Tax Bill’s Section 199A Expansion Would Boost BDCs

By Stuart E. Leblang, Michael J. Kliegman, and Amy S. Elliott

The tax changes in the so-called “One Big Beautiful Bill Act” that narrowly passed the House May 22¹ —and now moves to the Senate with the aim for Congress to send the bill to President Trump for his signature by July 4—include a number of expansions to the Section 199A pass-through deduction ² for qualified business income (QBI), including making permanent the deduction at an increased percentage (of 23 percent, from 20 percent).

But it’s another change to the deduction that is poised to supercharge what is already a fast-growing segment of the capital market: business development companies (BDCs). The provision, which was originally championed by Congressman Jodey Arrington (R-TX) ³ , would allow the bulk of dividends from many BDCs to constitute income eligible for the pass-through deduction.

What Are BDCs?

Congress created BDCs in 1980 ⁴ to generally help smaller operating companies attract capital investment. BDCs are in the business of providing venture capital. They essentially take investor money and use it to finance (through debt or equity investments) developing or distressed companies that may not have access to conventional loans or the public capital markets. They also provide guidance to such companies to ensure that their investments are successful.

From a technical standpoint, BDCs are closed-end ⁵ investment companies that are not registered with the Securities and Exchange Commission (SEC) as investment companies but have elected to be subject to more limited rules under the Investment Company Act of 1940. There are lots of rules for BDCs. BDCs are generally required by law to invest at least 70 percent ⁶ of the value of their total assets in (among other things) private securities of so-called eligible portfolio companies ⁷ (essentially, domestic non-investment companies that are either unlisted or are small- or mid-sized ⁸) and to make available to such portfolio companies significant managerial assistance. In addition, they have a leverage cap whereby their debt-to-equity ratio cannot exceed 2-to-1.

About one-third of all BDCs are publicly traded. Most BDCs primarily offer debt as opposed to equity financing, originating loans for their portfolio companies and receiving interest income in return.

The Tax Reform Act of 1986 ⁹ made it possible for electing BDCs to be treated as tax-qualified regulated investment companies (RICs) under Section 851. Just like real estate investment trusts (REITs), RICs are technically taxable C corporations (that issue Forms 1099 to investors instead of Schedules K-1). However, they operate as pass-throughs in that they are able to avoid the imposition of corporate tax to the extent that they distribute their income in the form of dividends to shareholders (and they must distribute at least 90 percent of their income each year to retain their RIC status, among other RIC requirements, including diversification rules).¹⁰ 

In the case of a BDC that primarily earns interest income, the dividends paid out to shareholders would generally be taxed at ordinary rates (i.e., a top rate of 37 percent) and would not constitute qualified dividends ¹¹ eligible for the long-term capital gains tax rate (i.e., a top rate of 20 percent). In that case, treating such dividends as eligible for the Section 199A deduction would reduce the effective tax rate on such income by nearly 9 percentage points to 
28.49 percent.¹² 

Proponents of the Section 199A change note that qualified REIT dividends ¹³ (any dividend from a REIT that is neither a capital gain dividend nor qualified dividend income) were made eligible for the Section 199A deduction when it was created in the 2017 Tax Cuts and Jobs Act. To “level the playing field,” qualified BDC dividends should also be eligible for the Section 199A deduction, argues the Small Business Investor Alliance (SBIA).¹⁴ 

The SBIA notes that: “BDCs are critical to providing capital to small and growing businesses, especially in underserved markets. However, they currently do not receive the same tax benefits as other pass-through entities, potentially limiting the flow of private capital into small businesses that need it most. By allowing BDCs to take the . . . QBI deduction, the legislation seeks to incentivize more investments in BDCs, ultimately channeling additional funding to lower middle market companies.”

