Section 199A - Qualified Business Income (QBI) Deduction
One of the important changes in the new Tax Cuts and Jobs Act is the introduction of Section 199A (the QBI deduction). This was created to keep pass-through entities and sole proprietorships competitive with C corporations after that tax rate was cut to 21%. The basics of Sec. 199A is 20% of income from the taxpayer’s qualified business is allowed as a deduction on their tax return. The deduction will be available to both itemized and non-itemizing taxpayers and is only for federal tax purposes (not for payroll and not for states). However, there are multiple steps involved in the calculation that may phase-out part or all of the deduction, thus potentially making it a complicated calculation.
The first step of the calculation is to establish the QBI amount. QBI is determined separately by each qualified business of the taxpayer. Limitations to the deduction are based on if the taxpayer's taxable income is:
- below a lower taxable income threshold ($157,500, or $315,000 if filing a joint return),
- above a higher taxable income threshold ($207,500, or $415,000 if filing a joint return), or
- between the lower and higher taxable income thresholds.
(Taxable income for this purpose is considered prior to any possible Sec. 199A deduction).
Which Businesses Qualify?
A qualified business is any trade or business, with the exception of a “specified service trade or business” (SSTB), which includes a trade or 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. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
For taxpayers with income below the lower threshold they will simply take the lesser of 20% of their total QBI from all qualified sources or the overall limitation of 20% of the taxpayer's taxable income less any net capital gain.
If the taxpayer’s income is above the higher threshold then two issues need to be considered. First, if the business is a SSTB (as described above), the 199A deduction is not allowed. However, if the business is not a SSTB, it will be subject to a W-2 wage and capital limitation. The outcome of this calculation will determine whether the taxpayer will get the full 20% deduction or if it will be limited.
Taxpayers with income between the two thresholds will be subject to a phase-out of the deduction. This rule is similar to when income is above the higher threshold, except there is an additional step to find the amount to reduce the deduction by.
With all the limitations and thresholds, it is important to plan ahead and project income for your business(es) and the impact on your personal tax return. Especially for taxpayers above the threshold amounts, finding the best way to optimize this deduction will ensure you are able to lower your taxes and keep the most money in your pocket.
Contact Us With Your Questions
If you have questions about the QBI calculation or need help with tax planning, contact our tax professionals at The Innovative CPA Group at 203-489-0612. Or contact us online.