Placing policy aside, the 2017 Tax Cuts and Jobs Act is still perhaps the most controversial tax bill in recent history. Why? The process. The 2017 Tax Cuts and Jobs Act has been largely criticized as hastily drafted without appropriate public consideration, feedback, and debate. Dana Trier, for the most part, disagrees. His authority for this assessment? He was in the room.
On March 21, 2019, Dana Trier spoke at the Temple University Beasley School of Law as the 2019 Frank & Rose Fogel Lecturer. Mr. Trier, a former Deputy Assistant Secretary for Tax Policy at the U.S. Department of the Treasury, focused his lecture on the process behind the drafting of the 2017 Tax Cuts and Jobs Act, the changes to entity taxation, and the potential implications of §199A.
What most people fail to realize, Mr. Trier asserted, is that many of the changes in the 2017 tax bill were actually debated and drafted as far back as 2012. In fact, Congress drew much of its inspiration from what Mr. Trier referred to as an “inventory” of previously completed work that, for a variety of political reasons, simply had yet to make it into the formal legislative process. While this was the case for large swaths of the 2017 bill, Mr. Trier conceded that it was not the case for §199A, which provides a deduction for qualified business income from pass-through entities. Though changes such as those seen in §199A had been considered in the past, there was no real “inventory” to draw from. As such, the guiding precedent used for much of §199A was drawn from other sections of the tax code. While Mr. Trier criticized this as an inappropriate drafting method, he noted it was equally inappropriate to evaluate tax legislation until the accompanying regulations have been published and the full impact of the bill is observable in the market writ large.
Here’s why §199A matters. The 2017 Tax Cuts and Jobs Act dropped the top marginal income tax rate for an individual from approximately 39% to 37%, and the corporate tax rate from 35% to 21%. Given these changes, the difference between the two rates increased from about 4% to 16%. In a pass-through entity, income from the entity flows to the partners and gets taxed at their individual rate. Given the newly enlarged gap between the top individual rate and the corporate rate, Mr. Trier asked the audience to consider what might happen next. Will there be a tendency for business currently conducted through pass-through entities to become C-corporations?
Citing his experience from when this used to be the case, Mr. Trier said that “closely-held” businesses turning back into C-corporations would be detrimental to the system as a whole. Therefore, he concludes that, regardless of the process that got us here, the §199A deduction and the intermediate rate it creates for qualified business practices in pass-through entities (about 29.6%) is a good thing. While the gap between this rate and the corporate rate is still about 8.5%, Mr. Trier predicted that this gap may be sufficiently small to prevent closely-held businesses from turning into C-corporations, as they often were in the 1970’s and early 1980’s.
Mr. Trier did have a few criticisms of §199A. As it is currently written, income from certain specified service-based lines-of-business within a pass-through entity are exempt from the §199A deduction. However, the type of business income that qualifies for the deduction is not as clear as one would hope. This places the IRS in the uncomfortable position of picking “winners and losers” with respect to what businesses (and business practices) will qualify for deduction. Additionally, Mr. Trier expressed concern that, given this exemption to the deduction, pass-through entities may end up substituting service-based income for other types of income that do qualify for the deduction.
In concluding the lecture, Mr. Trier urged the audience to “give this [§199A] grand experiment a chance,” regardless of the process that got us here. His hypothesis is that when §199A expires in 2025, it will not be the new deduction that receives the most criticism, but the fact that not all lines-of-business within a pass-through entity qualify to receive it. As Mr. Trier noted, there does not seem to be a convincing argument for why certain business activities within a pass-through entity should be treated differently than others.
As a member of the audience I can tell you, Mr. Trier almost has me convinced. However, just because our legislators are drawing from an inventory of previously completed work, does that mean the public is not still owed a substantive vetting process before a proposal is put to the vote? While I am skeptical of this practice, Mr. Trier has at least convinced me that, since this “grand experiment” is now law, I should reserve full judgment on the policies now in place until we can analyze how they have played out in the market, regardless of the process that got us here.
Andrew LeDonne (LAW ’21) is a student editor for the 10-Q.