IRS Asked to Clarify Trump Tax Deduction for Pass-Through Businesses

By | April 26, 2018

The Republican tax law’s new deduction for pass-through businesses, intended to help small businesses, was “ill thought through” and will end up benefiting the wealthy, experts told the U.S. Senate Finance Committee on Tuesday at a hearing on the law’s early impacts.

The tax overhaul, which sailed through the Republican-controlled U.S. Congress in December without Democratic support, created a new 20 percent deduction for income that owners of so-called pass-through businesses report on their individual tax returns.

Republicans said the deduction would provide tax relief for the type of smaller, family-run businesses that would not benefit from the reduction in the top corporate rate to 21 percent from 35 percent. In a move to further limit its use by high-income workers, they exempted those in “services” professions such as law and accounting from qualifying.

But tax professionals and business groups have said the law is unclear. They have asked the Internal Revenue Service to issue guidance on which types of business income are eligible for the pass-through deduction.

Douglas Holtz-Eakin, an economist who heads the American Action Forum, a conservative think tank, told senators on Tuesday that even once the IRS weighs in later this year, the pass-through provision drew “haphazard lines in the sand” that “are the exact kind of lines that tax lawyers and experts will attempt to try to game.”

Democrats have complained that the tax code rewrite favors businesses and the wealthy, and that working-class taxpayers will see little benefit. The pass-through provision is just one reason why Republicans should work with them to rewrite portions of the hastily passed law, Democratic senators said on Tuesday.

A new analysis from the nonpartisan Joint Committee on Taxation released ahead of the hearing was used by Democrats to bolster their argument.

The JCT estimated that in 2018, more than half of the pass-through benefit will go to taxpayers making $500,000 or more, with $17.8 billion going to those reporting more than $1 million in income, and another $3.6 million going to taxpayers earning $500,000 to $1 million.

By 2024, more than 60 percent of the pass-through benefit will go to taxpayers making $500,000 or more, with $31.6 billion going to those reporting more than $1 million in income, and another $5.3 million going to taxpayers earning $500,000 to $1 million, the JCT said.

David Kamin, a New York University School of Law professor, told the committee the pass-through deduction was “ill thought through” and “one of the worst provisions that’s been added to the tax code in the last several decades.”

But David Cranston, president of Cranston Material Handling Equipment Corp. in McKees Rocks, Pennsylvania, estimated the pass-through deduction will save him up to $10,000 annually. He said it has allowed him to expand into a new product line.

It “put me in a better financial position to self-fund this new product,” Cranston told the committee.

Editor’s Note: As reported by Insurance Journal (How Insurance Brokers, Risk Managers View the Political Dysfunction in Washington), the tax deduction is an issue for some larger insurance agents and brokers, according to Joel Wood, senior vice president, the Council of Insurance Agents and Brokers. Wood told attendees last week at the RIMS annual conference that there remains uncertainty about the tax breaks for two-thirds of CIAB’s member firms that are pass-through organizations including S-Corps, LLCs and partnerships. The businesses are awaiting clarification. “We will be seeing in a couple of weeks if they are going to put their finger on the scale towards granting the most possible 20 percent pass-through tax relief for the most possible number of entities. So that’s a big, big issue out there,” Wood said.

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