The Next Tax Reform Glitch Is Coming to Main Street Businesses

B ack when the Tax Cuts and Jobs Act (TCJA, the original version) was passed in December 2017, there were two major drafting errors that weren’t caught until it was too late — the “retail glitch” (retail establishments were accidentally barred from taking advantage of 100 percent full expensing) and the “grain glitch” (agricultural co-ops were unintentionally excluded from the small business deduction). These errors were very costly for everyone involved. They launched years of lobbying efforts by dozens of industries, and were a bonanza for campaign contributions. The errors were used by congressional Democrats, whose cooperation was needed to fix the mistakes, to extract wins elsewhere. The grain glitch took until March 2018 to fix; it took Covid and one of its tax bills to finally fix the retail glitch. Beltway consultants and political campaigns got rich off these drafting snafus.

Congress is about to make the same mistake again. If the error is not fixed before it’s too late, tax historians will be calling this flub the “Main Street Glitch.”

Under the tax code, businesses with separate tax entities (corporations, Subchapter-S companies, partnerships, and LLCs/LLPs taxed as one of these) can pay state and local taxes on business profits at the entity level, which creates a federal ordinary and necessary business tax deduction. Corporations pay the state corporate income tax and deduct it against taxable corporate income. The other types of firms, overwhelmingly family companies, can pay state profit tax in 36 states (the rest generally don’t have income taxes). The ability of the latter firms to do so was enshrined in the conference report of the 2017 TCJA and is a permanent part of tax law. President Trump’s own Treasury Department issued the regulations that govern the payment and deduction of business-entity taxes.

Businesses of all shapes and sizes pay taxes at the entity level, from giant corporations like Tesla all the way down to your local realtor or dental practice.

The “One Big Beautiful Bill” which was reported out of the House Ways and Means Committee preserves the ability of companies to continue this system, with one notable exception — specified service trades or businesses, known as “SSTBs.” These scarlet-letter companies are already discriminated against in the tax code, their owners (beyond a small income phaseout) being unable to claim the “Qualified Business Income” (QBI) deduction for reasons no one quite understands. But now these companies — and these companies alone — have been singled out and told they can no longer deduct entity level taxes paid by their businesses.

What types of companies are SSTBs? They generally fall into three categories: medical professions (offices of doctors, pharmacists, nurses, veterinarians, dentists, physical therapists, psychologists, chiropractors, etc.); financial services professions (offices of accountants, bookkeepers, tax preparers, auditors, actuaries, financial planners, retirement advisers, etc.); and legal services professions (offices of lawyers, paralegals, arbitrators, mediators, estate planners, etc.).

By and large, these companies are organized as S-corporations and partnerships (or LLCs/LLPs taxed like them), and could populate any Main Street in America. The dentist is next door to the tax preparer, who is next door to the veterinarian. They are not wealthy, and did not think they would be getting a big tax increase when they helped vote in President Trump and congressional Republicans to make the TCJA permanent.

The inequities the House Ways and Means bill creates border on the absurd. A physical therapy office on one side of the street cannot deduct its state income tax, but a hardware store across the street can. A community pharmacy on one side of the street cannot deduct its state income tax, but giant multinational competitor CVS across the street can. That’s lousy tax policy, and it’s unsustainable politically. It picks winners and losers in the tax code, at random by any normal person’s analysis.

This “Main Street Glitch” is also bad for economic growth. The Tax Foundation recently did a study on this matter, and they found repealing the ability of family businesses to deduct their state income tax paid would kill 103,000 jobs and shrink the economy by 0.3 percent (nearly $100 billion in 2025).

One can easily imagine a Beltway consultant’s dream scenario — Congress passes this obvious mistake into law, and immediately the “Main Street Tax Fairness Coalition” is formed. It’s made up of trade associations and companies from the SSTB list above. Lobbyists are hired, PAC checks are cut, digital ads are pushed out. The Democrats, of course eager to help, extract their toll in the form of other tax or spending policies they want to get from Republicans. In short, it’s a repeat of the “grain glitch” and “retail glitch” snafus all over again.

Alternatively, the House or Senate could fix this, restore fairness to Main Street companies singled out for tax code discrimination, and avoid the whole damned mess.