Enactment of the Big Beautiful Bill was a big beautiful win for Main Street – making permanent the lower tax rates, 20-percent deduction for small and family-owned businesses, and the higher estate tax exemptions. All these provisions help pass-through businesses compete with their larger, publicly-owned competition and they help to protect the 2.6 million jobs that depend on the 199A deduction.
With the bill signed into law, what’s next? This from Bloomberg:
“Everyone’s been coming off the momentum, because we’ve had a lot of wins, and so I think that’s what’s been pushing this idea that we’re going to maybe do a second reconciliation bill,” Curtis Beaulieu, senior policy adviser to Johnson, speaking at an event organized by accounting giant Ernst & Young…
A future bill could include tax measures that didn’t make into the package signed into law, like increasing the passthrough business deduction under Section 199A to 23% from 20%, he said.
So what might 199A 2.0 look like? Here are some ideas:
23 Percent: As Bloomberg notes, the House-passed reconciliation bill sought to bump the 199A deduction by three percentage points. Over 120 Main Street trade associations backed the proposal, citing the economic benefits the change would bring, as well as the need for a more generous deduction amid other longstanding tax hikes squarely targeted at pass-throughs. While that proposal was left out of the final bill, it’s clear there’s support both on Capitol Hill and within the business community for expansion.
Foreign Income: As part of Chairman Smith’s Tax Teams exercise last year, we submitted comments that touched on the inequitable treatment of foreign-source income earned by pass-through businesses. While C corporations are permitted to deduct a significant portion of their foreign earnings and otherwise enjoy favorable treatment under the GILTI regime, pass-throughs are excluded from territorial treatment and pay rates up to 37 percent on their overseas income immediately — without the benefit of the 199A deduction. This discrepancy discourages global investment by American pass-throughs and puts them at a competitive disadvantage when doing business abroad. A future tax package should allow qualified foreign business income to receive the same 199A deduction as domestic income.
199A Deficit Accounts: As we noted earlier this year, current law prevents many pass-through businesses from accessing the 199A deduction due to so-called “199A deficits” — losses incurred in prior years that must be fully recouped before the deduction becomes available again. This restriction has proven especially punitive for businesses that took losses during the pandemic in order to keep their employees on payroll and operations running.
Now that many of these businesses are back in the black, they find themselves unable to benefit from 199A until they run through all their accumulated losses. C corporations, by contrast, face none of these obstacles. NOLs generated by C corporations apply broadly to all income and allow them to reduce taxable income without limitation, all while benefiting from a flat 21 percent rate. Pass-through businesses operate under a far more restrictive regime, with narrower deductions and tighter eligibility rules.
To address this challenge, we proposed a one-time election to wipe out existing 199A deficit balances, enabling affected businesses to immediately reclaim the deduction. This simple change would help businesses harmed by the pandemic and restore the original promise of 199A, ensuring it remains a reliable source of tax relief for millions of family businesses.
Eliminate the SSTB Designation: Another unique feature of the 199A deduction are the so-called “guardrails” that limit its application above certain income levels. Generally, if a business owner’s taxable income exceeds about $500,000, they don’t get the 199A deduction benefit if they are in the wrong industry (professional services) or if they don’t have significant levels of employees and/or investment. According to Treasury, these guardrails have a significant bite and reduce the 199A benefit by about 40 percent.
S-Corp supports some of these guardrails. For example, we first proposed the wage and investment limitation as a means of ensuring the 199A benefit goes to real businesses with real employees and investment. As a business owner, if you don’t create jobs and invest in your community, you don’t get the 199A deduction. Critics of 199A completely ignore this aspect of the law.
The exclusion of certain industries (Specified Service Trade or Business, or SSTB), on the other hand, is an extraordinarily bad policy. Why should a manufacturer with 500 employees get the 199A deduction but an accounting firm with 500 employees is excluded? Don’t accounting jobs matter too? Superficially, the SSTB designation was to prevent professionals whose income derives primarily from their own efforts from getting the deduction, but we already solved that challenge with the wage limitation. Only lawyers and accountants that create jobs get the deduction. The SSTB provision does nothing but punish some business owners because they are in the wrong industry.
With the BBB behind us, it’s time for Congress and Main Street to start the discussion of what comes next. An improved 199A deduction needs to be part of that discussion.