President Joe Biden proposes to impose steep new taxes on high earnings and lucrative investments to help pay for expanded child care and other social programs. But if he’s serious about requiring wealthy Americans to pay more, he missed one of the most obvious places to start.
That would be by curtailing a gift to business owners granted by the 2017 Republican tax law, a special deduction that gives owners of partnerships and limited-liability companies a way to pay less than others who earn just as much money.
Business owners are allowed to deduct up to 20 percent of the income they receive from a pass-through business (so-called because the businesses’ profits pass through to owners directly and are taxed at the individual level) from their overall taxable income. That means a marginal tax rate as low as 29.6 percent instead of 37 percent for the highest earners.
To try to limit abuse, there are income thresholds in place for who can qualify for the full 20 percent deduction: $163,300 for single filers and $326,600 for married taxpayers filing jointly. But the statute was poorly written and includes several exceptions, which has resulted in a lot of tax avoidance.
Above the income thresholds, lawyers, doctors, investment bankers and some others who qualify as “service professionals” are limited from taking the full deduction. Taxpayers who aren’t involved in what the Internal Revenue Service has defined as service businesses or trades can still take the full deduction, provided they pay a certain amount in employee wages or have invested in capital such as real estate.
Not surprisingly, 66 percent of the provision’s benefits in 2019 were estimated to flow to those above the income guardrails, according to the nonpartisan Joint Committee on Taxation.
A better approach would be to allow the deduction only for people earning less than $400,000.
At a recent hearing, IRS Commissioner Chuck Rettig said tax evasion in the U.S. may total $1 trillion a year thanks to new tactics, including under-reporting from pass-through businesses.
It’s odd that Biden, who says he wants to give the IRS more money to end tax dodging by the wealthy, would forget about one of the prime tax-dodging structures, and a deduction that makes for an even sweeter deal.
Bizarrely, Biden’s tax plan targets two loopholes that pass-throughs often use to lower their tax bills–writing off excessive business losses and avoiding a Medicare tax–but is silent on the pass-through deduction itself.
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