The Trump loophole on state deductions

The House Republicans' new tax "reform" bill is even worse than you think.

As I've already written, its central organizing principle is to shovel massive amounts of money to the already-wealthy. But a group of New York University (NYU) law professors just caught a sneaky aspect of the bill that takes this tendency to galling new heights.

Right now, tax law allows you to deduct the state and local taxes you pay from your federal tax bill. The House Republicans' new bill would eliminate that deduction. That's caused a bit of a stink, and it would hit residents of high-tax states like New York — which tend to lean Democratic — pretty hard. But it's ostensibly in keeping with the GOP's goal of cleaning out loopholes.

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Here's the thing the professors caught, though: The bill doesn't kill the state and local tax deduction for everyone. If you own a business, and you make your income through that ownership, you can still deduct those state and local taxes. This would greatly benefit one particularly notable wealthy New Yorker while doing absolutely nothing for regular workers who would still lose out.

In their section-by-section summary of the bill, House Republicans state their intent is basically to divide fat cats from workers: "Under the provision, individuals would not be allowed an itemized deduction for state and local income or sales taxes, but would continue to be entitled to a deduction for state and local income or sales taxes paid or accrued in carrying on a trade or business or producing income."

Now, as David Kamin, one of the NYU law professors, said in his post on the subject, you might think this would still apply to regular employees: Aren't they also "carrying on a trade or business or producing income?"

Except under this logic, a regular employee would have to take deductions for state and local taxes as a business expense: "The proposed legislation expressly says that state and local income taxes, though no longer allowable as an itemized deduction, can be treated as a business expense or expense of earning income," explained Dan Shaviro, one of Kamin's colleagues at NYU, in his own post on the matter. "But the bill also disallows ALL itemized deductions by employees in relation to their trade or business of being an employee."

The end result? "The committee report makes it clear that they are trying to make state and local income taxes still deductible for 'business owners' and passive investors — but not for anyone else."

It's worth noting how flabbergasted both Shaviro and Kamin sound in their posts.

And it gets weirder. The Republicans' summary of the bill explicitly says they're trying to draw this distinction. But as Kamin lays out in his walk-through of the legislative text, GOP lawmakers may have screwed up the technical details. It's a complicated question involving how several sections of the bill interact and reference back to one another. But the gist is that the actual legislative language may not achieve what the summary says it achieves.

Which is kind of backwards from what you'd expect: Normally, if lawmakers are trying something underhanded, they write it into the actual legislative text and then try to downplay in the summary and talk around it, and legislative experts have to go digging for the mechanics. So maybe chalk this up to both deviousness and stupidity?

At any rate, as both professors say, the authors of the bill owe voters an explanation and clarification of their intentions, pronto.

Moreover, this is just the latest twist in the saga of how "pass through" income is treated in the House GOP bill.

Standard C-corporations — what you normally think of when you hear the word "corporation" — pay a specific federal tax on their profits. But companies can also incorporate as entities that fall under the "pass through" umbrella. These are ostensibly smaller businesses without a ton of shareholders, so their profits "pass through" as regular income to the owners, and are hit by the regular individual income tax instead.

It's for this "pass through" income that the special preservation of the state and local tax deduction applies.

The House GOP bill cuts the tax rate on C-corporations' profits from 35 percent to 20 percent. To give pass-through businesses a similar break, they capped their max tax rate at 25 percent — significantly lower than the 35 percent or 39.6 percent individual income tax brackets the GOP bill would preserve. There were fears that higher-earning individuals might rejigger their income tax filing and claim to be a "business" of their own — and thus nab the 25 percent maximum tax rate rather than the higher regular income tax rates. To head off that possibility, the GOP introduced complex rules limiting the availability of the lower "pass through" rate for people who actually work in the businesses they claim to own in their tax filings.

Shaviro explains the bizarre and byzantine way this all works out: A regular wages-for-work employee will have to pay the regular income tax rates, and won't get the deduction for state and local taxes. Meanwhile, a partner at a law firm, for example, won't get the lower pass-through rate either, because they work in the firm. But they will get to keep the state and local deduction, as one of the owners of the firm.

Finally, a purely passive business owner will get the the 25 percent rate and get to keep the state and local tax deduction.

It hasn't escaped anyone's notice that President Trump himself falls into the third category. As Shaviro wrote, "his president's salary aside, [Trump] is actually getting an expanded state and local income tax deduction compared to present law." This is in keeping with several other aspects of the Republicans' overall tax plan, which would result in a massive payout for Trump's family real estate business. Capping the pass-through tax rate at 25 percent is a massive break for his family real estate business, as is getting rid of the alternative minimum tax. As a wealthy person with financial assets, Trump will also be a second-order beneficiary of the cut to C-corporations' profit tax. And of course his heirs could benefit mightily from killing the estate tax.

In Marx's old conflict between capital and labor, the whole Republican bill is basically one giant payout in capital's favor. And as someone whose entire career has been about "deals" — leveraging ownership claims and financial trades, basically — Trump is a representative of capital par excellence.

The fate of the state and local tax deduction is just the most galling instance of that bias.