25 June 2025 Senate Finance Committee's bill could significantly affect high-income taxpayers
On June 16, 2025, the Senate Finance Committee released its budget reconciliation bill (the Senate Bill), which largely serves to permanently implement Tax Cuts and Jobs Act (TCJA) tax rates and tax cuts but also includes provisions that could significantly affect high-income taxpayers. While much of the Senate Bill's provisions mirror those passed by the House a few weeks ago, including preservation of the existing individual tax rates, changes to the excess business loss limitation, and an overall limitation on itemized deductions for those in the top 37% tax bracket, the following key changes are ones to watch:
This Tax Alert focuses on the differences proposed in the Senate Bill that affect high net-worth individuals. Under current law, for tax years beginning after December 31, 2017, and before January 1, 2026, an individual taxpayer may deduct: (1) 20% of qualified business income from a partnership, S corporation or sole proprietorship; and (2) 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deduction is not permitted with respect to certain specified service trades or businesses (SSTBs) above certain income levels. The 20% deduction may not be used in computing adjusted gross income and may be utilized both by non-itemizers and itemizers. "Qualified business income" is the net amount of domestic qualified items of income, gain, deduction and loss from the taxpayer's qualified business.
The House bill would make the qualified business deduction permanent and increase the deduction amount from 20% to 23% (For more on the House proposal, see Tax Alert 2025-1205.). While the Senate Bill would make the qualified business deduction permanent, the deduction amount would remain at 20%. The Senate Bill also would increase the deduction limit phase-in range from $50,000 to $75,000 (single filers) and $100,000 to $150,000 (married filing jointly filers). In addition, the Senate Bill would establish a new minimum deduction of $400 (adjusted for inflation) for taxpayers with at least $1,000 of qualified business income from one or more active trades or businesses. The Senate Bill's provisions are less beneficial to owners of SSTBs than the House bill would be. For example, while a married attorney with $1 million of QBI and $600,000 of taxable income would receive an IRC Section 199A deduction of $75,950 under the House bill, the Senate Bill would offer no deduction at all. Current law allows an individual taxpayer to claim an itemized deduction for state, local or foreign property or sales taxes up to $10,000 ($5,000 if married filing separately) of the amount paid. Additionally, individuals are generally able to deduct their distributive share of state and local property taxes allocable from a pass-through entity (the so-called PTET deduction). While the House bill would increase the cap for the state and local tax from $10,000 to $40,000, the Senate Bill would permanently extend the $10,000 cap for tax years beginning after December 31, 2025. The Senate Bill, however, notes that the cap is the subject of ongoing negotiations. The lower SALT deduction cap included in the Senate Bill was identified as a placeholder pending further negations. If the SALT deduction cap remains at the current $10,000 under the Senate proposal, it would prove disappointing to those in states with higher state and local taxes who believed the provisions in the House bill would offer some, albeit limited, relief. To circumvent the $10,000 individual SALT cap enacted by the Tax Cuts and Jobs Act, many states adopted PTET regimes that allow a partnership or S corporation to pay state taxes at the entity level, with each participating owner receiving a credit against their state tax liability. In Notice 2020-75, the IRS provided that these PTET payments may be deducted as business expenses of the partnership or S corporation. The Senate Bill would clarify and modify the list of taxes subject to, and not subject to, the state and local tax cap. The Senate Bill also would:
Unlike the House bill, which would eliminate the pass-through entity tax deduction for investment activities and SSTBs, the Senate Bill would establish a pass-through entity limitation that would allow individual pass-through entity owners to deduct the unused portion of their SALT cap plus the greater of:
The new limitation on PTET under the Senate Bill would provide a welcome increased deduction for these taxes to certain taxpayers compared to the House bill, which would eliminate the deduction for certain SSTBs. At the same time, it would further curtail the deduction for all others who would not have faced limitation under the House bill. Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under IRC Section 168(k) in the year in which qualified property is placed in service through 2026 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). It also allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). Bonus depreciation phases down to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system, certain off-the-shelf computer software, water utility property or certain qualified film and television productions, as well as certain qualified theatrical productions. Certain trees, vines, and fruit-bearing plants also are eligible for bonus depreciation when planted or grafted. Property is generally eligible for bonus depreciation if the taxpayer has not used the property previously (i.e., it is the taxpayer's first use of the property), provided the taxpayer does not acquire the "used" property from a related party or in a carryover basis transaction). Unlike the House bill, which would extend additional first-year depreciation through 2029 (2030 for longer production period property and certain aircraft), the Senate Bill would permanently extend bonus depreciation. It would allow taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, as well as specified plants planted or grafted after that date. In addition, the Senate Bill would modify IRC Section 168(k)(10) to give taxpayers the option to elect to claim 40% bonus depreciation (or 60% for longer production period property or certain aircraft) in lieu of 100% bonus depreciation for qualified property placed in service during the first tax year ending after January 19, 2025. The change would generally apply to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. While a permanent 100% bonus depreciation for eligible property acquired after January 19, 2025 is a welcome change for taxpayers with the "right" kind of income, other provisions in the House bill and Senate Bill may limit the availability of this deduction for many high net-worth individuals. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, as defined in IRC Section 163(j)(6), (ii) 30% of the taxpayer's adjusted taxable income (ATI), as defined in IRC Section 163(j)(8), and (iii) the taxpayer's floor plan financing interest, as defined in IRC Section 163(j)(9). For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation, and amortization (EBITDA). Thereafter, a taxpayer's ATI is computed with regard to any deduction allowable for depreciation, amortization, or depletion (i.e., the IRC Section 163(j) limitation is generally based on earnings before interest and taxes (EBIT)). Further, while IRC Section 163(j)(8) does not address a US shareholder's treatment of CFC income inclusions under IRC Sections 78, 951(a) or 951A(a), the final IRC Section 163(j) regulations provide that such amounts (referred to as "specified deemed inclusions") are not included in the determination of the US shareholder's ATI. However, under proposed IRC Section 163(j) regulations, which taxpayers may have been applying prior to finalization, a US shareholder may be able to effectively include in ATI a portion of the specified deemed inclusions to the extent there is CFC excess taxable income as defined in the proposed regulations. In general, under the final IRC Section 163(j) regulations, IRC Section 163(j) applies after the application of provisions that subject business interest expense to disallowance, deferral, capitalization, or other limitation. More specifically, under the final IRC Section 163(j) regulations, IRC Section 163(j) applies after the application of provisions that require the capitalization of interest, such as IRC Sections 263A and 263(g). As a result, capitalized interest expense under those sections is not treated as business interest expense for purposes of IRC Section 163(j). The Senate Bill would amend IRC Section 163(j)(8)(A)(v) to provide that ATI is once again computed without regard to any deduction allowable for depreciation, amortization, or depletion (i.e., based on EBITDA), and, unlike the House bill, the Senate Bill would make this reversion permanent. The Senate Bill would also amend IRC Section 163(j)(8)(A) to adjust the ATI calculation of a US shareholder by fully excluding CFC income inclusions under IRC Sections 78, 951(a), and 951A, consistent with the final IRC Section 163(j) regulations but contrary to the proposed IRC Section 163(j) regulations. The Senate Bill would also modify interest deductibility under IRC Section 163(j) by providing that the IRC Section 163(j) limitation is generally applied before interest capitalization provisions, thus making business interest expense that might otherwise be capitalized subject to the IRC Section 163(j) limitation. However, the Senate Bill would provide that any interest that is required to be capitalized under IRC Sections 263(g) or 263A(f) would not be treated as business interest expense for purposes of the IRC Section 163(j) limitation, consistent with the treatment of such interest amounts under the final IRC Section 163(j) regulations. The reversion to EBITDA would be effective for tax years beginning after December 31, 2024, and would remain permanently. This is a significant change from the House bill, pursuant to which the reversion to EBITDA would only be effective for five years, through tax years beginning before January 1, 2030. The provisions relating to CFC income inclusions and the coordination with capitalization provisions would be effective for tax years beginning after December 31, 2025. The permanent addback of depreciation and amortization to ATI (in conjunction with the potential return of 100% bonus depreciation) will provide significant relief to certain taxpayers by reducing the amount of interest limited