Understanding the Section 199A Deduction
The historic Tax Cuts and Jobs Act (TCJA), passed in December 2017, contains several major provisions for business owners, including the 199A Qualified Business Income deduction. Section 199A details a new addition to the tax code that allows business owners—excluding corporations—to deduct 20% of qualified business income (QBI). Read on for more details.
Who Can Claim the Section 199A Deduction?
The deduction is available to most pass-through entities with positive taxable income. Owners of qualified trades and businesses can claim this new deduction starting with their 2018 federal income tax returns. Taxpayers can deduct QBI from one or more of the following:
- S-corporations and sole proprietorships,
- Real estate investment trust dividends, and
- Publicly traded partnership income
Some exclusions apply. Neither corporations nor employees can claim a QBI deduction. Additionally, specified service trades and businesses (SSTB) above a particular income threshold are excluded from taking the deduction; these include a number of professional services, most notably law, accounting, and financial services.
How Does the Qualified Business Income Deduction Work?
QBI is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. Think of it as the regular, non-investment income brought in by a business (within the U.S.). Only items included in taxable income are counted.
Generally, the deduction is the lesser of these two amounts:
- 20% of QBI plus 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income; or
- 20% of taxable income computed before the QBI income deduction minus net capital gains.
However, the deduction includes a threshold amount of $315,000 for married filing jointly ($157,500 for all other filers). For taxpayers whose income exceeds the threshold, the deduction may be subject to additional exceptions.
According to the IRS, income above the $315,000 threshold but below $415,000 for married filing jointly ($157,000/$207,500 for all other filers), may face limitations on the deduction – which is based on “whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property used by the business.” These limitations are phased in for this specific income range.
When taxable income exceeds the upper limit of $415,000 for married filing jointly ($207,500 for all other filers), additional criteria apply. In order to qualify for the deduction the business must not be considered a “specified service business” (see previous section) and must either pay wages or own property.
For more details, including information on limitations, phaseouts, thresholds, and special definitions, take a look at this summary from the BDO Alliance USA.
What Do Qualified Taxpayers Need to Do?
This new deduction is likely to have a very large impact on your taxes, moving forward. It has the potential to decrease the effective business income tax rate for those in the top bracket from 37% to 29.6%—quite a significant benefit. To take full advantage of the tax savings potential, qualified business owners should consider seeking expert analysis of their business in one or more of the following areas:
- Specified service trade or business,
- Choice of entity,
- Cost segregation/depreciation, and
- Partner capital accounts.
We strongly urge you to reach out to your WNDE tax advisor in order to address making changes to your tax planning strategy. We are excited to help our clients develop an approach that optimizes the Section 199A deduction and leads to increased tax savings.