There is a new 20 percent tax cut for small businesses that is part of the 2017 Tax Cuts and Jobs Act (TCJA) which was passed on December 27, 2017. It’s called the Section 199A Qualified Business Income Deduction. Since the passage of the TCJA, there have been hundreds of articles on the topic, some in favor of the act and others opposed. Some taxpayers are excited about the lower tax rates and others are nervous about how their taxes will change. Most importantly, small businesses are utterly confused as to whether they qualify for the generous Section 199A deduction, which is considered the biggest tax cut of all. This article breaks down each section of the 199A and helps readers determine if they qualify.
What is the 199A Deduction
Section 199A deduction is a 20 percent deduction on Qualified Business Income from a “qualified trade or business.” If eligible, the deduction is a huge tax benefit for small businesses. The problem is that the deduction is not as simple as it sounds and the eligibility requirements are very confusing to say the least. For example, even the term qualified trade or business has created confusion among business owners because up until recently, it was unclear what types of businesses were deemed qualified businesses. Also, if the business does qualify, they have to do a convoluted calculation involving their W-2 wages and unadjusted basis of property.
What Entities Qualify
The 199A QBI deduction is only available to pass-through entities such as S-Corporations, LLCs, sole-proprietors, trusts, and estates. The motivation behind the 199A QBI deduction was to level the playing field between c-corporations and pass-through entities. Since the new TCJA reduced the tax rate on C-Corporations to a flat 21% on all income levels, the objective of the 199A QBI deduction was to reduce the tax on pass-through entities to a similar amount. So while many businesses in the US are structured as pass-through entities, that does not immediately qualify them for the generous deduction; they still have to pass another hurdle. Corporations classified as Specified Service Trade or Businesses cannot take the deduction if their taxable income exceeds the phaseout limits. What is a SSTB you might ask? Well see below for the IRS definition.
What Are The Income Thresholds
In order to qualify for the new 199A QBI deduction, a taxpayer must meet certain income thresholds. If a taxpayers taxable income is less than $315,000 (married filing jointly) or $157,500 (for all other filers) and they are deemed a pass-through entity, they qualify for the deduction even if they are a SSTB. However, if the taxpayer’s income is above that income threshold, they are not eligible for the 199A QBI if they are a SSTB.
New IRS Terms
With the new tax law, the IRS also created new terms and re-wrote the definition of existing words. For example, A SSTB does not qualify for the new 199A QBI deduction unless they meet the income thresholds, but what is a SSTB? According to the IRS, an SSTB is a “trade or a business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.” The last sentence is basically a catchall to ensure all service-like businesses are excluded. For some reason, engineers and architects were singled out and are eligible for the 199A QBI deduction are not deemed a SSTB.
In addition, the IRS created a new term called Qualifed Business Income (QBI) and defined it as “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer. Such term shall not include any qualified REIT dividends, qualified cooperative dividends, or qualified publicly traded partnership income.” The accounting community has asked the IRS for more clarification on the definition of QBI.
How to Calculate
If the paragraphs above were not confusing enough, now we’re going to go through the actual calculation of the 199A QBI deduction. Assuming the business qualifies for the deduction, it must separately calculate two values and take the greater of those two values: first, the entity must calculate the total W-2 wages of the entity (the IRS also recently issued guidance on three methods of calculating W-2 wages); second, it must calculate 25% of W-2 wages and add 2.5% of the unadjusted basis of qualified property. The 199A QBI deduction is the greater of those two values.
Bottom Line
As you can see, the new Section 199A QBI deduction is anything but simple. The accounting community has been pressing the IRS to issue clarification guidance on a variety of issues related to Section 199A. Luckily, the IRS issued a voluminous 184 page guidance document on August 8, 2018 with additional clarification. ACap is the process of drafting a comprehensive white paper on this subject and will continue to update it as we receive more information from the IRS. In the meantime, it is very important for business owners to meet with their CPAs to begin proactive tax planning for 2018 and beyond.
Ara Oghoorian, CFA, CFP®, CPA is the President & Founder of ACap Asset Management.
ACap Accounting Services, Inc. provides payroll, bookkeeping, and business tax preparation and advising, headquartered in Los Angeles, CA specializing in helping doctors and healthcare professionals make sound financial decisions.
Contact ACap at info@acapam.com or 818-272-8511.