under IRC Section 163(j). However, certain taxpayers with foreign operations may see this benefit eroded (starting in tax years beginning after December 31, 2025) by the exclusion of Subpart F and GILTI (and any associated IRC Section 78 gross up) from ATI. Due to the proposed IRC Section 163(j) ordering rule, taxpayers that remain IRC Section 163(j) limited (even after the reversion to EBITDA) in tax years beginning after 2025 would have a more limited opportunity to reduce the impact of the IRC Section 163(j) limitation through elective interest capitalization. Current law allows taxpayers who itemize deductions to receive a deduction for charitable contributions. The deduction amount is subject to a specified limitation based on the type of contribution gifted. The Senate Bill would create a permanent deduction for taxpayers who do not itemize their deductions. For tax years beginning after December 31, 2025, the Senate Bill would permanently allow non-itemizers to claim a deduction of up to $1,000 if a single filer ($2,000, married filing jointly) for certain charitable contributions. For those who itemize, the Senate Bill would impose a 0.5% floor on any charitable contribution otherwise allowable for tax years beginning after December 31, 2025. This change would reduce a taxpayer's charitable contributions for a tax year by 0.5% of the taxpayer's contribution base for that tax year. The Senate Bill also would permanently extend the increased contribution limit for cash gifts to qualified charities. High net-worth individuals who routinely give to charity would see the corresponding value of that deduction decrease in 2026. This new "floor" on the deduction would apply in addition to the limitation on the value of itemized deductions for the highest earners that was already proposed by the House bill. IRC Section 1202 provides an exclusion of gain from the sale of QSBS that is held for more than five years. The exclusion is 100% for stock acquired after September 27, 2010, and either 50% or 75% for stock acquired in earlier periods. The gain excluded under IRC Section 1202 is not treated as a preference item for purposes of the alternative minimum tax (AMT) under IRC Section 57(a)(7) for post-2010 acquisitions. The exclusion is subject to a per-issuer cap, which is generally the greater of $10 million or 10 times a taxpayer's basis in the subject stock. The exclusion does not apply if a corporation's aggregate gross assets exceed $50 million at any time from the corporation's date of formation through the moment immediately after the stock is originally issued to the taxpayer. The Senate Bill would establish a tiered gain exclusion for QSBS: 50% for QSBS held for at least three years, 75% for QSBS held for at least four years, and 100% for QSBS held for at least five years. This change would only apply to stock originally issued after the enactment date of the One Big Beautiful Bill Act. The gain excluded under the three- and four-year rules would not be treated as a preference item for purposes of the AMT under IRC Section 57(a)(7) if the stock was acquired after September 27, 2010. The per-issuer cumulative exclusion limitation would increase from $10 million to $15 million, subject to an annual inflation adjustment increase. If in any tax year a taxpayer fully utilizes the inflation adjusted per-issuer limitation, the taxpayer would no longer be eligible for additional inflation adjustments. The Senate Bill would also make conforming amendments to ensure married filing separately taxpayers are able to benefit from the inflation adjusted per-issuer limitation. Finally, the Senate Bill would increase the "aggregate gross asset" calculation under IRC Section 1202(d) to $75 million, which would also be subject to an annual inflation adjustment. Amendments made by the proposed legislation would generally be effective for stock issued or acquired, and to tax years beginning on or after, the date of enactment unless otherwise stated above. The proposed legislation affecting IRC Section 1202 would represent a significant expansion of the incentive and make much-needed changes to the statutory framework as it relates to the incentives' original purpose to encourage Americans to make high-risk, long-term, growth-oriented investments. The Senate Bill would retain proposed IRC Section 899, which was included in the House bill, albeit with some key changes. Under the Senate Bill, proposed IRC Section 899 would now target "applicable persons" of "offending foreign countries" (the House bill referred to "discriminatory foreign countries") that have an "unfair foreign tax." The Senate Bill would maintain the definition of an "applicable person"; in contrast to the House bill, it would define a "publicly held corporation" as a corporation where at least 80% of its stock (by vote and value) is regularly traded on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) (e.g., Nasdaq Stock Market or New York Stock Exchange), or any established securities market that meets similar regulatory requirements as determined by the Secretary. The Senate Bill would revise the definition of an "unfair foreign tax" to include an "extraterritorial tax" (e.g., a UTPR) and a "discriminatory tax" (e.g., a