The Experts Are Wrong (Part 5)
Ways & Means Chairman Jason Smith recently told reporters that Section 199A permanence is at the top of his priority list. Yet some in the DC Tax Community continue to crusade against this provision that directly benefits the vast majority of businesses in this country.
A good example is a recent Tax Notes panel on the 2025 tax outlook. During a discussion on Section 199A, Bill Gale of the Brookings Institute commented:
I mean, it’s well known to be expensive, to be extremely regressive, and not to have had anywhere near the desired impact on either investment or hiring etc. It was created for equity for passthrough owners given that the corporate tax was being cut.
We previously addressed the questions of cost and economic growth here and here. In this post, we will address the question of whether 199A reduces the progressivity of the Tax Code.
Regressive? Hardly
A recent CRS report flatly states that the 199A deduction is neutral regarding progressivity — “The Section 199A deduction appears to have little effect on vertical equity, as it does not appear to diminish the progressivity of the federal income tax.” As the report explains:
The deduction has little effect on vertical tax equity. In theory, it reduces statutory marginal tax rates by the same factor (20%), leaving a progressive rate structure intact for pass-through business owners.
Nonetheless, available evidence indicates that high-income taxpayers might capture much of the Section 199A deduction’s overall benefit. Such an outcome would be consistent with what is known about the income distribution of pass-through business profits.
We put together this table to illustrate what the CRS report is talking about. As you can see, in 2019 the top 1 percent of taxpayers earned 54 percent of pass-through income and received 55 percent of the 199A deduction benefits:
This neutrality occurs despite the fact that, as a deduction, Section 199A benefits are tied to the marginal tax rate paid by the owners. The higher the rate, the higher the ultimate benefit. Given that, you’d expect the tax benefits of upper income taxpayers to exceed their income shares, but the table above shows they are consistent with income. What gives?
The reality is that large pass-throughs get the 199A deduction, but only if they employ lots of people or make significant investments. That’s because 199A imposes so-called guardrails on large pass-through businesses so, for example, they only get the deduction up to 50 percent of the W-2 wages they pay, or a similar cap tied to capital investments. A Treasury study shows how these guardrails exclude about 40 percent of pass-through income from the 199A benefit, all from business owners making more than $400,000.
Finally, it is important to remember that Section 199A was not enacted in a vacuum – it was part of a package that included many tax hikes. These included the caps on SALT deductions, excess loss deductions, interest deductions, amortization of R&E expenses, etc. Many of these provisions are permanent and all of them raise taxes on pass-through businesses, primarily larger ones.
For context, consider this table from Tax Notes. It shows the SALT cap will impose around a $50 billion tax hike on taxpayers making more than $1 million next year. That amount is almost the entire tax benefit of the Section 199A deduction. Obviously, pass-through owners make up just a subset of all taxpayers, but if the concern is progressivity, it’s clear the combined individual and pass-through provisions in the TCJA made the Tax Code more progressive, not less.
The same cannot be said for the corporate rate cuts. Critics argue that the TCJA primarily benefited wealthy taxpayers, but that is mostly due to the corporate rate cuts. This table from the Tax Policy Center shows that as income rises, so does the benefit from the corporate rate cuts.
Corporate rate cuts don’t benefit pass-through business owners, but it doesn’t stop the critics from blaming 199A anyway.
Where the Pass-Through Jobs Are
So the experts are wrong again. The Section 199A deduction does not reduce the progressivity of the Tax Code. That’s good for the parts of the country that spoke loudest last month. Those areas rely heavily on pass-through businesses for their jobs and growth (all that green), and those are the areas that have the most at stake when Congress tackles the TCJA sunsets next year.
Ultimately, making Section 199A permanent is not just about fairness and parity — it’s about safeguarding the economic vitality of the communities that rely on pass-throughs. These businesses are the backbone of the American economy, particularly in regions that have been left behind in the modern economic landscape. Section 199A ensures these job creators have the resources to reinvest in their operations, hire more workers, and contribute to local economies.
As Congress looks ahead to addressing the TCJA sunsets, it should recognize the critical role Section 199A plays in sustaining economic opportunity for literally every community across the country.
Latest on CTA Injunction and a Legislated Delay
The national injunction on CTA filing imposed by the Eastern District of Texas Court Tuesday provides millions of business owners with a good possibility – but just a possibility – of permanent relief from this poorly thought-out law.
With the year-end filing deadline looming, where do things stand?
