Changes in qualifying business income | Small Business Tax Fairness Act

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On July 20, 2021, Senate Finance Committee Chairman Ron Wyden (D-OR) released the Small Business Tax Fairness Act. The bill, if enacted, would make changes to the 20% deduction available under IRC Sec. 199A for income earned through partnerships, limited liability companies, S companies and sole proprietorships established by the Tax Reductions and Employment Act 2017 (“TCJA”). The bill should phase out the deduction for those earning more than $ 400,000, but keep it, clarify it and possibly extend it for certain small businesses.

The TCJA created the 20% deduction essentially to create parity with the lowering of the corporate tax rate from 35% to 21%. IRC Sec. 199A allows an unincorporated taxpayer a 20% deduction from qualifying business income (“QBI”). Therefore, an unincorporated taxpayer in the 37% tax bracket would pay an effective tax rate of 29.6% (80% X 37%) on the QBI. QBI is generally defined as US source income generated by an intermediary entity by certain companies.

Phasing out of income over $ 400,000

Senator Wyden raised several issues with the deduction. According to Senator Wyden, “half of the benefit of the transfer deduction goes to millionaires, and because the benefit is so skewed upward, many small business owners on Main Street are being excluded.” To eliminate this benefit for wealthy business owners, the QBI deduction would begin to disappear for all taxpayers with income over $ 400,000 and would be removed from $ 500,000 altogether. Under current law, there is no limit to the amount a taxpayer could take for QBI (subject to limits on taxable income, salary and unadjusted costs).

Elimination of SSTB

He also noted that the deduction is currently designed so that business owners in certain industries may benefit more from the tax relief than business owners in other areas. Owners of certain service companies, known as ‘specified trades or service companies’ (SSTBs), such as healthcare firms, law firms and accounting firms, face restrictions on the deduction, which applies for 2021 to single tax filers with income over $ 164,900 and married couples with income over $ 329,800.

Senator Wyden’s bill would extend eligibility for the full deduction to currently ineligible businesses and professions by removing the SSTB designation and making the deduction available to all qualifying businesses. However, this is not all good news. given that the proposed phase-out of $ 400,000 would limit the benefits to these taxpayers.

Simplification of the QBI calculation

Senator Wyden’s bill would also seek to simplify the calculation of the QBI deduction. Under the bill, the calculation of a taxpayer’s QBI deduction would simply be an amount equal to 20% of

  1. the taxpayer’s eligible business income,
  2. the threshold amount {for 2021, taxable income less than $ 329,000 married spouse & $ 164,900 for all other taxpayers}, or
  3. the taxpayer’s taxable income for the tax year less the net gain (as defined in IRC Sec. 1 (h)) of the taxpayer for that tax year.

This eliminates the unadjusted salary and cost requirements under current law which add complexity to the overall calculation.

Changes to eligible taxpayers

Under current law, the QBI deduction is available for trusts, estates, and taxpayers who have married separately. Under the bill proposed by Senator Wyden, the QBI would nott be available for trusts, estates and married taxpayers reporting separately.

The proposal comes after Senate Democrats come to an agreement on a $ 3.5 trillion budget plan, and it comes as some Democrats are discussing how to pay for their spending priorities. Changes to the transfer deduction could be an attractive way for Democrats to increase their income. However, Republicans are likely to argue that an overhaul of the tax break would equate to a small business tax hike, making the passage of the bill a bottom-up battle.

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