DST). Unlike the House bill, which defined an unfair foreign tax to expressly include a diverted profits tax (DPT), in addition to a UTPR and DST, the Senate Bill would not explicitly include a DPT in the definition of an "unfair foreign tax"; the Secretary is authorized, however, to determine other taxes that are a "discriminatory tax." In a significant change from the House bill, the Senate Bill would increase "specified rates of tax" only for applicable persons with a connection to countries with an extraterritorial tax (e.g., a UTPR). Thus, the rate increase would not apply to countries that only have a "discriminatory tax" like a DST. The Senate Bill would retain the House bill's definition of a "specified rate of tax." It would apply the increased tax rate to certain taxes, such as taxes on FDAP income and ECI of foreign corporations, if the tax were "otherwise applicable" to an applicable person but "not imposed by reason of an exemption or exception, or [imposed] at a rate of tax equal to zero." Thus, for these "otherwise applicable" taxes, the Senate Bill would appear to override any exemptions, exceptions or zero rates provided elsewhere, including under an applicable US income tax treaty. Unlike the House bill, the Senate Bill would explicitly provide an exception from proposed IRC Section 899 for:
The Senate Bill generally would maintain the House bill's list of withholding tax rates subject to increase, while also adding a reference to the withholding tax rate under IRC Section 1443(b), which applies to income of certain foreign organizations described in IRC Section 4948. Like the House bill, the Senate Bill also would explicitly prevent IRC Section 892(a)(1) from applying to an applicable person that is a government of an offending foreign country. The Senate Bill, however, would modify the cap on the rate increase to 15 percentage points above the otherwise applicable rate. This is a notable change from the House bill, which generally allowed an increase up to a 20 percentage points over the statutory rate. Moreover, the Senate Bill would modify the definition of "applicable date," which is relevant for determining the applicable number of percentage points. Under the Senate Bill, the "applicable date" would be the first day of the first calendar year beginning on or after the latest of (i) one year after the enactment of proposed IRC Section 899 (compared to 90 days in the House bill), (ii) 180 days after the enactment of the unfair foreign tax that results in the foreign country's treatment as an offending foreign country, or (iii) the first date that the unfair foreign tax begins to apply. Unlike the House bill, the Senate Bill would provide rules coordinating proposed IRC Section 899 and IRC Section 891. The Senate Bill would slightly modify the wording of current IRC Section 891 and define the terms "extraterritorial tax" and "discriminatory tax" by referencing the definitions in proposed IRC Section 899(d). Additionally, a coordination rule would preclude a rate increase under proposed IRC Section 899 from applying during any period a rate increase is in effect under IRC Section 891. A Tax Alert with a more detailed discussion of the Senate Bill's changes to proposed IRC Section 899 is forthcoming. Compared to the House bill, the Senate Bill would delay the application of proposed IRC Section 899 by one year. Specifically, increases in the rates of taxes, other than withholding taxes and modifications to the base erosion anti-abuse tax, would apply to each tax year beginning on or after the latest of:
The Senate Bill would also retain the House bill's blending rules for determining the applicable number of percentage points when multiple tax rate increases are in effect during a taxpayer's tax year, which could be relevant for fiscal-year taxpayers. Like the House bill, increases in withholding tax rates would apply for each calendar year beginning during the period the person is an applicable person. Under the modified definition of "applicable date" (described previously), however, the increased withholding tax rates would not apply until January 1, 2027. The Senate Bill would retain the rule for determining the applicable number of percentage points for withholding taxes based on the payment or disposition date (as applicable). The Senate Bill also generally would retain the safe harbors included in the House bill. While the Senate has effectively delayed the enactment of IRC Section 899 to 2027, individuals who are shareholders in certain foreign corporations, have interests in partnerships, or who are beneficiaries of certain foreign trusts, should pay close attention to the evolution of this provision. Like the House bill, the Senate Bill would include provisions addressing qualified opportunity zone incentives. For more on these incentives, see Tax Alert 2025-1317. Both the Senate Bill and House bill contain favorable provisions for extending the benefits of the Opportunity Zone Program. This remains an area of interest to many high-income earners and should be watched as Congress moves to pass the tax bill. While new Opportunity Zone designations may be created, stricter qualifications are also likely for new investors.
Document ID: 2025-1350 | ||||||
