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Congressional Democrats are considering reforms to the 20% pass-through tax deduction as part of a $3.5 trillion federal spending package.
Democrats’ proposal would phase out the tax break for business owners with taxable income exceeding $400,000, according to a discussion list obtained by CNBC. It would also make the tax cut available to more people below the $400,000 threshold by removing some existing restrictions.
A discussion list is a draft of ideas that lawmakers assemble before formally pitching them in the House or Senate. Democrats are weighing changes to the tax code to help raise money for up to $3.5 trillion in spending on climate, education, paid leave and other measures.
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Reforms to the pass-through deduction would raise “significant revenue while providing a new tax cut for Main Street small business owners,” according to the list.
The deduction, also known as 199A, was created by Republicans’ 2017 tax law, President Donald Trump’s signature legislative achievement. It lets the owners of pass-through businesses — such as sole proprietors, partnerships and S corporations — write off 20% of their business income.
Most of its benefits accrue to wealthy taxpayers.
In 2018, about 53% of its $40 billion value went to those with incomes over $500,000, according to the Joint Committee on Taxation, a nonpartisan body that reports to the U.S. Congress. By 2024, that share is expected to grow to 61% of a total $60 billion.
Potential changes
While Democrats’ discussion list is short on details, the pass-through policy changes it floats sound like concepts that Senate Finance Committee Chairman Ron Wyden, D-Ore., included in a recent bill.
Wyden’s legislation would phase out the 20% deduction for business owners whose taxable income exceeds $400,000, eliminating the tax break completely once income breaches $500,000.
The Wyden-sponsored bill would also expand eligibility for the tax break.
Currently, owners of certain service businesses — like lawyers, doctors, veterinarians and financial advisors — can’t get the full deduction if their income exceeds $164,900 (single filers) or $329,800 (married couples filing jointly) in 2021. They can’t get it at all if their income exceeds $214,900 (single) or $429,800 (married).
The pass-through deduction is scheduled to disappear after 2025, meaning any reforms would end after a few years’ time absent an extension. President Joe Biden didn’t propose changes to the tax break in his annual budget.
Some business groups have argued that limiting or repealing the deduction would hurt small businesses and lead to fewer jobs, lower wages and less economic growth.
“Such changes would amount to a direct tax hike on America’s Main Street employers, a key reason why the tax plan released by the White House in March left the deduction fully intact,” according to a joint letter published in June by a coalition of trade associations.