Lawmakers, businesses and tax professionals are eagerly awaiting a guidance package from the Treasury Department and IRS on a key deduction in the new tax-cut law that will play a huge role in determining just how much certain business owners can reduce their tax bills.
The guidance is for the 20 percent deduction for income from noncorporate businesses known as “pass-throughs.” The deduction could play a critical role as President TrumpDonald TrumpJan. 6 committee chair says panel will issue a 'good number' of additional subpoenas Overnight Defense & National Security — Presented by AM General — Pentagon officials prepare for grilling Biden nominates head of Africa CDC to lead global AIDS response MORE and Republicans seek to frame the tax law as driving the economy forward.
The deduction is complicated, leaving stakeholders unclear how exactly to calculate it and wondering how the IRS will police it.
And there’s a growing urge for the guidance to be issued as soon as possible so that businesses can plan to take advantage of the deduction.
“We’re hoping that guidance gets out quickly so that taxpayers can plan how to capture the benefits and to facilitate compliance,” said Debbie Fields, partner-in-charge of the pass-throughs group in the Washington national tax practice of KPMG.
Pass-through businesses are entities such as partnerships and sole proprietorships whose income is taxed through the individual code on their owners’ returns. Most businesses in the U.S., including many small businesses, are organized as pass-throughs.
Business groups and GOP lawmakers pushed for pass-throughs to get relief while the law was being drafted, arguing it would boost the economy and give pass-throughs parity with corporations, who were seeing their rate cut.
At the same time, lawmakers wanted to avoid a situation where wealthy individuals were reclassifying their wage income as pass-through income in order to avoid taxes.
The result was a new 20 percent deduction for certain pass-through income that includes restrictions on what income qualifies for the deduction.
A married couple with taxable income of less than $315,000 can take the full deduction on their pass-through income without restrictions. A couple making more than that has the amount that they can deduct limited, with the limit based on the greater of 50 percent of wages paid by the business or 25 percent of wages plus 2.5 percent of the unadjusted basis of the business’s eligible property.
Additionally, if a couple makes over $315,000 and has income from a specified service business, such as an accounting or law firm, the deduction phases out and is zeroed out for couples with total taxable income of at least $415,000.
Given that the deduction is brand new and has a number of complexities, business owners have a number of questions about how to determine the amount they can deduct and what business tactics they can use to maximize their deductions.
Lawmakers have been divided on the pass-through deduction, with Republicans praising it as beneficial for small-business owners and some Democrats arguing that it largely benefits the wealthy and is hard for small businesses to use. Lawmakers on both sides of the aisle are looking forward to IRS guidance.
House Ways and Means Committee Chairman Kevin BradyKevin Patrick BradySunday shows preview: Pelosi announces date for infrastructure vote; administration defends immigration policies House panel advances key portion of Democrats' .5T bill LIVE COVERAGE: Ways and Means to conclude work on .5T package MORE (R-Texas) met with Treasury Secretary Steven MnuchinSteven MnuchinThe Hill's Morning Report - Presented by Alibaba - Biden jumps into frenzied Dem spending talks Former Treasury secretaries tried to resolve debt limit impasse in talks with McConnell, Yellen: report Menendez, Rubio ask Yellen to probe meatpacker JBS MORE and acting IRS Commissioner David Kautter earlier this month to discuss implementation of the tax law and guidance that is “naturally needed,” including on the pass-through deduction.
Ways and Means Committee ranking member Richard NealRichard Edmund NealWhy Democrats opposing Biden's tax plan have it wrong Biden says he supports taxing billionaires' investment gains annually Overnight Energy & Environment — Presented by the League of Conservation Voters — EPA finalizing rule cutting HFCs MORE (D-Mass.) urged Treasury and the IRS in a letter last month to promptly issue guidance on the deduction because “taxpayers are left struggling to understand [the tax law’s] implications, and opportunities to exploit its ambiguities abound.”
Kautter said at a conference in Virginia earlier this month that a guidance package on the pass-through deduction could come out “within a couple weeks,” according to Tax Notes. He said the agency has zeroed in on crafting general rules, aggregation rules, anti-abuse rules and guidance on the definition of a service business whose income can be ineligible for the deduction. These areas have also been top priorities for businesses seeking guidance.
Stakeholders said that it’s important for the IRS to issue aggregation rules in order for taxpayers to figure out how to calculate the deduction.
In cases where there are several entities that are part of one overall business, there are ambiguities about whether the deduction has to be calculated for each entity separately or for the business as a whole. Experts said that in some circumstances, business income might not qualify for the deduction if the deduction has to be calculated for each subsidiary separately.
The U.S. Chamber of Commerce and a bipartisan group of lawmakers have recommended that guidance allow pass-throughs to aggregate for purposes of calculating the deduction amount.
“Pass-through businesses see the benefits of tax reform and are seeking IRS guidance to ensure they’re operating according to the new laws,” said Caroline Harris, vice president of tax policy and economic development at the Chamber.
Another area where guidance is expected and sought is anti-abuse rules. Because income from service businesses is often eligible to be deducted, some pass-throughs might consider separating the service aspects of their businesses and other aspects of their businesses in order to maximize the deductions their owners can take. Tax professionals want Treasury and the IRS to clarify what types of tax-planning strategies are allowed and what aren’t.
“There’s always a fine line between what’s permitted tax planning and what’s considered abuse,” said Gerald Thomas, chairman of the business tax group at McGuireWoods.
Stakeholders are also seeking more clarity about what constitutes a service business. For example, “health” businesses are considered service businesses, but there are ambiguities about what counts as a health business. The law also says that a business is a service business if its main asset is the reputation or skill of one or more of its employees, and stakeholders are unclear about what businesses would fall into that category.
“There’s no real definition around what that means,” said Zach Rudisill, a partner at Akin Gump who worked for Sen. Rob PortmanRobert (Rob) Jones PortmanRepublicans criticizing Afghan refugees face risks Anti-Trump Republicans on the line in 2022 too Major US port target of attempted cyber attack MORE (R-Ohio) while the tax law was being developed.
Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, predicted that some of the IRS’s decisions about what does and doesn’t qualify for the deduction will be somewhat arbitrary, because the tax law is vague on some aspects of the pass-through deduction,
“The Treasury and the IRS have a lot of discretion here,” he said.