AGC recently submitted comments to the Committee on Ways and Means “tax teams.” These teams, started by Chairman Jason Smith (R-Mo.) earlier this year, have solicited input from interested parties about legislative priorities going into 2025, when many important provisions from the 2017 Tax Cuts and Jobs Act (TCJA) expire. Over the next few weeks, we will do an in-depth review of some of these priorities to highlight certain tax provisions that have proven to be important to the industry over the previous seven years. Today’s section will focus on the Section 199A “qualified business income deduction,” sometimes referred to as the “small business deduction” (although it doesn’t only apply to small businesses).
Prior to passage of TCJA in 2017, construction firms organized as “C-Corporations” were taxed at a top rate of 35 percent, while construction firms organized as a pass-through business—such as S Corporations, Partnerships, or Limited Liability Corporations (LLC), which are taxed at the individual rate—had a top tax rate of 39.6 percent. The TCJA eliminated many deductions, used by all businesses regardless of their structure, to “pay for” a cut in the corporate tax rate to 21 percent, but only cut the top individual rate to 37 percent. To ensure that pass-through businesses, including the majority of construction firms, did not experience a significant tax increase, Congress created the Section 199A Qualified Business Income (QBI) deduction.
The QBI deduction is a 20 percent deduction available to businesses organized as a pass-through, which lowers the top effective marginal tax rate to 29.6 percent. Service businesses whose income primarily comes from labor, such as accounting firms, law firms, and lobbying firms do not qualify for this deduction above a certain income level. An additional guardrail ensures that, in order to qualify for the deduction, at least half of a business’s income must be wages paid to employees.
Without this deduction, construction firms organized as pass-through businesses would face a persistent disadvantage to competitors organized as C-Corporations. One recent study conducted by Ernst & Young (EY) found that, without the QBI deduction, pass-through businesses would pay, on average, 8 percent higher taxes compared to C-Corporations. For larger businesses, the disparity would increase to 16.5 percent. Ernst & Young also found that the QBI deduction supports roughly 900,000 direct jobs, and nearly 2.5 million indirect jobs. These jobs would be in jeopardy if the QBI deduction expires.
The QBI deduction is also particularly important to construction because of its impact on retained earnings. In commercial construction, a contractor’s bonding capacity often dictates how large of a project, and how much work a contractor can work on at any given time. Generally, commercial projects require surety and performance bonds—and for public work, including most federal work, it is legally required—to ensure that a project is completed, contracts are honored, and subcontractors are paid. Sureties thus have an outsized influence on construction firms, and how they deploy capital. Having a “fortress balance sheet” with enough liquidity and reserves in the company’s treasury, is essential in the prequalification process. For many pass-through construction firms, the only distributions paid to the owners are for tax payments; everything else is retained in the company.
It is also important to note that, while the QBI deduction will have by far the biggest impact on pass-through construction firms if it is allowed to expire, it is not the only expiring provision that will affect pass-throughs. Other key changes include:
• The individual tax rates revert to pre-2017 levels, including a 39.6% top rate;
• The State and Local Tax (SALT) deduction limitation sunsets; and
• The “Pease” limit on itemized deductions returns.
For the average business organized as a pass-through, its effective tax rate will increase from 27.4 percent to 32.9 percent—a 20 percent increase. Importantly, this impact will be felt differently across the income spectrum. According to a calculator developed by a respected Washington think tank called the Tax Foundation, a business owner with $50,000 in business income will see their taxes increase by 16 percent, while someone with $100,000 in business income will see their taxes increase by 25.7%.
Preserving the Section 199A QBI deduction, as in H.R. 4721 and S. 1706, the Main Street Tax Certainty Act introduced by Rep. Lloyd Smucker (R-Pa.) in the House, and Senator Steve Daines (R-Mont.) in the Senate, is of paramount importance to the construction industry, and it is essential that it be maintained in 2026 and beyond.
If you have any questions or would like additional information, please contact Matthew Turkstra.