Tax Bill SALT Treatment Punishes Mom-and-Pop Service Businesses

The sweeping new tax package being scrutinized by the US Senate offers favorable tax rates and preserves benefits for large corporations—but it’s coming at the expense of millions of service-based pass-through businesses across the country.

Service-based businesses that make up our local economies—such as community pharmacies, neighborhood doctors, your friendly veterinarian and local tax prep shops, among others—won’t be able to deduct state and local taxes. But corporations such as Walgreens, H&R Block Inc., and PetSmart Inc. can.

When Congress passed the Tax Cuts & Jobs Act of 2017, the cap imposed on deducting state and local taxes was a significant concern for many taxpayers and businesses. According to former US Rep. Kevin Brady (R), who was chair of the House Ways and Means Committee in 2017, it wasn’t Congress’ intent to cap the SALT deduction for pass-throughs.

In the wake of that bill, many states enacted legislation—supported by the IRS—to mitigate the $10,000 SALT limitation for pass-through entities (businesses in which the income, deductions, etc. are passed through to the individual owner).

The state legislation allowed the SALT liability on pass-through entities to shift from the owner to the entity itself, thereby making the majority of the pass-through entity SALT deductible. This approach helped provide some parity between corporations and pass-throughs.

The recent federal budget reconciliation, backed by the current House Ways & Means Committee, would hamstring certain pass-through entities—those known as specified service trade or business. These are businesses where the service being offered is dependent on the individual’s skill or reputation, such as bookkeepers, dentists, pharmacists, doctors, lawyers, and nurses.

The bill would remove the ability for the service business to deduct any state and local income tax at the federal level. This change would apply regardless of the partners’ or owners’ income level or the state in which they live.

The proposed bill unfairly targets these service businesses and trades by excluding them from taking the SALT deduction while allowing corporations to retain their ability to deduct an unlimited amount of state and local taxes.

It also proposes an individual state and local tax deduction limit of $40,000 for most taxpayers and $20,000 for married individuals filing separately. The SALT deduction for these service businesses would be subject to their individual state and local tax deduction limitation.

By eliminating the entity level deduction for specified service trade or business pass-through entities, the bill is targeting service providers, who were already hamstrung under the rules for the qualified business income deduction.

This change would indirectly increase taxes on millions of service-based businesses. According to the Tax Foundation, the disallowance of the SALT deduction by specified service trade or businesses could reduce the US gross domestic product by 0.2%, suggesting a broader negative effect on the economy.

The bill further introduces confusion and uncertainty for all pass-throughs. Pass-through entities would have to perform complex calculations and analysis to determine if they are eligible for any SALT deduction.

For state and local income tax deductions, non-specified service trade or businesses would need to perform a gross receipts calculation. For all other state and local taxes, pass-through entities would have to see if they qualify for the substitute payments provision (another complex set of calculations).

These businesses singled out by Congress are the backbone of the US economy. Pass-through entities are job creators, and a recent poll from the Winston Group found that 82% of voters preferred equal SALT deduction treatment among corporations and small or family-owned businesses.

Our laws shouldn’t discourage the formation of critical service-based businesses and disincentivize professionals from entering such trades and businesses. Congress must retain the ability of all pass-through entities to deduct entity-level state and local taxes at the federal level.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Melanie Lauridsen is vice president of tax policy and advocacy for the American Institute of Certified Public Accountants.

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