Beginning in 2018 new Section 199A permits the owner of a non-C corporation business to deduct up to 20% of the owner’s share of the company’s qualified business income (QBI) from taxable income. For example, if an owner of an LLC earns $200,000 QBI from its business, then he or she may be able to deduct up to $40,000. Assuming that the owner is in a 30% tax bracket, the federal tax is reduced by $12,000.
There are special limitations on higher income owners tied to payroll and asset costs. One limitation is that the Section 199A deduction cannot exceed 50% of W-2 wages. But there are techniques to save a bundle by merely adjusting how profits are distributed. For example, assume an S corporation with one owner-shareholder has taxable income (before the deduction for the owner’s compensation) of $900,000. If the owner takes $125,000 as employee compensation, the $775,000 balance of income is treated as a taxable distribution to the owner from the company. Under the rules of Sec. 199A, let’s assume the owner may be entitled to the Sec. 199A deduction of $62,500. However, if the owner’s salary is raised $125,000 to $250,000 (thereby lowering the shareholder’s S corporation taxable distribution to $650,000), then the Sec. 199A deduction would be $125,000 due to the higher payroll expense. That change alone could reduce the owner’s income tax by over $20,000.
There are many rules, including possible limitations based on taxable income, company payroll, asset cost. The owners can be sole owners or owners of LLCs, partnerships, and S corporations. Trusts can be owners as well. There limitations for professional service businesses, including, among others, lawyers, accountants, consultants and doctors.
This tax tip barely scratches the surface of tax savings opportunities under Sec. 199A and in the rest of the Tax Act. There are many reasons to plan for the changes in this law, especially for business owners. Delay, when action today can save money, is costly.