Senate Finance Chairman Ron Wyden (D-Ore.) has introduced legislation that modifies the 20% pass-thru deduction, and it will likely become a part of the infrastructure/reconciliation discussions taking place on Capitol Hill.
The pass-thru deduction became law as part of the 2017 tax reform bill and since its enactment Democratic lawmakers have argued it overwhelmingly benefits wealthier business owners. Wyden’s bill seeks to address this issue by phasing out the deduction for qualified business income over $400,000. The deduction is fully phased out at $500,000.
The pass-thru deduction is set to expire at the end of 2025. Between now and then, Wyden said his bill would keep $147 billion in deductions from being claimed by pass-thrus with more than $500,000 in taxable income. The phase out will drive down the overall cost of the bill.
“Our expectation that the cost for helping small businesses…are relatively modest,” Wyden said. He did not provide a cost estimate for his bill.
The Senator's bill would also extend the deduction to businesses that currently don’t qualify for it (like certain accounting firms). It is not clear how this adjustment would affect the bill’s cost.
In the context of infrastructure/reconciliation discussions, Wyden’s bill could serve as an offset to the $3.5 trillion reconciliation bill that only Democrats are expected to support.
Still, his bill presents a quandary for Democrats. If they create a middle-class tax cut that expires in roughly four years, there might be political pressure to extend it using reconciliation. If that occurs, they would have to pay for the cost of the extension.
Under reconciliation rules, a provision cannot add to the deficit after ten years. Since the pass-thru deduction is set to expire at the end of 2025, any extension beyond that year would be a cost to the government that would need to be offset by either an increase in revenue or decrease in spending.
However, there is a work-around to having to pay for the extension. Democrats could extend Wyden’s pass-thru deduction for less than ten years and then they would not have to pay for its cost. But that sets up a future tax hike and adds another temporary tax break to a tax code that is already riddled with temporary provisions. Making the tax break temporary could be politically unpopular.
Regarding the bipartisan infrastructure bill, it seems unlikely that Wyden’s legislation will hitch a ride on it. The infrastructure bill requires the support from at least ten Senate Republicans, most of whom oppose tax increases.
Republicans are likely to view Wyden’s legislation as a tax increase because it repeals the pass-thru deduction for wealthier business owners. Republicans in both chambers have vowed to oppose any legislation that increases tax, especially if it undoes pieces of the 2017 tax reform bill that President Trump signed into law.
Currently, there is no legislative text for the reconciliation bill or the bipartisan infrastructure bill, so it is too soon to know if Wyden’s legislation will be included in either bill.
The text of the legislation can be found here.
A one-page explainer of the bill can be found here.
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