The SBIA has developed a tool that identifies which BDCs have invested in which companies on a state-by-state basis. ¹⁵  According to the association, half of all BDC shares are held by individuals and about a third are held through retirement accounts.¹⁶  

Potential Market Impact

According to the Investment Company Institute (ICI), at the end of 2024, there were 162 BDCs, up from 97 in 2020 (an increase of 67 percent).¹⁷ BDC total net assets have grown exponentially over that period from $67 billion in 2020 to $225 billion in 2024 (an increase of 235 percent).¹⁸According to the SBIA, 48 BDCs are publicly traded.¹⁹  Some of the largest public BDCs include:

BDCs are viewed as supporting small Main Street businesses in ways that create jobs, which is why expanding eligibility for the Section 199A deduction to include income from most BDC dividends should generally be popular with lawmakers. The Joint Committee on Taxation scored the proposal, which (if enacted as drafted) would be effective starting in 2026,²⁷as costing $10.7 billion over 10 years.²⁸

But BDCs aren’t the only part of the private credit (i.e., non-bank lending) market that is booming, and access to Section 199A could prove to be a distinguishing factor for certain investors.

Certain private credit funds that take the position that they are engaged in the trade or business of lending to U.S. businesses may assert that they are not engaged in an a specified service trade or business (SSTB)²⁹due to final regulations that greenlighted such treatment where there is loan origination.³⁰Even so, in the private credit fund context for high-income investors, the amount of any potential Section 199A deduction would be reduced by the so-called wage and qualified property (WQP) limitation.³¹

If the proposed BDC change to Section 199A is enacted, then qualified BDC dividends (like qualified REIT dividends) would not be subject to either the SSTB or the WQP limitations—meaning (among other things) the amount of their Section 199A deduction would not be limited simply because the BDC shareholder happens to have taxable income (before the deduction) that is above (e.g, for 2024) the lower threshold of $191,950 (or $383,900 for joint filers).

How would tax-enhanced BDCs compare to another favorite of retail investors—exchange-traded funds (ETFs)? While a limited number of ETFs (those focused on the REIT sector, for example) take the position that more than 95 percent of their dividends paid constitute QBI,³² for most ETFs, the QBI percentage is much lower (often in the single digits).

Treasury Secretary Scott Bessent has said that small businesses “are the backbone of the American economy” and has pushed for increased lending capacity for Main Street businesses, so that they can hire workers, drive investment and “restore the American Dream.”³³
If this proposal is enacted, the demand for BDCs could rise significantly.

^{[1] Rules Committee Print 111-3 (https://rules.house.gov/sites/evo-subsites/rules.house.gov/files/documents/rcp_119-3_final.pdf) and Managers Amendment (https://amendments-rules.house.gov/amendments/RCP_119-3_Managers_xml%20(002)250521201648156.pdf).}

^{[2] Added to the tax code as part of the 2017 Tax Cuts and Jobs Act (TCJA), the §199A pass-through deduction was designed to deliver an effective rate cut to businesses taxed as pass-throughs (including partnerships) that was somewhat more comparable to the significant rate cut that TCJA delivered for corporations (from 35% to 21%). The business income of pass-throughs is taxed at the individual level, and TCJA only reduced the top rate for individuals from 39.6% to 37% (excluding the 3.8% net investment income tax and state and local taxes). However, for income deemed eligible for the current 20% Section 199A deduction (including QBI), the effective rate could be further reduced from 37% to 29.6%. There are detailed rules governing what constitutes QBI and there are limitations placed on the deduction. At a high level, for taxpayers with adjusted gross income (AGI) over certain thresholds (starting at, for 2024, $383,900 for joint filers and $191,950 for others), the 199A deduction is reduced to take into account the amount of W-2 wages paid by the business or the unadjusted basis of the business’s qualified property (this is referred to as the wage and qualified property or WQP limitation). In addition, limitations are placed on the amount of the deduction if the QBI comes from a specified service trade or business (SSTB), which are generally businesses that: (i) provide services in accounting, health, law, actuarial science, athletics, brokerage services, consulting, financial services, or the performing arts; (ii) provide services in investing and investment management, trading, or dealing in securities, partnership interests, or commodities; or (iii) derive much of their income from the reputation or skill of one or more of the firm's owners or employees. Once AGI exceeds the upper threshold (in 2024, $483,900 for joint and $241,950 for others), then the deduction is capped at 50% of the owner’s share of W-2 wages (or, if the amount is greater, 25% of those wages plus 2.5% of the owner’s share of the unadjusted basis of qualified property used in the business)—and no deduction is allowed in cases where all of the QBI comes from an SSTB. Under current law, 20% of all qualified REIT dividends and qualified PTP income can be deducted without limitation (the SSTB and WQP limitations do not apply).}

