Analyse of a Section 199A Qualified Income Deduction Proposal

Annette Nellen, co-editor of the South-Western Federal Taxation Series

Each session of Congress sees hundreds of bills with tax changes. Very few of these bills get enacted into law. Few of these bills are discussed among the tax-writing committee members and the public. Many of the proposals can be used to aid students in understanding tax rules and principles.
H.R. 4947, Small Business Prosperity Act. This bill, among other changes, would raise the SS199A deduction by 20% to 43% (47% after 2020). The sponsor suggests that this change is necessary because it lowers the maximum tax rate on small-business revenue to 21 percent, the same low rate that large multinational corporations have enjoyed since 2018.
Is this correct? What about the tax impact of double taxation on corporate earnings? What about the marginal tax rate of 24% for many business owners?
An alternative approach to analyzing the sponsor claim would be to prepare comparisons of tax rates on the common amount of business income for both a C corporation or sole proprietor at varying marginal personal tax rates.
Here’s an example of such calculations.

Effective tax rates under current law:

Here’s the analysis with a 43% QBI percentage per H.R. 4947:

This analysis shows that business owners will have a 21% effective business tax rate at a marginal tax rate of 37%, which is less than 5% for individuals. A marginal rate of 37% is the most common rate for sole proprietors. This means that they already have a lower effective tax rate than 21% on their business income. This rate is lower than that for C-corporations if double taxation is assumed. A corporation may be able delay distributions.

Questions for students to think about:
What other factors should you consider when evaluating H.R. 4947?
Should H.R. Should H.R.
Should the 20% QBI deduction be adjusted if the corporate rate is raised to reduce the debt and deficit caused by COVID-19 tax changes? Explain.
Is self-employment tax to be included for sole proprietors? Or does it serve a different purpose that income tax on business income. Explain.
Is there a way to equalize the income tax structure on business income, regardless of type of entity, other than the QBI deduction? Is this the right thing? Why or why not?

SWFT Chapters

Chapters 1 and 9 of SWFT Individuals
Chapter 2: SWFT Corporations
SWFT Comprehensive: Chapter 7
SWFT Essentials: Chapters 1 & 11

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