The 199A pass through deduction brought significant change for small business owners. This deduction is designed to help alleviate the tax burden for a variety of small business owners by allowing them to deduct up to 20 percent of qualified business income (QBI). It aims to provide some tax relief to SMBs who do not benefit from the lowering of the corporate tax rate.
There is still a lot of uncertainty around 199A since the law is new, and practitioners are coming to grips with it. If accountants are using software, it is essential that they review their settings carefully and make looking for the deduction part of their review process. It can easily be missed if not specifically watched out for.
199A Deduction: The 101
Starting on January 1, 2018, taxpayers with income from pass-through businesses, such as sole proprietorships, S corporations and partnerships (not including publicly traded partnerships), and select rental activities—will be able to deduct up to 20 percent of their qualified business income from their individual taxes.
There are a few exceptions to which types of income can fall under qualified business income including income generated outside of the United States, capital gains or losses, interest income, and dividend income.
For qualifying taxpayers, the 199A deduction is calculated as the lesser of:
- 20% of the client’s QBI plus 20% of the client’s qualified real estate investment trust dividends and qualified publicly traded partnership income or
- 20% of the client’s ordinary taxable income minus net capital gains
Limitations
There are limitations for this deduction once the taxable income exceeds $157,500 for an individual or $315,000 for a married couple filing jointly. Businesses other that specified trade or businesses (described later) deductible amount for each qualified trade or business is the lesser of 20% of its QBI, or the greater of either 50% of its wages, or 25% of its wages plus 2.5% of its unadjusted basis immediately after the acquisition of all qualified property.
If the taxable income exceeds the relevant threshold, business income from any specified service, trade, or business (SSTB) enters a phase-out range and becomes ineligible for the deduction at $217,500 for individuals and $415,000 for married filing jointly.
Who Does NOT Qualify?
C corporations AND If the taxpayer’s taxable income exceeds $207,500 for an individual or $415,000 for a married couple filing jointly; the following specified services, trades, or businesses will not be eligible for the deduction:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Investing and investment management
- Trading
- Any trade or business where the principal asset is the reputation or skill of one or more of its employees
The 199A pass-through deduction can be really beneficial for small business owners, so it is important to have a thorough understanding of how it works. It is not often the IRS allows you to turn taxable income into nontaxable income. This 199A deduction effectively allows up to 20% of your qualified business income to escape being taxed.
Author Bio: Michael Law is a CPA subject matter expert manager, leading a team developing tax software at Canopy. Michael earned a master’s degree in taxation from Golden Gate University and has more than 20 years of experience in accounting and tax. Prior to Canopy, he served as the Vice President of Tax Operations for the Salt Lake City branch of Goldman Sachs. Connect with him @CanopyTax