Prepared by Joel Stettler, CPA– Tax Manager
The Tax Cuts and Jobs Act of 2017 made sweeping changes to our tax code, most of which take effect in 2018. This legislation included Code Section 199A; a 20% profit deduction for eligible pass-through business owners who file as a sole proprietorship and/or receive pass-through income from a partnership or S Corp. Code Section 199A is estimated to have a favorable impact on over 10 million taxpayers.
Sec. 199A allows taxpayers a deduction of up to 20% of their Qualified Business Income taxable profit, effectively reducing income tax by 20% on this qualified business income. The deduction is taken on your personal tax return that will be calculated on your combined eligible business activity.
The deduction is allowed in full for passthrough business owners with taxable income of less than $315,000 for couples married filing a joint income return ($157,500 for other filers.) If taxable income is greater than this threshold, the calculation of the deduction becomes more complex and is possibly limited or eliminated in two main areas:
- Certain “Specified Service Trade or Businesses” are phased out and eventually prohibited from taking the deduction as the individual’s income rises above the aforementioned thresholds. Examples of these types of businesses include those in health, law, accounting, certain consulting, financial services, certain brokerage businesses, and any profession where the principal asset of the business is the reputation or skill of the employees or owners.
- A second limitation is based upon percentages of the amount of salaries paid and depreciable property in the business. The deduction cannot exceed the greater of (1) 50% of the total W-2 wages paid by the business, or (2) 25% of the total W-2 wages plus 2.5% of the remaining depreciable basis of fixed assets. Land does not count since it is not depreciable. The lower the wages and depreciable property in your businesses, the more likely a limitation may become a factor.
It important for your tax advisor to understand the nature of your business as this will impact your potential deduction. Please contact us with any questions about these important updates to the pass-through deduction and to discuss opportunities to engage in tax planning to maximize the benefit. The regulations of the deduction are complex and need to be considered carefully.
Billy Griffin, a partner in our tax department, has a video here to explain the Section 199A deduction.