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1 Scott Greenberg & Nicole Kaeding, Reforming the Pass-through Deduction 1 (2018)

handle is hein.taxfoundation/refptd0001 and id is 1 raw text is: Reforming the Pass-Through Deduction FISCAL FACT No. 593 June 2018 Scott Greenberg Senior Analyst Nicole Kaeding Director of Special Projects The Tax Foundation is the nation's leading independent tax policy research organization. Since 1937, our research, analysis, and experts have informed smarter tax policy at the federal, state, and local levels. We are a 501(c)(3) nonprofit organization. @2018 Tax Foundation Distributed under Creative Commons CC-BY NC 4.0 Editor, Rachel Shuster Designer, Dan Carvajal Tax Foundation 1325 G Street, NW, Suite 950 Washington, DC 20005 202.464.6200 taxfoundation.org Summary * The Tax Cuts and Jobs Act of 2017 created a deduction for households with income from pass-through businesses - companies such as partnerships, S corporations, and sole proprietorships, which are not subject to the corporate income tax. * The pass-through deduction allows taxpayers to exclude up to 20 percent of their pass-through business income from federal income tax. The deduction is subject to several limits, intended to prevent abuse, which are based on the economic sector of each business, the amount of business wages paid, and the original cost of business property. These limits only apply to upper- income taxpayers. * The design of the pass-through deduction leaves room for improvement. The rules for claiming the deduction are relatively complex, and will arbitrarily favor certain economic activities over others. Meanwhile, it is unlikely that the current limits on the deduction will be sufficient to prevent abuse. Finally, several features of the provision's design will diminish its economic effect. * Lawmakers should consider reforming the pass-through deduction, in order to make the taxation of pass-through businesses less complex, less prone to abuse, more neutral, and more economically efficient. * One option for reform would be to limit the pass-through deduction based on how much businesses have invested and whether the investment costs have already been deducted. Under this proposal, businesses would only be able to claim a larger pass-through deduction if they invest more - which would likely make the pass-through deduction less prone to abuse and more economically efficient.