A significant but complicated tax deduction for business owners that could expire at the end of next year has delivered savings for some — especially the wealthiest owners. Its impact on jobs and economic growth is murkier.
The Section 199A
But hundreds of thousands of eligible taxpayers who could have reaped savings haven't claimed the deduction, the CRS report showed. Proponents of the QBI argue the exemption gives small businesses a tax rate closer to the lower ones for C-corporations under the legislation that helps generate jobs and capital investment in the economy. Highly intricate rules, and the QBI's unclear impact on jobs and investment, could prompt Congress to make major changes to it or let the deduction expire after 2025. Advisors and tax professionals must navigate those elaborate details while guiding clients through questions on the fate of the deduction.
"There are just so many factors that go into it," Gary Russell, co-founder of Everett, Washington-based
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Some business-owner clients may not know about the QBI tax policy, which
"The deduction for qualified business income from pass-through entities does not often become part of
The deduction guidelines are tricky. For starters, the maximum exemption of 20% of qualifying income ticks down starting at $383,900 for joint filers and $191,950 for individuals in 2024, with no eligibility starting at $483,900 in joint households and $241,950 for individuals, the report said. In addition, the deduction drops based on limitations tied to a business owner's share of the company's wages and to the unadjusted tax basis of certain assets, as well as restrictions for income from a "specified service trade," which includes health, law, athletics, performing arts and the financial services.
"The maximum deduction is equal to 20% of an eligible business's QBI, provided the deduction does not exceed 20% of a taxpayer's taxable income, excluding long-term capital gains," the report said. "The deduction's complexity increases the cost of compliance for taxpayers who might benefit from it, although it is not clear to what extent. There is also uncertainty about which businesses qualify for the deduction. Some lower-income taxpayers may not claim it because of the complexity and compliance cost. Many upper-income pass-through business owners may claim the deduction, but only with the assistance of tax professionals."
Nonetheless, at least 89.6 million filers claimed $677.1 billion in QBI deductions in the first four years of it being available between 2018 and 2021, according to IRS data cited in the report. Wealthier business owners "have captured much of the tax savings from the deduction," with those at incomes of $200,000 or more filing 28% of the claims and getting 76% of the total value of the exemptions in 2021, the report said.
The lower rates for business owners as compared to wage earners of the same income, the deduction's lack of direct correlation to job creation and the disproportionate benefits at upper income levels explain why many progressives and tax policy experts are
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At the same time, many less wealthy business owners may not even be tapping into the available savings. In the first year of the deduction, at least 887,991 returns appeared eligible but didn't claim it, according to research by the Treasury Inspector General for Tax Administration cited in the report. Large pass-through entities are generally "more likely than smaller ones to use tax practitioners to file a claim for the deduction," the report said.
"Many high-income pass-through business owners likely hire tax practitioners to find ways to maximize the deduction's tax benefit," it stated. "Not all planning strategies may comply with the law. Some strategies might require combining or splitting pass-through businesses to qualify for the deduction. Tax planning of this sort can be expensive. … Disparities in access to effective tax planning arguably represent one way in which the Section 199A deduction unintentionally picks winners and losers among pass-through business owners."
In terms of jobs and economic growth, the impact of the deduction becomes more difficult to track. Overall, the Tax Cuts and Jobs Act "enhanced the incentive for business investment in tangible assets," and this specific deduction "may have boosted the desirability of operating as a pass-through business rather than a C-corporation," according to the report. It's also unknown whether the deduction has led to hiring, employee salary raises or other investments into businesses — or if the tax savings have simply increased the owners' wealth, the report said.
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An extension of the deduction under its current rules would cost an estimated $1.7 trillion in lost tax revenue between 2026 and 2040, according to a study cited by the report. Numbers like that will loom large as the next Congress faces a deadline to alter the deduction and other sunsetting provisions of the law or let them expire. Some policy ideas have explored methods of simplifying the deduction or linking it more directly to jobs, while others seek to make the deduction permanent. If Congress doesn't act, business owners will see direct consequences.
"If the deduction and the TCJA's cuts in individual income tax rates are both allowed to expire, the top marginal tax rate for pass-through business profits would rise to 39.6%, from 29.6% under current law," the report said.
Advisors have grown familiar with the need to speak with clients early and often about potential shifts in federal policies, as well as keeping each other in the loop about them and following pending legislation like a package of tax credits that's stuck in the Senate after
"It's just how these things go," he said. "You've got to plan on your feet and be nimble and prepared for anything."
