Closely held businesses have already faced a challenging operating environment in 2025. As we near the end of 2025 the impact of expiring tax provisions and a new tax bill may continue to challenge many small businesses. The One Big Beautiful Bill (OBBB) was passed by the House of Representatives in May. While we do not have a final version of the bill yet, this version provides some insight into the potential impacts on closely held businesses taxes in 2026, as well as certain changes that may affect your business this year.
First, we need to start back in 2017 when the Tax Cuts and Jobs Act (TCJA) made significant changes to itemized deductions and lowered the corporate tax rate. Closely held businesses owners of pass though entities (S – Corporations and Partnerships) saw their state tax deduction at the individual level limited to $10,000 under the TCJA. This change impacted business owners in states with an income tax more significantly. Owners of pass though business, saw some reprieve with a 20% deduction for qualified business income on their individual income tax returns. Not all businesses are eligible for this deduction. Many professional service businesses don’t qualify if their individual income is over a certain threshold. These provisions are set to expire at the end of 2025. The OBBB is the current tax legislation which will determine the rules going forward.
Following the passage of the TCJA 36 states established programs commonly referred to as Pass-Through Entity Taxes to assist closely held businesses operating as pass-through entities. These programs vary by state; however, their primary objective is to enable businesses to pay and deduct the owners’ state income tax at the business level. Thus, circumventing the $10,000 cap at the individual level. The business then passes out a tax credit to the business owners for inclusion on their personal tax return.
How will the current version of the OBBB impact closely held business owners with pass though entities in states that have state taxes?
- The qualified business income deduction will increase from 20% of business income to 23% for qualified business.
- The state and local tax deduction in 2025 increases from a limit of $10,000 up to $40,000. Unless you make more than $500,000 individually. Then your deduction will still be limited.
These proposed changes appear to be business friendly for most pass-through businesses. Retail companies, restaurants, construction and other contractors should see a benefit from the increased qualified business income deduction and possible the higher state and local tax deduction on their individual returns.
However, for owners of closely held businesses operating as a partnership or S-corporation in a specialized service trade or business (SSTB), the news is less favorable. These service-based businesses will face even greater limitations on their state and local tax deductions under this bill. They could lose the ability to deduct any state income taxes.
Examples of SSTBs include health care professionals, accountants, attorneys, financial services businesses, performing artists, and consultants. These also cover businesses where an individual’s reputation or skill is the essential asset of the business.
One important consideration to remember; it remains uncertain whether Congress will permit states to retain the Pass-Through Entity Tax deduction programs. Should the final legislation eliminate these programs, it could adversely affect many closely held business owners of pass though entities in states with state income taxes.
The OBBB tax legislation will affect closely held businesses and their owners. It may provide some benefit to owners of pass-through entities as they experience tax reductions starting this year. However, the current draft bill does not offer a more advantageous outcome for owners of SSTB’s and will put these business owners in a worse position than they were prior to the TCJA changes from 2017. All business owners should consult their tax professional to prepare for the upcoming changes.
