Senate Juices Up Tax Cut For Pass-Throughs

November 15, 2017 | By: Robert A. Green, CPA

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Update Nov. 24: The Senate Finance Committee posted the legislative text for the “Tax Cuts and Jobs Act” bill on Nov. 22. There are five haircuts on calculating the deduction on qualified business income for pass-through entities. The Senate bill’s definition of a “specified service activity” includes a trading business. (See my blog post, Five Haircuts On The Tax Deduction For Pass-Through Entities.)

In the Nov. 14 modified mark of the tax cut bill prepared by the staff of the Joint Committee On Taxation for the Senate Finance Committee, there are two significant improvements in the 17.4% deduction for pass-through businesses for taxpayers with taxable income up to $500,000 (married) and $250,000 (other individuals). Under this upper-income threshold, the Senate committee removed the 50% wage limitation and allowed specified service businesses to use the 17.4% pass-through deduction. There are phase-out rules over the limit of $100,000 (married) and $50,000 (other individuals).

In the original mark, the specified service business income threshold was $150,000 (married) and $75,000 (other individuals). The 50% wage limitation is complicated for taxpayers over the income limit.

The House improved its pass-through provisions with modifications to HR-1 in 115–39, scrapping the original bill’s expansion of self-employment income (SEI). The modified House bill helps middle-income taxpayers by adding an 11% maximum pass-through tax rate, phasing down to 9%, on the first $75,000 of business income, which phases out between $150,000 and $225,000 for married filers.

I prefer the Senate’s modified markup to the House’ modified bill for pass-through provisions. Deciphering the House’s complicated rules is difficult. For many small business taxpayers, the Senate’s modified mark delivers more significant tax savings.

I look forward to seeing the Senate committee’s actual bill — I hear it should be the vehicle for the final legislation negotiated by conferees in the Senate and House.

The text of the Senate’s modified provision is as follows (download the entire document JCX-56-17.pdf here):

“The Chairman’s modification provides that in the case of a taxpayer who has qualified business income from a partnership, S corporation or sole proprietorship, the amount of the 17.4-percent deduction is generally limited to 50 percent of the taxpayer’s allocable or pro rata share of W-2 wages of the partnership or S corporation or 50 percent of the W-2 wages of the sole proprietorship.

“W-2 wages of a partnership, S corporation, or sole proprietorship is the sum of wages subject to wage withholding, elective deferrals, and deferred compensation paid by the partnership, S corporation, or sole proprietorship during the calendar year ending during the taxable year.

“Under a special rule, the W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $500,000 for married individuals filing jointly or $250,000 for other individuals. The application of the W-2 wage limit is phased in for individuals with taxable income exceeding this $500,000 (or $250,000) amount over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.

“The modification further provides that the exception allowing the 17.4-percent deduction in the case of certain taxpayers with income from a specified service business applies to those whose taxable income does not exceed $500,000 for married individuals filing jointly or $250,000 for other individuals. The benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.”

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