The House-passed reconciliation bill, H.R.1 contains a provision increasing the Section 199A deduction for qualifying non-corporate business income from 20 percent to 23 percent There is no expiration date on the provision, which also contains modifications to eligibility for use of the deduction.
Among the bill’s modifications to Section 199A, and other provisions that impact the Section 199A deduction, are:
- A new rule for calculating the 199A deduction when the taxpayer claiming it has taxable income exceeding the threshold amount—the rule allows for indexing of the threshold amount, starting in 2025. The threshold amount is $394,500 for married couples filing jointly and $197,300 for individuals. The deduction phases down for income above these threshold amounts, so a partial deduction is available for those with taxable income of $494,600 for married couples filing jointly and $247,300 for individuals.
- A two-step process for determining eligibility for the Section 199A deduction—for the first step, the taxpayer must limit the deductible amount for each qualified trade or business to the greater of W-2 wages or W-2 wages and capital investment for each trade or business. Then, the taxpayer must compare the sum of deductible amounts for each trade or business to a new phase-in rule. Under that rule (step two), the taxpayer first takes 23 percent of qualified business income from all trades or businesses without regard to the W-2 wages and capital limitation and then reduces that amount by a limitation phase-in amount equal to 75 percent of the excess of taxable income over the threshold amount. Finally, the taxpayer compares the aggregate deductible amounts under the first and second steps and includes the greater of the two amounts in combined qualified business income.
- There is a limitation on the state and local tax (SALT) deduction that will impact all taxpayers in the 37 percent tax bracket, but that could have an enhanced impact on the section 199A deduction available to those taxpayers. The provision in question limits the value of itemized deductions for taxpayers in the 37 percent tax bracket. The limitation would reduce allowable itemized deductions for these taxpayers by the sum of 5/37 of the lesser of their total itemized deductions or the amount by which their taxable income plus total itemized deductions exceeds the 37 percent bracket threshold and 2/37 of the lesser of itemized deductions less SALT or taxable income in excess of the top bracket amount. The effect of this proposal would be to reduce the tax benefit of itemized deductions for 37 percent bracket taxpayers from 37 percent to 32 or 35 percent. For the 2025 tax year, the 37 percent tax rate applies to single individuals with taxable income over $626,350 and married couples filing jointly with taxable income over $751,600.
In addition, the House-passed bill would change the year at which inflation adjustments are triggered to 2025 from 2017.
This “tax-the-rich” provision could have considerable impact on pass-through businesses (partnerships, Subchapter S corporations, sole proprietors), and therefore could undercut the value of the Section 199A deduction.
- A decrease in the exemption amount for purposes of the alternative minimum tax (AMT) would also adversely impact the value of the section 199A deduction. The House-passed bill lowers the AMT exemption amount from $89,400 ($139,900 for married filers) to $70,300 ($109,400 for joint filers). In addition, it phases out the exemption amount from the AMT from $639,500 ($1,271,900 for married taxpayers) to $500,000 ($1 million for joint filers).
If this new set of 199A rules is included without change in the Senate version of the reconciliation bill (which is currently being constructed), it would take effect for tax years beginning after 2025.
Prospects: The Senate is now working on its version of the reconciliation bill, and Republican Senators (Democrats are united in opposition to the bill) are publicly vowing to make changes to the bill. Whether those changes will impact Section 199A is still unclear, although the House provision adds complexity and thus it is possible the Senate will seek to simplify the rule. Senate action is expected later this month.
NAIFA Staff Contact: Jayne Fitzgerald – Director – Government Relations, at jfitzgerald@naifa.org.