Senate Finance Committee Chairman Ron Wyden (D-OR) has introduced the so-called, ‘‘Small Business Tax Fairness Act,’’ which imposes a tax hike on small businesses by limiting the Small Business Deduction. This tax hike would hurt small businesses' ability to reinvest money back into new jobs, higher wages, and business growth at a time when small businesses are just beginning to recover from shutdowns and restrictions.
Specifically, the bill limits the Small Business Deduction in the Tax Cuts and Jobs Act, which allows pass-through businesses to take a deduction of up to 20 percent for qualified business income that is available under Section 199A. Pass-throughs include sole proprietorships, partnerships, LLCs, and S-corporations. These are entities that are taxed at the individual owner level and are comprised overwhelmingly of small businesses. This provision enables small businesses to invest more in employee compensation, new hires, capital, or other avenues for business growth. If this proposal along with Democrats’ other tax proposals are passed, it would impose for many small businesses a top tax rate of 39.6 percent.
The majority, or 64 percent, of pass-throughs in 2011 had fewer than five employees while nearly 99 percent had fewer than 500 employees, according to the Congressional Research Service. Of the 26 million businesses in 2014, 95 percent were pass-throughs. Pass-through businesses also account for 55.2 percent, or 65.7 million of all private sector workers.
In this way Senator Wyden’s bill would be a direct tax hike on a major amount of small businesses.
Further, this deduction has been incredibly helpful for small businesses. According to NFIB’s Small Business Introduction to the Tax Cuts and Jobs: Part I survey, “55 percent of small business owners say that the deduction is “very important” with another 29 percent say it is “somewhat important.”” In fact, 90 percent of small business owners support permanently extending the Small Business Deduction.
One example of this is the Cranston Material Handling Equipment Corp in McKees Rocks, Pennsylvania:
“Like many business owners, I pay quarterly estimated taxes,” Cranston testified. “In order to pay those taxes, I take cash from my company each quarter. Those payments suck my working capital right out of my business quarter after quarter. Under the Tax Cuts and Jobs Act’s new Section 199A, I now qualify for a 20 percent deduction on my pass-through income. In real terms, this means I will be able to keep between $1,200 and $2,500 a quarter in my business that I would otherwise have paid in taxes. The ability to keep $5,000 to $10,000 a year in my company is a big deal to a small business owner like me.”
While characterized by Wyden and other Democrats as a “giveaway” or “loophole” for the wealthy, the Small Business Deduction is limited to prevent taxpayers from taking advantage of the tax code by improperly allocating wage income, which is paid by the individual, as business income.
One of the main limitations within Sec. 199A is a wage limitation combined with a capital limitation. The wage limitation applies to taxpayers with greater than $315,000 in income for joint filers or $157,500 for single filers and is phased in over the next $100,000 or $50,000, respectively.
Past this threshold, the 199A deduction is limited to the greater of 50 percent of a business’s W-2 wages or 25 percent of W-2 wages plus a capital limitation of 2.5 percent of the “unadjusted basis” immediately after acquisition of all qualified property.
At a time when small businesses especially have been hit hard, Senator Wyden’s proposal is out-of-touch, short-sighted, and could be incredibly harmful. There are tens of millions of pass-through businesses, and their 65.7 million workers, that would be harmed by the elimination of the deduction, having serious implications on wages, jobs, and economic growth.