QBI tax break — should it stay or should it go?

With the fate of many expiring provisions of the Tax Cuts and Jobs Act hinging on this year's election, one particularly controversial deduction for certain business owners is in flux.

The exemption of 20% of qualified business income for owners of pass-through entities such as sole proprietorships, partnerships and S-corporations under Section 199A of the Internal Revenue Code is providing tens of billions of dollars every year in tax savings to some clients of financial advisors and tax professionals. The deduction represents "one of the biggest areas of planning that we can have under the new law," which might have been called "the tax professional, lawyer and financial advisor job security act," one tax expert said the year after the legislation passed Congress and was signed into law by President Donald Trump in 2017.

Backers argue the deduction simply gives small business owners rates on their income that are more similar to the lower corporate taxes paid by larger companies after the law. Critics question whether the provision has helped small businesses preserve and create enough jobs to justify its significant price tag and the disproportionate benefits flowing to wealthy taxpayers. With the temporary deduction's sunset slated for the end of next year, the qualified business income exemption represents a bellwether for an array of changes from the law that would add up to a total cost of $3.3 trillion if extended for another decade, according to one estimate.

"It's part of the 2025 tax cliff with all the other individual tax changes," as well as "an area of real contention between Democrats and Republicans on the future of this deduction," Garrett Watson, a senior analyst and modeling manager at the nonpartisan, nonprofit Tax Foundation, said in an interview. "The debate will very much be, 'Do we make this thing permanent, or do we let it expire?'"

READ MORE: 26 tips on expiring Tax Cuts and Jobs Act provisions to review before 2026

Status uncertain

Lawmakers have introduced legislation —  the Main Street Tax Certainty Act — in the Senate and the House to enshrine the deduction into the law without an expiration date.  Two Democrats have signed on as cosponsors in the lower chamber to the otherwise GOP-backed bills. The bills stand little chance of passage in this congressional session, considering that a different tax-credit extender bill that passed the House in a rare landslide vote last month currently faces an uncertain fate in the Senate. For advisors and tax professionals, the pass-through entities have taken on more importance in recent years for business owner clients who can use them for this deduction or as a potential workaround in some states to the $10,000 limit to the exemption for state and local taxes.

Business advocacy groups like the U.S. Chamber of Commerce are calling on Congress to make the pass-through deduction permanent. Doing so would ensure that the owners of pass-through entities are not "put at a tax disadvantage" compared to other businesses and support "one of the major sources of jobs in our nation," according to an interactive graphic on the deduction's impact released earlier this month by the Chamber.

"We put the data together to show these businesses are major employers in every state and every district," Curtis Dubay, chief economist in the Chamber's Economic Policy Division, said in an email. "The data is the data. It's indisputable these businesses are large employers. Without the deduction, the rate on pass-throughs would be higher than on big businesses. That's untenable. It is essential to preserve to prevent the loss of jobs and a slower growing economy."

Other policy experts find reason for skepticism. About 88% of the savings from the deduction goes to taxpayers in the highest quintile of wealth, with 50% for the top 1% of households, according to data from the Congressional Budget Office cited by Steve Wamhoff, the federal policy director of the nonpartisan, nonprofit Institute on Taxation and Economic Policy. 

The tax break "mostly benefits the richest individuals and has no discernable impact on employment," Wamhoff said in an email. "If you have clients who are not very high-income individuals but who nonetheless benefit from this deduction, congratulate them on being among the lucky few."

The Chamber and other advocates for extending the provision haven't presented any evidence "that fewer people would be employed if not for this deduction," because "none exists," he added.

"They imply, without demonstrating, that taking the deduction away from high-income business owners, even those with incomes of more than half a million dollars, would adversely affect employment," Wamhoff said. "This is an argument against any tax increase on rich people ever. Most employers are rich people or companies owned by rich people, so, by this logic, the rich should not pay taxes at all. Most Americans would disagree."

READ MORE: 24 tax tips for self-employed clients

A long paper trail

Two academic studies assessing the impact of the deduction found little to no economic impact stemming from the change, according to a report last summer by the Center on Budget and Policy Priorities, a progressive think tank that opposes making the exemption permanent.

"This suggests that, just as the pass-through deduction has had no discernible economic upside, its expiration would have little to no economic downside," the report said. "In fact, its expiration would free up more than $700 billion over 10 years to use on deficit reduction or important investments with proven economic benefits for families, such as expanding the Child Tax Credit, helping people afford rent and making quality child care and pre-K more affordable and accessible."

The Tax Foundation's models from a November report on the price of potentially making the Tax Cuts and Jobs Act permanent suggest a slightly lower impact to tax revenues of $608 billion over the next decade. Extending all of the provisions of the law would create 829,000 jobs, with a relatively small number, 41,000, attributable to the pass-through deduction. 

Potential alternatives between letting the deduction expire completely or extending it forever include restricting the claims to taxpayers with less than $400,000, which is in line with President Joe Biden's campaign pledge not to raise taxes on Americans below that income level, or tying the exemption to job-creating investments by businesses, according to Watson. In a 2018 report, the Tax Foundation outlined a series of possible reforms to the deduction. 

Capital gains and dividends at the shareholder level and various other expenditures going to large companies make calculating the rates paid by them compared to pass-through entities much more complex than looking at corporate versus personal income taxes, he said. 

"To what extent is this deduction for activity that might otherwise happen?" Watson said. "If you let this thing expire, the effective rates won't be that different. The challenge is that it's mostly been limited to the wonky tax space and not to the wider discussion."