What is it? Under new Section 199A of the Code, certain non-corporate taxpayers are entitled to a tax deduction equal to as much as 20% of their qualified business income. That’s about all that is easy to understand about Section 199A. It is available to owners of partnerships and S corps, but also to sole proprietors, so in that sense, it is not a pass-thru deduction. It is a below the line deduction, so it does not reduce the taxpayer’s adjusted gross income, but can be taken whether or not the taxpayer itemizes. It is limited to the taxpayer’s taxable income, so losses from other businesses may affect the ability to take the deduction and losses from a qualified business have to be carried forward and may reduce qualified business income in future years.
Who can take it? Generally, any trade or business, other than the business of being an employee, can generate qualified business income, so the owner(s) of that business may be entitled to a deduction related to the business’s qualified business income, which excludes certain types of income that do not relate to the business, such as interest and dividends. However, above the Threshold Amount (discussed below), special rules apply to exclude all income from specified service trades or businesses, including health, law, accounting, investments, consulting, performing arts and athletics, or other trades or businesses where the principal asset of the trade or business is the reputation or skill of one or more of its employees. There are also limitations on other types of businesses where an owner of that business has taxable income in excess of the Threshold Amount.
What is the Threshold Amount? The Threshold Amount of taxable income of the trade or business owner for maximum deduction is $157,500 (or $315,000, if filing jointly). That amount will be adjusted in the future for inflation. Taxable income amounts above the Threshold Amount and below $207,500 ($415,000, if filing jointly) (whichever applies is herein referred to as the “Cap”) are entitled to a pro-rated deduction and are technically within the Threshold Amount. The Threshold Amount is tested at the individual partner or shareholder level. As a result, some partners and S corporation shareholders may be entitled to some or all of the deduction and others may not. Guaranteed payments to partners and reasonable compensation to S corporation shareholders are not considered qualified business income, so how a partner or shareholder receives income from the business may also impact their ability to take the deduction.
What if your taxable income exceeds the Cap? If the business you own is engaged in one of the specified service trades or businesses, you will not get a deduction related to your income from that business if your taxable income exceeds the Cap. With respect to other businesses, if taxable income is above the Cap, the amount you can deduct is limited by the payroll and depreciable assets of the business. It is the lesser of a) 20% of taxpayer’s qualified business income or b) the greater of i) 50% of the W-2 wages of the business or ii) the sum of 25% of the W-2 wages of the business plus 2.5% of the unadjusted basis immediately after acquisition of qualified property, which is generally depreciable property that has not been fully depreciated.
Should you change the form of your business? Each individual trade or business will need to analyze its tax situation to see if another form of business may be advantageous. There is no simple formula or guide to determine whether or not a pass-thru or a C corporation will be more beneficial to the taxpayer. This discussion is necessarily brief and does not cover all of the provisions of Section 199A. You should discuss your specific situation with your tax advisor to determine whether or not any changes to your business operation could improve your tax situation.