Tax Proposal Details: 199A

199A – Pass-through (a.k.a. Small Business) Deduction – Impact of Reconciliation Proposals

Section 199(A) permits pass-through businesses such as sole proprietorships, S corporations, and partnerships to take up to a 20% deduction for qualified business income, subject to certain limitations. Currently, a pass-through business in the highest 37% bracket would pay an effective rate of 29.6% (37% x 0.80) on qualified business income. This provision is scheduled to sunset after 2025.

As a part of the tax and reconciliation package, the House Committee on Ways and Means approved approximately $2 trillion in tax increases. Included therein are several provisions that affect the taxation of pass-through income. Many steps remain before this legislation is finalized.

• Limitation of Section 199(A) maximum allowable deduction
  • The maximum allowable deduction under Section 199(A) capped at $500,000 (joint filer), $400,000 (individual), and $10,000 for an estate or trust.
  • The proposal permits eligible filers to claim the capped deduction (provided other rules are met) even if QBI exceeds $2.5 million.
• Individual income tax rate
  • The top marginal tax rate increases from current level of 37% to 39.6%.
  • The tax bracket threshold decreases from current level of $523,600 to $400,000 (individual) and from $628,301 to $450,000 for those married filing jointly.
• Surcharge on high income individuals, trusts and estates
  • A new 3% tax on high-income individuals with a modified adjusted gross income in excess of $5 million.
  • For trusts and estates, the surtax will apply for MAGI above $100,000
• Expansion of 3.8% Net investment income tax (NIIT)
  • Under current law – the NIIT applies only to income from investments – including dividends, interest and capital gains.
  • This proposal will also apply the NIIT to all business income from pass-through entities.
  • Will apply to individuals with an income above $400,000 (and $500,000 for married filing jointly).

In 2021, a flourishing pass-through business operator might be subject to an effective tax rate of 29.6%. Under this proposal, the same business operator in 2022, might face an effective federal tax rate of 46.4% when you factor in the above taxes (39.6% top individual rate, PLUS new 3% surtax, PLUS 3.8% NIIT for pass-through business income).  This increase would also be substantially higher than the 26.5% C-corporate tax rate in the same proposal.

The House Ways and Means Committee proposals are also drastically different from a separate proposal from Senate Finance Committee Chairman Ron Wyden. His bill called for a phaseout of the 199(A) passthrough deduction at $400,000 taxable income, full phase-out at $500,000 and removing the “specified service and trade and business” (SSTB) limitations.

Finseca is actively working to preserve 199(A) for the financial security profession and your clients. Finseca is advocating for the best pass-through deduction allowing small businesses to continue investing in their workforce and their communities. We do expect changes in this area. If you have questions, please reach out to Alex Kim at [email protected].