WASHINGTON—Owners of closely held businesses would still get a 20% tax deduction under President Biden’s tax plan, leaving high-income people who run construction companies and manufacturing firms benefiting—for now—from a provision that Republicans created in 2017 over Democratic opposition.
Administration officials haven’t said why they haven’t proposed curbing the break at this point, and the White House didn’t comment. Treasury officials said Friday that some campaign proposals need more work and others may appear in future plans.
The deduction “just seems to be kind of without redeeming qualities and frankly, I was a little surprised that the Biden administration didn’t propose curtailing it,” said William Gale, a senior fellow at the Brookings Institution, a left-leaning Washington think tank.
Kevin Kuhlman, vice president of government relations at the National Federation of Independent Business, said he had been bracing for the deduction to be removed.
“There is a sensitivity to direct tax increases on small businesses and I think that’s one of the reasons it may not have been included,” he said.
He and other advocates of the provision say congressional Democrats’ wariness about some Biden tax-increase proposals could lead them to seek to change this break as a potential alternative way to raise money.
“That’s where you fear this getting resurrected, particularly when you consider the revenue pressure they’re going to be under,” said Dustin Stamper, tax legislative affairs practice leader at accounting firm Grant Thornton LLP.
Sen. Ron Wyden
(D., Ore.), chairman of the Senate Finance Committee, is working on a series of changes to the break that could sharply curb it for the highest-income households while opening it up to upper-middle-class service-business owners.
“I’m looking at ways to revamp the deduction to ensure it’s not just a giveaway to the top,” Mr. Wyden said. “The benefit could be made more generous for middle-class small-business owners and still generate revenue for other priorities like child care.”
Congress created the tax break—Section 199A of the tax code—in the 2017 tax law that got through Congress without a single Democratic vote. It gives a deduction worth 20% of income—basically a 20% rate cut—to business income that shows up on individual tax returns. That includes income from partnerships, sole proprietorships and S corporations, all of which are known as pass-through businesses because their income passes through to their owners without the separate business-level taxes that typically apply to corporations.
The idea for the provision was twofold: to create rough parity with corporate taxes that were also dropping and to provide a break to millions of businesses across the country, part of a political compromise that satisfied lawmakers such as Sen. Ron Johnson (R., Wis.) and Steve Daines (R., Mont.) who wanted to make sure that closely held firms benefited. The deduction is saving taxpayers $46 billion this year, according to the congressional Joint Committee on Taxation.
The break comes with some limits for high-income households, defined as individuals with taxable income above $164,900 or married couples with income above $329,800 this year. In those income groups, service businesses such as law firms and medical practices aren’t eligible, the idea being that their income is more akin to wages, not business ownership.
Other companies can qualify only if they have significant employees or assets, so the break tends to benefit the real estate, manufacturing and construction industries.
Democrats say the break is an unnecessary boon to the rich. About half the benefit goes to households making more than $1 million, according to the Joint Committee on Taxation. A study by two career Treasury Department economists and two other academics found that—at least in its first year—the deduction spurred no noticeable change in economic activity and little of the tax avoidance that some had feared.
“What’s bad is…how do I count the ways?” Mr. Gale said. “The fairness, the incentive structure, the complexity are probably the three bad things. And then there’s the lack of good things.”
During the 2020 campaign, Mr. Biden proposed phasing out the break for business owners with incomes above $400,000. As president, when he released his infrastructure and family-spending plans, he detailed trillions of dollars of tax increases, including some that weren’t in his campaign proposals. This provision didn’t get touched.
The administration is relying on corporate tax increases to fund the infrastructure plan and tax increases on individuals’ capital gains and ordinary income to pay for family and education spending. While some of those changes would mean significant tax increases for many pass-through businesses, they would retain the 20% deduction.
Some Democrats support keeping the break as is. Reps.
(D., N.J.) and
(D., Texas) have co-sponsored a bill to make the break permanent, and with the slim Democratic majorities, any division can prove difficult.
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Repeal also may not generate much money over the 10-year budget window. Like other pieces of the 2017 tax law, the deduction is scheduled to expire at the end of 2025. So repealing or curbing the break would raise money only for a few years.
Mr. Wyden’s approach also likely wouldn’t generate as much money as the Biden campaign proposal. That is because while he might phase out the break for households making above $400,000, he would also make it more generous for some business owners below that level. He is considering removing the restrictions on the break that start at $164,900 for individuals and $329,800 for married couples—a move that could benefit service-business owners in that income range such as lawyers and accountants.
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