- The DOJ filed an appeal to get the injunction lifted last Thursday, December 5th. No word on when the 5th Circuit might rule. Will it come before or after the end of the year?
- FinCEN meanwhile posted a notice on its BOI landing page that it would comply with the court order and that covered entities are, for the moment, under no obligation to complete their CTA filings. The site is still open if you want to file “voluntarily.”
- Talks with leadership and the banking committees have been moving forward, and it appears a one-year delay of the filing deadline – providing much needed clarity – is a very real possibility.
- FinCEN reports that less than 10 million of the 36 million covered entities have filed as of the beginning of December with only 1 million new filings taking place each week. That’s sure to slow as a result of the court order, suggesting something in the range of 20 million small businesses will be out of compliance at the end of the year if filing resumes.
In practical terms, this means many businesses who have yet to file are hitting the pause button for now but continuing to prepare in the event 1) the injunction gets lifted and 2) the legislative delay fails to develop.
In terms of likelihood, we believe it is unlikely the 5th Circuit stays the injunction this close to the filing deadline, particularly with so many covered businesses not in compliance yet. Meanwhile, the odds of legislated relief appear to rise by the day. So hope for the best but prepare for the worst? A clear statement by Congress or the 5th Circuit really would be welcome right now.
Court Decision
On Tuesday, the Federal District Court issued an 80-page preliminary ruling and injunction in favor of NFIB and the business community as a whole. Similar to an earlier court decision last March in Alabama, the court found the CTA exceeded Congress’ authority under the Constitution:
At its most rudimentary level, the CTA regulates companies that are registered to do business under a State’s laws and requires those companies to report their ownership, including detailed, personal information about their owners, to the Federal Government on pain of severe penalties. Though seemingly benign, this federal mandate marks a drastic two-fold departure from history. First, it represents a Federal attempt to monitor companies created under state law—a matter our federalist system has left almost exclusively to the several States. Second, the CTA ends a feature of corporate formation as designed by various States—anonymity. For good reason, Plaintiffs fear this flanking, quasi-Orwellian statute and its implications on our dual system of government. As a result, Plaintiffs contend that the CTA violates the promises our Constitution makes to the People and the States. Despite attempting to reconcile the CTA with the Constitution at every turn, the Government is unable to provide the Court with any tenable theory that the CTA falls within Congress’s power. And even in the face of the deference the Court must give Congress, the CTA appears likely unconstitutional. Accordingly, the CTA and its Implementing Regulations must be enjoined.
DOJ Appeal
The DOJ appealed the injunction on Thursday. Here’s Forbes on the process from here:
On December 5, 2024, the Financial Crimes Enforcement Network (FinCEN) filed an appeal against the nationwide preliminary injunction issued by the U.S. District Court for the Eastern District of Texas, which had halted enforcement of the Corporate Transparency Act (CTA). The appeal challenges the court’s decision that the CTA likely exceeds Congress’s constitutional authority.
The appellate court’s response to FinCEN’s appeal is pending. The court is expected to move swiftly to either uphold the injunction, modify its scope, or overturn it, potentially reinstating the CTA’s reporting requirements of the December 31, 2024 deadline. Given this uncertainty, we recommend that businesses remain prepared to comply with the CTA should the injunction be lifted. This includes gathering necessary beneficial ownership information and staying informed about legal developments.
What counts as “swiftly” is unclear, but it would be nice to have some clarity in the next week. The more time that goes by, the more difficult it will be for all those “paused” businesses to resume their filing plans on a timely basis.
FinCEN Notice
On Thursday or Friday, FinCEN posted a statement indicating it would abide by the injunction but continue to accept voluntary submissions. The key paragraph:
While this litigation is ongoing, FinCEN will comply with the order issued by the U.S. District Court for the Eastern District of Texas for as long as it remains in effect. Therefore, reporting companies are not currently required to file their beneficial ownership information with FinCEN and will not be subject to liability if they fail to do so while the preliminary injunction remains in effect. Nevertheless, reporting companies may continue to voluntarily submit beneficial ownership information reports.
Legislative Relief
As S-Corp readers know, we have been pressing Congress to delay the filing deadline to 1) give business owners more time to learn about the new law (many still don’t know it exists) and 2) give the courts time to review the law and make a final determination whether it’s constitutional. Spoiler Alert: It’s not.
Word from the Hill is a one-year delay is under consideration and has a chance to catch a ride on the year-end spending bill. This would be a massively helpful development as, noted above, only about one-in-four covered businesses (9 million) have filed to date. That’s a lot of felons.
