AICPA proposes changes to Senate bill that would help most US businesses

The AICPA submitted a letter with comments Monday on the Senate Finance Committee reconciliation bill, recommending three changes it said would put most U.S. businesses and many family-owned businesses — known as passthrough entities (PTEs) — on more even tax footing when compared with corporations.

The three changes recommended by the AICPA in the letter are:

• Retain full deductibility of state and local taxes (SALT) for all passthrough entities;
• Allow excess business loss carryforwards to offset business and nonbusiness income; and
• Repeal the personal casualty loss limitation.

These recommendations would ensure that the Senate committee’s version of the bill, issued June 16, “would not needlessly disadvantage certain taxpayers, would enhance tax parity among and consistency to taxpayers, and would promote tax administrability,” the letter to leaders of the Senate Finance and House Ways and Means committees stated.

The changes are needed, according to the AICPA, because PTEs experienced a “consistent decrease in parity” compared with corporations under the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, and would experience an even larger gap under the Senate committee bill. The House version of the bill passed May 22.

Details on each recommendation, as outlined in the letter:

Full deductibility of SALT taxes for all passthrough entities

The AICPA, CPA societies from 53 states and jurisdictions, and other stakeholders have raised concerns over the House-passed budget bill, H.R. 1, the One Big Beautiful Bill Act, because it prevents specified service trades or businesses (SSTBs) from deducting state and local income taxes at the PTE level. It does not limit non-SSTBs and corporations from taking the deductions.

The Senate committee bill eliminates that disparity but does not address the lack of parity caused by allowing corporations a complete deduction for all SALT, while limiting all PTEs’ ability to deduct SALT, the letter said. As the AICPA noted in its letter, most U.S. businesses are structured as PTEs (partnerships, S corporations, limited liability companies, or sole proprietorships). “Our laws should not discourage the formation of PTEs, as these business structures provide the flexibility and control desired by many owners that is not available within the more formal corporate structure.”

The SALT proposal in the Senate committee bill would maintain the existing $10,000 limit for individuals and would also allow a separate PTET deduction for owners of all PTEs, including SSTBs. PTE owners could deduct PTET up to an amount not to exceed the greater of $40,000 ($20,000 for married filing separately), or 50% of PTET. If an owner has an excess of PTET over the $40,000 or 50% limitations, the owner may apply the excess PTET to the $10,000 individual limit, if any remains.

On this subject, the AICPA made recommendations in the following areas:

• Passthrough entity tax exception for jurisdictions with income taxes

Generally, PTET would be defined as any tax described in Sec. 164(a)(3) to the extent it is paid in carrying out a trade or business or Sec. 212 activity, the letter said. One exception to the definition of PTET (under proposed Sec. 702(d)(1)(B)) would provide that Sec. 164(a)(3) taxes paid will not be considered PTET if three factors are satisfied, the third factor being that the tax liability for such tax by any PTE may not exceed 102% of the liability imposed on an unmarried individual with net income equal to the net income of the PTE. Satisfaction of all three factors precludes a PTET deduction in its entirety.

The tax liability by a PTE generally should not exceed the 102% limit unless significant overpayments are made intentionally. Many PTET regimes implemented by various states require partnership payments on behalf of partners to be made equal to the state’s top individual marginal rate. Although this could potentially generate an overpayment for certain individual partners whose effective rate is lower than this top marginal rate (these partners will have taxable refunds in the subsequent year), the AICPA interprets the current language to consider such payments as a “passthrough entity tax.”

However, Sec. 702(d)(1)(B)(iii) as drafted could be interpreted so that it unintentionally captures taxpayers that are not violating the spirit of the provision, meaning they would not be able to take the entire PTET deduction.

The Senate Finance Committee should consider language, the AICPA letter said, that would prevent the harsh result of a complete disallowance of the PTET deduction in the event the 102% provision unintentionally captures legitimate claims (e.g., the PTET deduction could be disallowed by any amount over the 102% limitation).

• Mandatory state and local taxes paid by the PTE should not be subject to any limitation

The AICPA urged the Senate Finance Committee to incorporate mandatory state and local taxes into the definition of an “excepted tax” under proposed Sec. 275(b)(4), which would “properly and fairly distinguish true mandatory business expenses from elective PTET taxes.”

Certain states and localities have taxes that are imposed upon the PTEs as the taxpayers, not the partners. Because these are taxes on the entity, it would be fair to treat such mandatory taxes as ordinary and necessary business expenses of the entity deductible at the entity level, just like for corporations, the AICPA letter said. Compounding the problem is “the issue of whether these mandatory taxes are deductible under either Sec. 164(a)(3) or the flush language of Sec. 164(a) is unclear and would remain subject to interpretation.”

• Clarify the definition of substitute payments under proposed Sec. 275(b)(5)

The AICPA also encouraged the Senate Finance Committee to more clearly define the term “substitute payments” to ensure that the definition narrowly targets its intention and explicitly lists the types of taxes that are not subject to the substitute payment provision. Specifically, the committee should clarify that the “pass-through entity tax” (as defined under proposed Sec. 702(d)(1)) would not be a substitute payment.

Proposed Sec. 275(b)(5)(A) would define substitute payment as “any amount (other than a tax described in paragraph (3)(A)) paid, incurred, or accrued.” That makes it appear that a substitute payment is intended to be any amount, other than PTET and disallowed foreign real property taxes. However, proposed Sec. 275(3)(A) would define “specified tax” by affirmatively incorporating any tax under Sec. 164(a)(1), Sec. 164(a)(2), and Sec. 164(a)(3), and then removing any excepted tax and PTET tax. Under the language in both versions of the budget bill, “(other than a tax described in paragraph (3)(A))” could be interpreted in different ways, one interpretation simply being that a substitute payment is not a specified tax. Under this unlikely intention, nonspecified taxes would be subject to their own rules but would then need to be analyzed in light of this substitute payment provision.

On its other recommendations, the AICPA said the Senate should:

Allow excess business loss carryforwards

The Senate committee bill would amend Sec. 461(l)(2) to provide that any excess business loss carries over as an excess business loss, rather than as a net operating loss (NOL). This amendment would effectively provide for a permanent disallowance of any business losses unless or until the taxpayer has other business income with which to offset the business losses.

The AICPA recommended that this provision be removed and that Congress retain the treatment of excess business loss carryforwards under current law, which is that the excess business loss carries over as an NOL, when it is no longer subject to Sec. 461(l) in the carryforward year.

Repeal the personal casualty loss limitation

The AICPA urged Congress to restore the personal casualty loss deduction under Sec. 165 to all taxpayers with losses from disasters, crimes, and scams. The TCJA suspended the personal casualty loss deduction for tax years 2018–2025 unless the loss was caused by a federally declared disaster. The One Big Beautiful Bill Act and the Senate committee bill would make the suspension permanent, although the Senate version would allow losses for both federal- and state-declared disasters.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.