^{[3] See, for example, H.R. 5225, the “Small Business Investor Tax Parity Act of 2023.”}

^{[4] Small Business Investment Incentive Act of 1980 (P.L. 96-477).}

^{[5] They offer a fixed, limited number of shares and do not continually issue new shares (unlike an open-end fund, such as most mutual funds and most exchange-traded funds (ETFs)).}

^{[6] 15 USC §80a-54(a).}

^{[7] 15 USC §80a-2(a)(46).}

^{[8] A company with a class of securities listed on a public exchange must have a market cap of less than $250 million in order to constitute an eligible portfolio company (2008 expanded threshold; https://www.sec.gov/files/rules/final/2008/ic-28266.pdf).}

^{[9] P.L. 99-514.}

^{[10] Giving rise to a dividends-paid deduction that effectively wipes out their corporate tax.}

^{[11] IRC §854.}

^{[12] Note that the amendment (supra Note 1) defines a “qualified BDC interest dividend” as “any dividend from an electing business development company received during the taxable year which is attributable to net interest income of such company which is properly allocable to a qualified trade or business of such company.” We interpret the “of such company” language to mean “of the BDC,” and we would take the view that most BDCs are in the qualified trade or business of loan origination.}

^{[13] IRC §199A(e)(3).}

^{[14] Press Release, SBIA, House Bill Would Level Playing Field for BDC Investors (Jan. 24, 2025) (https://sbia.org/2025/01/24/sbia-expresses-support-for-bdc-tax-parity-bill-119/).}

^{[15] https://sbia.org/bdc-council/}

^{[16] https://sbia.org/bdc/}

^{[17] ICI, The Closed-End Fund Market, 2024 (April 2025; May 2021) (https://www.ici.org/system/files/2025-04/per31-04.pdf).}

^{[18] Id.}

^{[19] https://sbia.org/bdc/}

^{[20] As of market close May 21, 2025.}

^{[21] https://www.arescapitalcorp.com/portfolio/}

^{[22] https://www.blueowlcapitalcorporation.com/}

^{[23] https://www.bxsl.com/}

^{[24] https://www.fskkradvisor.com/} 

^{[25] https://www.mainstcapital.com/investors/}

^{[26] https://golubcapitalbdc.com/portfolio/}

^{[27] Technically, the effective date is for “taxable years beginning after December 31, 2025.”}

^{[28] Estimated Revenue Effects Of Provisions To Provide For Reconciliation Of The Fiscal Year 2025 Budget (JCX-22-25R), JCT (May 13, 2025) (https://www.jct.gov/publications/2025/jcx-22-25r/).}

^{[29] See the definition of qualified trade or business and SSTB in IRC §199A(d)(2)(B). QBI from an SSTB does not give rise to a §199A deduction if the owner’s adjusted gross income exceeds a certain upper threshold (for 2024, $483,900 for joint filers and $241,950 for others).}

^{[30] T.D. 9847, which among other things provides that the performance of services to originate a loan is not treated as the purchase of a security from the borrower.}

^{[31] Supra Note 2.}

^{[32] See, for example, Schwab U.S. REIT ETF (NYSEARCA: SCHH), which reported 98.32% of its dividends constituted QBI in 2024 (https://www.schwabassetmanagement.com/resource/schwab-etfs-section-199a-qualified-business-income-summary-2024).}

^{[33] https://home.treasury.gov/news/press-releases/sb0078; https://home.treasury.gov/news/press-releases/sb0079}