A Modest Proposed Simplification of the Passthrough Deduction

The tax reform and simplification law known as the Tax Cuts and Jobs Act enacted the section 199A passthrough business income deduction, which generally provides a 20 percent deduction for some types of income from 2018 through 2025. Owners of sole proprietorships, partnerships, S corporations, and real estate investment trusts can claim the deduction and obtain billions of dollars in tax relief each year, subject to a few limitations. Treasury and the IRS have said that the section 199A regulations can be understood with only a few hours of work.One admitted area of complexity is that the section 199A rules can apply separately to each distinct trade or business, and it is sometimes difficult to determine when trades or businesses can be aggregated. Two grocery stores may be treated as two separate businesses subject to separate computational requirements for each store.An easy path of regulatory simplification is to import the trade or business aggregation rules that are found in the more recent regulations that apply to tax-exempt organizations’ unrelated trades or businesses. Tax-exempt organizations can aggregate their trades or businesses as long as they have the same two-digit North American Industry Classification System (NAICS) sector code. When a law school can aggregate its investments in a yacht dealership and a liquor store because they are both in NAICS sector code 44 (retail trade), Treasury and the IRS should allow the country’s small business owners to do a similar level of aggregation as well.This paper has been cited by the United States Senate in Senate Print 117-24, Tax Expenditures, at 561 (2022)