The possibility of losing the 20% Qualified Business Income (QBI) deduction by the end of 2025 poses a significant challenge for American businesses, particularly pass-through entities, which employ more than half of private-sector workers. Enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA), this deduction aimed to provide parity between pass-through businesses and C corporations, which benefited from a substantial reduction in corporate tax rates. The TCJA’s key provisions, such as the permanent cut of the corporate tax rate from 35% to 21%, coupled with the QBI deduction, played an instrumental role in boosting capital investments and wage increases for employees. However, with the deduction’s expiration looming, the economic landscape for these businesses could change drastically.
Impact on Pass-Through Entities
For pass-through entities, including sole proprietorships, partnerships, and S corporations, the potential expiration of the QBI deduction could result in a marked increase in the effective tax rate. The top marginal tax rate for these businesses could surge from 29.6% to 39.6%, amplifying the financial burden on over 95% of American businesses. The QBI deduction had previously enabled these entities to reinvest in their operations, driving growth and innovation. Its removal threatens to reverse these gains, imposing higher taxes that could stifle capital investment and potentially lead to job cuts or reduced wages for workers.
Moreover, the economic ramifications extend beyond individual businesses to the broader economy. Small businesses are the backbone of the American economy, employing millions of people and significantly contributing to the nation’s GDP. Any factor that negatively influences their financial health will inevitably ripple through the economy, potentially shrinking the economic growth observed in recent years. The increase in tax rates without the QBI deduction could lead businesses to reevaluate expansion plans, delay hiring, or cut back on other investments, which would undermine the economic momentum gained since the implementation of the TCJA.
To illustrate the potential impact, a QBI Tax Increase Calculator has been introduced, providing business owners with a forecast model based on the projected 2026 tax brackets. This tool offers a visual representation of the financial implications, shedding light on the urgency for legislative action. Without the QBI deduction, many Main Street businesses may find themselves grappling with increased tax liabilities, which could diminish their competitiveness against larger corporations that continue to benefit from lower corporate tax rates.
The solution lies in proactive Congressional action to extend the TCJA provisions, ensuring small businesses retain the financial advantages that have spurred economic growth and job creation. Maintaining the current tax structure for pass-through entities is vital to preserving the advancements achieved over the past years. Recognizing the profound impact of potential tax increases, lawmakers must prioritize extending these provisions to support the sustained growth and stability of American small businesses.