Bottom Line: This country survived for 250 years without a CTA. It can survive a few months more.
CTA Struck Down by Texas Court!
For the Main Street business community, it looks like Christmas has come early. With less than a month to go before the Corporate Transparency Act’s year-end filing deadline, a federal court today issued a nationwide injunction that halts enforcement of the new reporting regime. It’s a massive win for the more than 33 million businesses who are currently subject to the onerous disclosure rules, many of which had no idea they could be starting the new year as de facto felons.
That positive outcome was secured by our good friends at the National Federation of Independent Business who, alongside several of their small business members, filed their constitutional challenge back in May.
As S-Corp readers are well aware, the CTA took effect this year and requires small businesses and other covered entities to report – and regularly update – the personal information of their owners and managers to the Financial Crimes Enforcement Network (FinCEN) at the Treasury Department. Put simply, the CTA is the largest data grab in history outside the Tax Code, and saddles law-abiding business owners with compliance headaches and criminal penalties while doing little or nothing to combat illicit activity.
S-Corp and its allies have been fighting the CTA for years, including calling out the ill-conceived law back in 2020, backing the legal efforts kicked off by the National Small Business Association (NSBA), organizing numerous industry support letters to push for delay and repeal in Congress, and otherwise educating lawmakers and various other stakeholders along the way.
Back to the Texas court ruling, the key passage reads as follows:
Having determined that Plaintiffs have carried their burden, the Court GRANTS Plaintiff’s Motion for a Preliminary Injunction. Therefore, the CTA, 31 U.S.C. § 5336 is hereby enjoined. Enforcement of the Reporting Rule, 31 C.F.R. 1010.380 is also hereby enjoined, and the compliance deadline is stayed under § 705 of the APA. Neither may be enforced, and reporting companies need not comply with the CTA’s January 1, 2025, BOI reporting deadline pending further order of the Court.
And here’s NFIB’s press release applauding the decision:
“This ruling is a huge victory for small businesses nationwide, and just in time” said Beth Milito, Executive Director of NFIB’s Small Business Legal Center. “For many Main Street small businesses, they were a mere four weeks away from the deadline to file their information in accordance with the CTA. The BOI reporting requirements are a harmful invasion of small business owners’ privacy and a misuse of their valuable time. Thankfully, the Court agreed and granted a preliminary injunction, giving small business owners a reprieve from this burdensome rule.”
The big question here is how FinCEN will respond. The agency pressed forward with enforcement even after a successful ruling in NSBA v Yellen and ultimately appealed the decision, which remains pending in the 11th Circuit. So while affected entities are off the hook for the year-end filing deadline, that’s all subject to change as the case moves through the courts – meaning we’ll still need to work with Congress and the new administration on a permanent fix.
That said, today’s ruling is a huge win for Main Street and comes as welcome relief to countless businesses across the country!
CTA Update | December 3, 2024
Notable Developments
- Senator Lankford pushes delay via NDAA
- CTA enforcement under Trump administration?
- Oregon plaintiffs file suit
- Op-eds highlight CTA’s fatal flaws
* * *
Legislative Update
Senator James Lankford (R-OK), a cosponsor of the Senate’s version of the CTA delay bill that overwhelmingly passed the House last year, is doubling down on his efforts to advance relief for the Main Street business community. As he posted on X.com on Monday:
The Beneficial Ownership Information reporting requirements (aka a new registry) for small business owners are unclear and overly broad. They are due on January 1, 2025, but I am pushing for a 1-year delay.
As we’ve written previously, the CTA originally was enacted as part of the FY2021 NDAA, so it makes sense to initiate a delay via this year’s version. It’s also worth noting that while the CTA was snuck into the NDAA at the time, S-Corp and its allies are being open and transparent about their efforts now.
* * *
Regulatory Update
Per the latest post from our friend and ally Carol Roth, there’s still hope that the incoming Trump administration might quash CTA enforcement:
The belief from my contacts is that even if none of that happens prior to the deadline, Trump won’t enforce penalties, especially with the large number of non-complying entities expected. However, as that is not guaranteed, you have to decide on which is a bigger risk—risking the government coming after you for the non-compliance fines or handing your information over to them.
My guess is if something does happen before year end, it will be at the 11th hour, not giving us a lot of time to make a decision.
