One of the largest changes of the Tax Cuts and Jobs Act is the Section 199A deduction. This new section allows taxpayers to deduct 20% of his or her Qualified Business Income (QBI) from passthrough entities. However, not all taxpayers will maximize their benefit or benefit at all from this new deduction, which is why tax planning throughout the year is so important. For the sake of our discussion, think of QBI as a business’ net income, and passthrough entities include Partnerships, S Corporations, Schedule C’s, and some rental properties.
For single taxpayers with taxable income under $157,500, or $315,000 for Married Filing Joint (MFJ), you receive a full deduction regardless of what type of business you own. One limitation when under these income thresholds is the taxable income limitation. If your QBI exceeds your taxable income, your deduction would be limited to 20% of taxable income.
Scenario 1:
A taxpayer and spouse are filing a joint return and have taxable income of $200,000 with QBI of $50,000, your QBI deduction would be $10,000, making your adjusted taxable income, $190,000. Please note that this deduction is applied after your taxable income has been calculated based on all other factors.
If you’re over the first income threshold ($157,500 or $315,000) you start to limit the deduction based on 50% of wages paid, or 25% of wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property. In situations where there are no wages paid, as is the case in many real estate businesses, that UBIA affords otherwise ineligible taxpayers the ability to claim the deduction, assuming they own qualified property.
If you have taxable income over the second income threshold of $207,500 Single, or $415,000 MFJ, you are limited to the lesser of 20% of QBI, or the greater of 50% wages paid, or 25% of wages plus 2.5% of UBIA.
However, if you are a “Specified Service Trade or Business” (SSTB) you receive no deduction if your taxable income is greater than $207,500 S, or $415,000 MFJ. SSTB’s are those in the fields of health, law, accounting, actuarial science, performing arts, athletics, financial services, brokerage services, and consultants.
Scenario 2:
Same as scenario 1, but taxable income is $500,000 and wages paid are $0. Since there were no wages paid, a deduction is not allowed.
Scenario 3:
Same as scenario 2, but wages paid are $80,000. Now, 50% of wages equals $40,000. Since you’re allowed the lesser of 20% of QBI ($10,000) or 50% of wages ($40,000), the taxpayer now qualifies for a $10,000 199A deduction.
Scenario 4:
Same as scenario 3, but the QBI comes from a Specified Service Trade or Business. Since the taxable income is greater than $415,000, the taxpayers receive no deduction.
This is by no means a comprehensive dive into what the 199A deduction really is. There are many more considerations and scenarios that we could spend hours discussing. We wanted to provide a brief overview to demonstrate how the deduction impacts taxpayers at different income levels, depending on what type of business they are in. If you wish to find out more about this deduction and how it could impact you, contact us here.