Treasury releases proposed rules on major part of Trump tax law

Treasury releases proposed rules on major part of Trump tax law
© Anna Moneymaker

The Treasury Department and IRS on Wednesday released eagerly anticipated guidance on a key part of the new tax law that allows certain businesses to significantly reduce their tax bills.

The guidance is intended to answer questions related to the tax law's 20 percent deduction for income of noncorporate businesses known as “pass-throughs.”

The pass-through deduction is one of the areas of the tax law that businesses have most wanted guidance from Treasury and the IRS about, since the deduction is a brand-new section of the tax code and has a number of complexities to it.


A senior Treasury official said the department’s aim with its new guidance was to release a fairly comprehensive set of rules that pertain to most pass-through businesses.

“This was intended to give small-business taxpayers everything they needed to navigate these rules,” the official said.

Pass-throughs, which have their income taxed through the individual code on their owners' return, include businesses such as sole proprietorships and partnerships. Many small businesses are pass-throughs, as are businesses such as real estate firms.

Married couples with income under $315,000 can claim the deduction without restrictions. For those making more than that amount, there are limits on the deduction.

Treasury said that the proposed guidance has three main components.

The first component involves ensuring that pass-through business income below the $315,000 threshold is eligible for the deduction without complications.

The second component of the guidance focuses on clarifying the process for claiming the deduction for taxpayers with income above the threshold.

This section of the guidance includes rules that streamline the process for taxpayers with income from multiple pass-throughs to aggregate their income across entities for purposes of calculating the deduction amount.

It also includes information about what constitutes a specified service, trade or business. Under the tax law, a married couple with income of over $415,000 can’t take the pass-through deduction for income from a specified service, trade or business, such as a law or accounting firm.

The third component of the proposed rules focuses on preventing taxpayers from abusing the deduction to avoid paying taxes. For example, the proposal prevents employees from being relabeled as independent contractors or treated as business owners when there’s been no economic change in employees’ relationship with the business, a senior Treasury official said.

Along with the proposed regulations, the IRS also released frequently asked questions about the deduction and guidance about how to calculate wages for the purposes of limits on the deduction.

“Pass-through businesses play a critical role in our economy,” Treasury Secretary Steven MnuchinSteven Terner MnuchinLawmakers fear voter backlash over failure to reach COVID-19 relief deal United Airlines, unions call for six-month extension of government aid House Democrats plan to unveil bill next week to avert shutdown MORE said in a statement. “This 20-percent deduction will lead to more investment in U.S. companies and higher wages for hardworking Americans.”

Lawmakers, businesses and tax experts on Wednesday offered some preliminary thoughts about the proposed rules as they started to examine the 184-page document.

“I think they did a good job of answering a lot of the questions,” said Debbie Fields, partner-in-charge of the pass-throughs group in the Washington national tax practice of KPMG. She added that she expects that stakeholders will provide the government with comments on how to improve the rules.

The Republican chairmen of the tax-writing committees were positive about Treasury's release of the guidance.

"These proposed regulations are intended to provide certainty and flexibility for Main Street businesses in this historic new small business deduction," House Ways and Means Committee Chairman Kevin BradyKevin Patrick BradyBusinesses, states pass on Trump payroll tax deferral Trump order on drug prices faces long road to finish line On The Money: US deficit hits trillion amid pandemic | McConnell: Chance for relief deal 'doesn't look that good' | House employees won't have payroll taxes deferred MORE (R-Texas) said in a statement. "We encourage local businesses to comment on these proposed rules as Congress and the Treasury Department work together to maximize the tax relief and the economic growth of America's new Tax Cuts and Jobs Act." 

Julia Lawless, a spokeswoman for Senate Finance Committee Chairman Orrin HatchOrrin Grant HatchBottom line Bottom line Senate GOP divided over whether they'd fill Supreme Court vacancy  MORE (R-Utah) said that the chairman "appreciates Treasury’s steady pace in releasing new regulations to help implement the new pro-growth tax law."

One piece of the proposed rules that stakeholders in particular were pleased with is the rule allowing aggregation. Businesses are often comprised of several entities, and in some circumstances businesses might not have been able to take advantage of the deduction if they had to calculate the deduction for each subsidiary separately.

“The U.S. Chamber is encouraged to see the IRS and Treasury issue guidance to bring tax code certainty to small and mid-size businesses," said Caroline Harris, chief tax policy counsel at the Chamber. "We continue to review the new guidance and are pleased to see the proposed rule’s aggregation approach."

Another piece of the proposal that stakeholders view positively is the effort to prevent taxpayers from using the deduction to improperly avoid taxes by being reclassified as independent contractors.

Steve Rosenthal, a senior fellow at the Tax Policy Center, called that part of the proposal "clever." Kyle Pomerleau, director of the Tax Foundation's quantitative analysis center, said that "it’s good that they addressed" the issue of reclassifying workers, since that was one of the most obvious ways that tax lawyers could have come up with schemes to use the deduction to avoid taxes.

But other parts of the proposed rules received criticism, particularly from Democrats. Many Democrats have argued that the deduction largely benefits wealthy taxpayers and is confusing.

“These new rules confirm that the fortunate few win and Mom-and-Pop shops lose under Trump’s tax law,” said Senate Finance Committee ranking member Ron WydenRonald (Ron) Lee WydenGOP senator blocks Schumer resolution aimed at Biden probe as tensions run high Republican Senators raise concerns over Oracle-TikTok deal Hillicon Valley: TikTok, Oracle seek Trump's approval as clock winds down | Hackers arrested for allegedly defacing U.S. websites after death of Iranian general | 400K people register to vote on Snapchat MORE (D-Ore). “Small business owners searching for clarity aren’t getting pulled out of a bureaucratic twilight zone any time soon. Many are still left wondering whether their business is blacklisted. For high fliers, the path ahead is paved in gold. Tax planners are already scouring through the nearly 200 pages of regulations in search of new ways to keep wealthy clients from paying their fair share.”

Some stakeholders have been critical of the fact that under the tax law, income from some types of businesses is eligible for the deduction while income from other types of businesses often isn't. They argue that the regulations only exacerbate the arbitrariness of which types of businesses qualify.

For example, under the proposed rules, managing real estate isn't considered a specified service business subject to restrictions, while managing a hedge fund is, Rosenthal said.

David Kamin, a law professor at New York University, said that Treasury decided to narrowly define service businesses that are based on the "reputation or skill" of their owners. As a result, more high earners will be able to take advantage of the deduction than would have if Treasury had defined the meaning of "reputation or skill" more broadly.

Kamin said that the rules emphasize "the poor decision making by Congress in their construction of this provision.” 

- Updated at 4:23 p.m.