As we’ve long maintained, the ultimate goal here is to quash the CTA’s reporting requirements before year end and prevent the federal government from establishing its database. Would a public announcement from Trump officials that they won’t enforce the CTA be enough to offer de facto amnesty to tens of millions of affected entities? Many of the legal eagles we’ve spoken to seem to think so, but it remains an open question.
* * *
Legal Update
On November 22nd a group of small business owners appealed an Oregon court’s ruling that struck down their CTA challenge. The suit was initially filed in June but was rebuffed in September. The appeal is backed by the Center for Individual Rights, whose press release reads:
Although it was enacted to combat financial crime, the law exempts large corporate entities and financial firms, leaving mostly small businesses and some non-profit organizations to comply. Failure to comply with CTA reporting can result in uncapped and unlimited daily civil penalties of up to $500 per day, and criminal sanctions of up to $10,000 in fines and up to two years’ imprisonment, or both.
“I can’t understand why the CTA exempts large corporations but threatens small business owners with criminal penalties unless we give up sensitive information to the federal government without any lawful purpose,” said Lisa Ledson, one of the plaintiffs and owner of an Oregon-based health care firm. Ledson stated that under Oregon state rules related to the nursing profession, she would have to self-report any sanctions made against her by FinCEN to the nursing board, which would put her at risk of losing her nursing license.”
As a reminder, there are now at least ten cases in various courts across the country challenging the validity of the CTA. Here are the links:
- Alabama (appealed): NSBA et al v. Yellen (11/15/2022)
- Ohio: Robert J. Gargasz Co., L.P.A. et al v. Yellen (12/29/2023)
- Michigan: Small Business Association of Michigan et al v. Yellen (3/1/2024)
- Maine: William Boyle v. Yellen (3/15/2024)
- Texas: NFIB et al v Yellen (5/28/2024)
- Massachusetts: BECMA et al v Yellen (5/29/2024)
- Oregon (appealed): Firestone v Yellen (6/27/2024)
- Utah: Taylor v Yellen (7/29/2024)
- Virginia: Community Associations Institute v. Janet Yellen (9/10/2024)
- Texas: Association of American Physicians & Surgeons et al v Yellen (10/28/2024)
* * *
Compliance Update
Here’s Carol Roth again with an excellent piece that spells out the regulatory nightmare that tens of millions of law-abiding small business owners are headed towards, along with a call to action:
Despite at least 10 pending lawsuits challenging the rule’s constitutionality, including one where a federal district court declared it unconstitutional, Congress has not taken definitive action. Multiple delay bills have been introduced in both the House and Senate, yet none have moved forward. A recent report estimated compliance rates at just 10%, meaning millions of small businesses could face penalties under an unconstitutional rule.
Small-business owners are not financial criminals. They are the backbone of the American economy and deserve better treatment. This rule unfairly targets them, and Congress or President-elect Trump must take immediate action to protect these businesses.
And a recent op-ed in Barrons reinforces Roth’s point regarding compliance:
But the low compliance rate so late in the year reflects problems with the general way the CTA was written, says Alan Granwell, an attorney at Holland & Knight. While many owners may not be aware of the new rules, even those who are and have best intentions to file are stumped by myriad questions, he says.
“We’re getting calls left, right and sideways about this stuff,” Granwell says. “You have different questions arise depending on whether you’re in private equity, venture, construction, real estate—each has its own issues.”
Some business owners may be holding off on filing, hoping that the CTA will be overturned in the courts or that Republicans, who typically favor easing regulations and less oversight on businesses, will cancel the CTA requirements next year now that they have a majority in the Senate and the House.
… “This just came up—one owner is in an elderly home and doesn’t have the required documents,” Granwell says. It’s unlikely identification can be applied for and granted by the year-end deadline.
Finally, small business owner Gary James, president of Dynalab in Reynoldsburg, Ohio, has a great piece in the Columbus Dispatch:
Reforming the regulatory state is also shaping up to be a priority of the incoming White House. Given that the onslaught of new government regulations implemented under the Biden administration has cost businesses upwards of $1.4 trillion, the pruning is sorely needed. The Corporate Transparency Act is a good example of such draconian government overreach and needs to be rescinded.
Large corporations have the luxury of propping up legal departments to navigate regulatory mazes and paperwork. Small businesses, on the other hand, do not. In fact, the average per employee cost of regulatory compliance for manufacturing businesses with fewer than 50 employees is double that of large firms in the same sector.
