Main Street supports the tax bill adopted by the Ways and Means Committee this week, but not all the bill’s provisions are worth keeping. The House provision limiting SALT deductions on pass-throughs is a good example of why the “experts” need close supervision.  These provisions are hopelessly complicated and will hurt members of the very Main Street business community this bill is supposed to help.

First, some history. The TCJA imposed a new $10,000 cap on individual SALT deductions. It did not cap the SALT deductions of business entities, so corporate SALT (C-SALT) and any SALT paid by pass-through entities directly continued to be deductible as a business expense.

This approach put pass-throughs at a disadvantage as most B-SALT is paid by the owners, not the entity. This was a big deal – losing the SALT deduction was equal to a 2-5 percentage point tax hike and effectively reduced the 199A benefit by about a third. The Main Street Employer coalition largely restored the lost deduction by encouraging 36 states to adopt our SALT Parity bills. (You can read the full history of our SALT Parity efforts here.)

The tax bill before the House would roll back about 40 percent of those deductions. At a high level, the changes preclude B-SALT deductions on business income that is designated as Specified Services Trade or Business (SSTB) income under Section 199A. How this works is remarkably complicated. Here is our best take:

  • Pass-through entities need to test if their SSTB income exceeds 25 percent of their aggregated business income. If it does, they are precluded from deducting any of their B-SALT as a business expense. This test requires business owners to engage in a complicated aggregation of all their income from related business entities. (More on that below.)
  • For entities that pass the test, they may deduct their SALT as a business expense, but only on non-SSTB income. For example, if a business has 20 percent SSTB income and 80 percent non-SSTB income, they get the B-SALT deduction on the 80 percent only.
  • Finally, any B-SALT paid on SSTB income must be newly reported to the business owners and then subject to the individual SALT cap.

It’s a “belt-and-suspenders” approach, but is all this really necessary? Clearly not. Here are some concerns:

Complexity 1: S-Corp strongly disagrees that B-SALT needs to be restricted. If Congress is determined to proceed, however, why do it in such a complex manner? Why not just exclude SSTB income from B-SALT deductions?  Why drag millions of businesses through a super complex, yet-to-be drafted 75/25 aggregation test when the provision already excludes SSTB income from the B-SALT deduction anyway?

Complexity 2: The bill would create two separate and conflicting rules for determining qualified income – the existing rule for determining qualified income under Section 199A and a new, much more punitive aggregation rule for determining B-SALT deductions. Since the bill already relies on Section 199A for the SSTB rules, why not use the 199A aggregation rules too?

It is an Election: On that note, why bother with the new K-1 reporting regime?  If SSTB income is precluded from B-SALT deductions at the entity level, why force pass-throughs also to report their SSTB deductions separately to their owners?  They are highly unlikely to get any benefit. We designed the PTET deduction as an election in order to side-step all this complexity. If you don’t benefit from a PTET tax, don’t make the election. No reporting required.

Parity 1: The argument against B-SALT deductions is that it disadvantages wage earners who are subject to the individual cap, but wage earners enjoy benefits not available to business owners. They get employer-paid FICA and HI taxes and tax-exempt benefits like health insurance coverage. It is not at all obvious who gets the best deal, an issue we addressed previously here.

Parity 2: As noted above, the reason our SALT Parity laws work is because Congress elected not to cap C-SALT deductions. In this bill, Congress again elected not to cap C-SALT, yet they are targeting B-SALT.  How does that make sense? The benefit is the same. A C corporation deducts its C-SALT from its income leaving it more resources to invest and create jobs, while any subsequent payments to shareholders will reflect the added value of those deductions.

Parity 3: By tying the B-SALT changes to Section 199A, businesses operating as an SSTB are in for a double whammy – their income doesn’t get the 199A deduction and under the House bill it will be excluded from SALT deductions too. Senators and Representatives should be prepared to hear from the excluded industries. When a constituent business owner complains about tax hikes under this bill, this is what they are talking about.

The House bill is important to Main Street. Absent action, pass-through businesses face a historically large tax hike next year. That said, the bill adds to the tax disparity between corporations and pass-throughs — corporations get substantial tax relief with almost no offsetting provisions, whereas pass-throughs are subject to a mixed bag of benefits and costs.

Several of those costs are hopelessly complicated provisions that will excite tax nerds and enrich accountants, all at the expense of Main Street businesses.  The B-SALT deduction limitation is foremost among these, and it needs to be scrapped.