Senate Modifies 17.4% Deduction for Pass-through Income to Expand Benefit for MLP Investors with Less than $500k Taxable Income
By Stuart E. Leblang Michael J. Kliegman, and Amy S. Elliott
Senate Finance Committee Chairman Orrin Hatch (R-UT) released a “modified mark” 1 of the Tax Cuts and Jobs Act of 2017 (TCJA) November 14 that further reduces the tax burden on some pass-through owners by eliminating the wage cap that applied to the 17.4 percent deduction for married individuals filing jointly with taxable income not exceeding $500,000. 2 (For more information on how the pass-through deduction works, see our included November 12 report “Senate Bill—With Deduction for Pass-through Income—May Have Radically Different Impact on Certain MLPs than House Bill; Treatment of REITs More Ambiguous, But Likely Favorable.”)
- The change means that for the “mass affluent,”3 including many retail investors, the income they receive from a master limited partnership (MLP) would get the full benefit of the deduction, resulting in effective tax rates of between 18.2 percent and 28.9 percent for married individuals filing jointly with taxable incomes between $77,400 and $500,000. In 2015, 34 percent of MLP unitholders were individuals.4
|
Over $77,400 but not over $140,000 |
Over $140,000 but not over $320,000 |
Over $320,000 but not over $400,00 |
Over $400,000 but not over $500,000 |
|---|---|---|---|
|
From 22% to 18.2% |
From 24% to 19.8% |
From 32% to 26.4% |
From 35% to 28.9% |
- This change could increase the attractiveness of MLPs relative to other investments and could decrease the chance that certain MLPs might consider converting to C corporations as a result of the 15 percentage point reduction in the corporate tax rate.
- Absent this change, the pass-through deduction could have had limited benefit for investors in MLPs that did not have much direct U.S. Form W-2 wage costs.
The original Senate proposal provided that dividends from a real estate investment trust (REIT) are generally treated as items of domestic qualified business income for purposes of the 17.4 percent pass-through deduction. Because the language in the original proposal is somewhat ambiguous, there is uncertainty as to whether the wage cap applies in the case of REIT dividends. We made the assumption that it does not.
- We would expect that if the wage cap does apply to REIT investors, the new wage cap exemption for an individual with married filing jointly taxable income under $500,000 would also apply to REIT dividends.
[1] The modified mark will replace the original mark released November 9 and is expected to be voted on and approved by the Senate Finance Committee November 17: https://www.finance.senate.gov/imo/media/doc/11.14.17%20Chairman’s%20Modified%20Mark.pdf
[2] The wage limit, which caps the deduction at half of an amount tied to the owner’s allocable share of the domestic Form W-2 wages paid by the partnership, would be phased back in for married individuals filing jointly with taxable income between $500,000 and $600,000.
[3] In general, the mass affluent have annual household income over $75,000. (https://en.wikipedia.org/wiki/Mass_affluent)
[4] MLP unitholder breakdown in 2015: 34% individuals, 20% corporations, 15% trusts, 9% IRA/SEP/KEOGH, 6% partnerships, 6% foreign entities, 10% other (https://www.alerian.com/why-foreign-ownership-in-mlps-is-up-300-over-the-last-10-years/)
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