Yesterday, the Main Street Employers coalition sent a letter to House tax writers raising concerns with their plan to provide temporary relief from the SALT deduction cap by raising the top tax rate applied to pass-through business income. As the letter states:
Individually and family owned businesses organized as S corporations, partnerships and sole proprietorships are the heart of the American economy. They employ the majority of workers, and they contribute the most to our national income. They also pay the majority of business taxes. A recent study by EY found that pass-through businesses pay 51 percent of all business income taxes.
The legislation introduced today would raise these taxes by 1) increasing the top rate pass-through businesses pay from the current 37 percent to 39.6 percent and 2) lowering the income threshold of the top rate from $622,050 to $496,600 (Joint) for the years 2020 through 2025, after which the 37 percent rate is scheduled to expire under current law.
The bill, titled the “Restoring Tax Fairness for States and Localities Act”, is scheduled to be considered by the House Ways & Means Committee today and voted on by the full House next week. According to the Joint Committee on Taxation, the bill provides the following relief from the SALT deduction cap:
- The proposal increases the dollar limitation on the deduction of certain State and local property, income, and sales taxes to $20,000 for married individuals filing a joint return and $10,000 for a married individual filing a separate return for taxable years beginning after December 31, 2018, and before January 1, 2020.
- The proposal removes the limitation on the deduction for certain State and local property, income, and sales taxes for taxable years beginning after December 31, 2019, and before January 1, 2022.
To pay for the SALT relief, the bill would repeal the new 37 percent tax bracket and return the restored 39.6 percent rate to its pre-tax reform income thresholds (from $622,050 to $496,600). Again, from the Joint Committee Taxation:
- The proposal increases the top individual income tax rate of 37 percent to 39.6 percent and reduces the dollar amounts at which the 39.6 percent bracket begins.
The relationship between the new SALT deduction cap and the pass-through business community is complicated. The SALT cap only applies in states with income taxes, and then only if the businesses taxes are paid at the shareholder level. So for S corporations residing in Texas (no income tax) or Wisconsin (where they adopted our SALT Parity legislation), SALT isn’t an issue and this legislation is just a tax hike. On the other hand, SALT is likely the reason so many California S corporations have converted to C corporation. The business community letter reflects this challenge, noting:
While this SALT relief will benefit some pass-through businesses, those savings will be reserved only for businesses residing in certain states, while the tax hike will apply to businesses in all fifty states.
One suspects the SALT issue is complicated for the bill’s proponents too. The SALT benefit is primarily enjoyed by the same upper-income taxpayers who will be subject to the higher top rate. As Richard Rubin at the Wall Street Journal tweeted yesterday:
“You can think of this as cutting taxes for some of the top 1% (and others below that) and paying for it by raising taxes on the top 1%. On balance, at first blush, it would be good for NJ/NY/CA rich/upper-middle-class people, not so much for TX/FL/WA rich people.”
Amid all this complexity, one point of clarity is that C corporations can continue to fully deduct their SALT while S corporations cannot. For that reason, S-Corp will continue to press for its SALT Parity legislation at the state level. Connecticut, Wisconsin, Oklahoma, Rhode Island, and Louisiana have already acted and restored the SALT deduction for their S corporations and partnerships, while several additional states are teed up to act early next year. The more quickly they act, the more quickly SALT ceases to be an issue for the pass-through community.