restore that treatment.
Disallowing SALT deduction cap workarounds for SSTBs would reduce GDP by 0.2 percent and the capital stock by 0.3 percent, per Tax Foundation analysis. Tax code neutrality is essential for future economic growth. If the choice of organizational form or industry specialization significantly affects an entity’s tax liability, unintended consequences may follow–including reduced incentives for certain businesses to continue operating and lower competition in some markets and industries.Stay informed on the tax policies impacting you.Subscribe to get insights from our trusted experts delivered straight to your inbox.
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