In addition to providing a tax break for corporations, the Tax Cuts and Jobs Act added new Internal Revenue Code Section 199A, which creates a deduction for owners of pass-through entities. While Section 199A definitely does not provide tax simplification, it does provide significant tax savings for many persons who operate their business in a partnership, limited liability company or S corporation, as well as for investors in such entities, REITS and publicly traded partnerships.
In general, a taxpayer is entitled to a deduction equal to 20 percent of the taxpayer’s so-called “qualified business income” from partnerships, limited liability companies, S corporations and sole proprietorships, and 20 percent of qualified REIT dividends, publicly traded partnership income and qualified cooperative dividends. This deduction, however, is subject to a variety of limitations and exclusions. First, except for the income of architects and engineers, income from a service business does not qualify for the deduction unless the taxpayer’s taxable income falls below $157,500 ($315,000 in the case of a joint return). Further, the deduction for any taxpayer whose taxable income exceeds the foregoing threshold is also subject to limitations based on W-2 wages and the adjusted basis in acquired qualified property. Application of Section 199A to pass-through entities will be challenging, as it will require a determination of each owner’s share of W-2 wages paid by the entity. Finally, note that the deduction will not apply to tax years beginning after December 31, 2025.
Duane Morris has developed a flowchart to assist with the tedious process of unravelling Section 199A. Note that both this Alert and the flowchart are only summaries of Section 199A and should not be viewed as a complete discussion of what is a complex and intricate law.
As is the case with any new tax law, there are uncertainties in the application of Code Section 199A that will hopefully be addressed in future IRS guidance.