Misdirected Recipients of Tax Reform: Section 199A, its True Beneficiaries, and Application to Low- and Middle- Income Residents

As part of the 2017 tax reform known as the Tax Cuts and Jobs Act, Congress passed a substantial new deduction for income earned through pass-through entities, such as partnerships, that was one of the most expensive provisions of the law, codified as section 199A of the Code. Section 199A provides a 20% deduction on the “qualified business income” of a taxpayer attributable to income earned through pass-through entities, offering a meaningful reduction in the taxpayer’s effective tax rate. At the time of the law’s passage, the Congressional rationale from supporters was that the deduction would help small businesses and middle-class residents by lowering tax bills, fostering investment and creating jobs. Meanwhile, on the ground after enactment, the reality is that nearly all of the billions of dollars for this deduction are flowing to high-income and wealthy individuals. At the same time, section 199A actually does stand to provide some benefit to small businesses and low- and middle-income taxpayers, including independent contractors and gig economy workers. However, this is a complex and tailored deduction, and taxpayers do not receive any indication regarding section 199A in annual tax reporting (e.g., Forms 1099), driving a gap between the allocation of the tax benefit and the ability for individuals to actually realize the benefit of the deduction. This article examines potential solutions in order to remediate the gap between the availability of a tax deduction or credit like section 199A, and the taxpayer ultimately claiming it, such as increasing existing information reporting to taxpayers, and increasing the role of the IRS in the preparation of tax returns. Section 199A, as representative of a broader pattern, cautions that, when future tax reform initiatives are proposed, additional attention needs to be paid to how and to what extent taxpayers are expected to claim a deduction, credit or other tax benefit, particularly low- and middle-income taxpayers.