Once again, the CTA is going to turn countless small business owners into felons come the end of the year, many of whom have no idea why. It’s time to enact relief now, and better yet put this ill-advised information dragnet to bed once and for all.
The Experts are Wrong (Part 4)
The key debate before Congress next year is how to tax large, family-owned businesses. There is no debate over how to tax smaller businesses. Nobody on the left or right is arguing to raise taxes on small businesses.
This reality is lost, once again, on the tax experts. For example, several economists at Treasury are out this month with a new paper on business tax rates and our friends at the Tax Foundation have already flagged it with misleading tweets:
A casual reader would conclude the Treasury paper demonstrates that S corporations pay less than their corporate competition, even when looking at larger businesses. Not so.
Instead, the paper looks at the same “horizontal” equity trap as previous works. Horizontal equity is where you measure how similar firms are treated under the Tax Code, depending on how they are organized. So a particular firm might pay one tax level as an S corporation, and another level as a C corporation. For example, the paper states:
Furthermore, we find spikes in mass around 11 percentage points (Panel A) and 9 percentage points 10 (Panel C), corresponding to the set of firms whose owners are in the 12% ordinary income tax bracket – e.g., joint filers in 2018 with ordinary taxable income between $19,050 and $77,400. For these firms, the S corporation ATR is 12% without Section 199A and 9.6% under current law, while the C corporation ATR is often exactly 21%, as these firms typically do not have GBCs, and their owners face a zero marginal tax rate on long-term capital gains and qualified dividends. Given that these firms tend to have relatively low income, these spikes do not appear nearly as visibly in the dollar-weighted panels.
Translated, small business owners in the 12-percent tax bracket pay less as an S corporation than as a C corporation. But everybody knows that, and it has nothing to do with the tax debate.
The real question is: Can family businesses compete with public C corporations when the corporate rate is 21 percent? Horizontal equity doesn’t apply here for the simple reason that family businesses can’t become public companies, as that would require them to sell the business. Lots of S Corp members have done just that in recent years, with the result that they are no longer family-owned businesses.
For an answer to that question, our EY study continues to be the best resource. It shows rough parity between large S corporations and public companies with 199A in place, but no parity without it.
Some other comments:
Adverse Selection: The paper looks at the taxes paid by S corporations, and then measures what they would pay as C corporations. Not surprisingly, the study finds that most – not all – businesses currently organized as S corporations would pay more if they converted. But what if the authors started with the private C corporations and measured how much they would pay if they converted to S corporations? If they pay less, why are they C corporations?
ESOPs: The study includes ESOPs in its averages, which drives down the averages for S corporations and C corporations alike: “If there is no match to any of these tax returns, we assume that the owner is an employee stock ownership plan (ESOP)…. We assume income flowing to ESOPs is entirely untaxed (whether the firm is a C corporation or an S corporation).”
Behavioral Changes: We have long argued that 199A revenue estimates need to include significant behavioral adjustments. The authors agree: “[I]f the law were to change such that all large S corporations were now taxed as C corporations, there would be substantial behavioral effects given the new tax regime, including businesses re-structuring, changes in payout rates, and potentially changes in the wages paid to owners. We have abstracted away from such matters, for the most part. Therefore, our estimates do not correspond to revenue estimates for such a policy change.”
Finally, there is this:
To some extent, these findings depend upon the values of the payout rate () and the deferral/avoidance parameter () that affect the C corporation counterfactual. On the one hand, a simple average across firms results in lower ATRs for S corporations relative to the C corporation counterfactual, regardless of the values of and and regardless of Section 199A. On the other hand, if we give more weight to higher-income firms, reflecting their greater economic importance, then there are some values of and that yield lower ATRs in the C corporation counterfactual. Relative to current law, only values of and quite close to zero would suffice (see Figure 8). Relative to the no-199A counterfactual, if we set = 0.28 (the average payout rate for similarly sized C corporations), then retained earnings would need substantial benefits from deferral to result in lower ATRs in the C corporation counterfactual. [Emphasis added.]
Translated, they are saying 1) smaller S corporations drive down all their averages and 2) larger pass-through businesses that pay out 28 percent or more of their after-tax profits are screwed regardless of how they are organized. We’ve been making that point repeatedly as well.
How to conclude? “Get ready” is what we say. The Corporate Tax Industrial Complex (CTIC) is in full swing and you can expect many more studies like this, coupled with sounding board tweets, panels, webinars, etc. As noted, this study says little to nothing about the debate before Congress, but that won’t stop them from trying to make you think it does.