The 2017 tax cuts, signed into law by then-President Donald Trump and enacted without Democratic support, made significant reductions to personal, corporate, and estate taxes that predominantly benefited the wealthy. One of the law's provisions allowed owners of pass-through businesses—partnerships, sole proprietorships, and S corporations—to deduct 20 percent of their qualified business income (QBI) when calculating their taxes. Initial estimates projected this new deduction would cost $414.5 billion, with the Congressional Budget Office estimating that extending it beyond its 2025 sunset would cost $684.2 billion from 2025 to 2034.
The pass-through deduction has been criticized for being costly, failing to produce promised growth, disproportionately benefiting the wealthy, and encouraging businesses to manipulate the tax code to maximize qualifying income. Tax filers with adjusted gross incomes (AGI) of $500,000 or more in 2021 claimed more than half of all pass-through deductions despite accounting for just 6 percent of all returns with the deduction. Wealthy filers claimed substantially larger average deductions compared to those with AGI below $100,000.
According to the Joint Committee on Taxation (JCT), nearly two-thirds of the 2019 decrease in taxes went to households with incomes of $409,836 or more. The JCT further projects that more than half of the tax benefit from Section 199A in 2024 will go to millionaires.
Over the past four decades, U.S. business income generated by pass-through businesses has increased significantly. In 2015, pass-throughs accounted for nearly two-thirds of all business income. This shift has contributed to widening inequality as pass-through income is concentrated at the top of the income distribution.
Pass-through businesses have been favored by tax laws over C corporations due to their single-level taxation at the owner/shareholder level. While C corporation income tripled from 1980 to 2015, pass-through income rose more than twenty-three times over.
Although often considered "small businesses," many pass-throughs are large entities. In 2019, over three-quarters of partnership assets were held by partnerships with more than $100 million in assets. High-wealth partnerships in finance and insurance and real estate accounted for a large share of these holdings.
Analysis published by JCT shows that nearly half of the Section 199A deductions in 2021 were attributable to businesses with no employees. More than 90 percent of sole proprietorships and over 80 percent of partnerships claiming this deduction had no employees.
Research indicates that large increases in capital and labor investments did not occur due to this deduction during its initial years. No evidence was found that Section 199A changed investment among eligible firms relative to ineligible firms or affected employment or wages paid.
Proponents argue that Section 199A was necessary to level the playing field between C corporations and pass-through businesses following corporate tax rate reductions in the same act. However, research suggests that even without this deduction, effective tax rates paid by pass-throughs were lower than those paid by C corporations.
Gaming opportunities expanded under Section 199A as some businesses recharacterized payments or modified shareholder payments to maximize deductions. Research found substantial declines in guaranteed payments while profit payouts increased among partners—indicating efforts to take advantage of this tax break.
Underreporting business income subject to personal income tax accounts for a significant portion of unpaid taxes (the tax gap). In recent years IRS projections show pass-through income accounted for $182 billion out an estimated $688 billion gross tax gap for one year alone.
IRS budget cuts prior passage Inflation Reduction Act exacerbated challenges auditing complex partnerships which grew rapidly recent years but received minimal scrutiny due understaffing issues now addressed through additional funding targeting audits large complex partnerships across industries utilizing advanced data tools artificial intelligence aiming increase audit rates tenfold addressing compliance gaps arising proliferation structures
Racial disparities also widened benefits largely accruing white families who received disproportionate share relative population percentages according Department Treasury study examining fiscal impacts specific demographic groups noting discrepancies particularly affecting Black Hispanic families relative overall filer proportions
Overall analysis concludes provision should expire scheduled citing inefficacy expense inequitable distribution benefits failure achieve intended economic outcomes job creation investment spurring concluding recommendations legislative action prevent continuation policy beyond current statutory limits expiration timeline
The author acknowledges contributions Samantha Jacoby Mike Kaercher David Mitchell comments Kennedy Andara David Correa assistance preparation report
