The Debate over Extending the Section 199A Deduction for Qualified Business Income

INSIGHTi

The Debate over Extending the Section 199A
Deduction for Qualified Business Income
Updated January 22, 2024
The 2017 tax law (P.L. 115-97, commonly known as the Tax Cuts and Jobs Act or TCJA) made significant
changes to the taxation of business income. For C corporations, the act permanently reduced the corporate
tax rate from a top graduated rate of 35% for tax years beginning before 2018 to a single rate of 21%. For
pass-through firms (i.e., sole proprietors, S corporations, partnerships, and limited liability companies),
whose profits are taxed at the individual income tax rate of owners, the law temporarily reduced marginal
individual income tax rates and established a temporary deduction under Section 199A of the federal tax
code that is equal to 20% of a firm’s qualified business income (QBI), subject to certain limitations. The
individual income tax rate cuts and Section 199A deduction are set to expire at the end of 2025.
There is bipartisan support in Congress for extending the Section 199A deduction beyond 2025. This
Insight briefly explains the deduction’s design, reviews arguments for and against such an extension, and
discusses what is known about the deduction’s effects.
Overview of the Deduction
Section 199A allows individuals, estates, and trusts with pass-through business income to deduct 20% of
their QBI in calculating their income tax liability, subject to certain limitations. The deduction lowers a
taxpayer’s adjusted gross income. QBI is a pass-through business owner’s net amount from items of
income, loss, gain, and deduction from every qualified business he or she owns. QBI does not include
wages, capital gains, dividends, and interest and annuity income unrelated to a trade or business. The
maximum Section 199A deduction cannot exceed 20% of a pass-through business owner’s taxable
income, less capital gains and dividends.
The deduction is subject to two limits: (1) a “specified service trade or business” (SSTB) limit and (2) a
wage and capital asset (WCA) limit. An SSTB is a personal service business such as accounting, law, and
medicine. Whether the limits apply depends on a taxpayer’s taxable income (without the deduction) and
filing status. In 2024, no limit applies if a taxpayer’s taxable income is less than $383,900 for joint filers,
and $191,950 for other filers. The limits phase in for income between $383,900 and $483,900 for joint
filers, and between $191,950 and $241,950 for other filers.
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Under the SSTB limit, an SSTB owner with taxable income above the upper income threshold may claim
no deduction for the SSTB’s QBI. Under the WCA limit, a non-SSTB owner with income above the
threshold may claim a deduction, but it cannot exceed the greater of 50% of the owner’s share of the
business’s W-2 wages or 25% of those wages plus 2.5% of the owner’s share of the business’s tangible
capital assets placed in service in the past 10 years.
Use of the Deduction
The Section 199A deduction was first available in 2018. Between 2018 and 2020 (the most recent year for
which data are available), the number of claims for it rose from 18.7 million to 22.8 million, and the total
amount of those claims rose from $149.9 billion to $166.1 billion. Table 1 shows the deduction’s
distributional effects. The figures indicate that the primary beneficiaries were pass-through business
owners with less than $1 million in adjusted gross income (AGI). The largest claims were filed by
taxpayers with an AGI of $5 million and above.
Table 1. Use of the IRC Section 199A Deduction for Qualified Business Income in 2020

Adjusted
Share of
Share of the
Average
Gross
Section
Amount of
Amount per
Income
199A
Section 199A
Section 199A
(AGI)
Claims
Claims
Claim
Up to
$200,000
80%
30%
$2,811
$200,000 to
$1 mil ion
18%
30%
$12,575
$1 mil ion to
$5 mil ion
2%
20%
$82,750
$5 mil ion and
above
0.2%
19%
$161,500
Overall
—
—
$7,222
Source: Internal Revenue Service, Individual Income Tax Returns: Complete Report, Table 1.4 for each year,
https://www.irs.gov/statistics/soi-tax-stats-individual-income-tax-returns-complete-report-publication-1304-basic-tables-
part-1.
Arguments For and Against Extending the Deduction
Proponents of the Section 199A deduction say that it should be extended because it encourages eligible
firms to grow faster. The deduction lowers the tax burden of a recipient. Proponents maintain that the
added profits allow pass-through firms to invest more in capital assets and hire more workers than they
otherwise would. In their view, another reason to retain the deduction is that it narrows the difference
between the marginal tax burden on corporate profits and the marginal tax burden on pass-through
business profits.
Critics of the deduction cite several reasons for letting it expire. First, they contend that there is no
evidence that the deduction has been an effective incentive for increased investment and job growth by
pass-through firms. Second, they say that calculating the deduction is needlessly complicated and costly
for many eligible small business owners, deterring some of them from claiming it. Third, according to
critics, the deduction is an inefficient way to promote business investment, as it applies to income from
past investments as well as income from new investments, producing a windfall gain for returns on

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pre-TCJA investments. Fourth, the deduction benefits some firms more than others for reasons that critics
say cannot be justified on economic grounds. Finally, the deduction entails a significant revenue loss:
according to the Joint Committee on Taxation, the deduction’s revenue cost will total an estimated $258
billion from FY2022 to FY2026.
Available Evidence on the Deduction’s Impact
There is limited research into the Section 199A deduction’s effects. A 2022 study by Lucas Goodman,
Katherine Lim, Bruce Sacerdote, and Andrew Whitten found no evidence of a “large response” to the
deduction by taxpayers and businesses in 2018, the only year covered by the study. More specifically,
Goodman et al. could find no evidence that the deduction altered the share of AGI classified as QBI.
There also was little change in the wages paid to S corporation shareholder-employees, even though those
wages do not qualify for the deduction; only S corporation profits qualify. The researchers did find
evidence that some partnerships responded to the deduction by reducing guaranteed payments to partners,
which do not qualify for the deduction, and replacing them with distributed profits, which are eligible.
Contrary to expectations, there was no evidence that the deduction had a significant impact on the number
of independent contractors and on pass-through business investment and hiring in 2018.

Author Information

Gary Guenther

Analyst in Public Finance




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