Understanding the new Sec. 199A business income deduction
Sec. 199A in general
Effective for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, a taxpayer other than a corporation is entitled to a deduction equal to 20% of the taxpayer's "qualified business income" earned in a "qualified trade or business."
The deduction is limited, however, to the greater of:
· 50% of the W-2 wages with respect to the qualified trade or business; or
· The sum of 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.The deductible amount of qualified business income for each of the taxpayer's qualified trades or businesses is determined separately and added together. The sum of these amounts is then subject to a second limitation equal to the excess of:
· The taxable income for the year, over
· The sum of net capital gain (as defined in Sec. 1(h)) plus the aggregate amount of the qualified cooperative dividends for the tax year.The purpose of this overall limitation is to ensure that the 20% deduction is not taken against income that is taxed at preferential rates.
Taxpayers entitled to claim the deduction
The Sec. 199A deduction is available to any taxpayer "other than a corporation."11 This includes:
· Individual owners of sole proprietorships, rental properties, S corporations, or partnerships; and
· An S corporation, partnership, or trust that owns an interest in a pass-through entity.
Qualified trade or business
A taxpayer must be engaged in a "qualified trade or business" to claim the Sec. 199A deduction. Sec. 199A defines a qualified trade or business by exclusion; every trade or business is qualified, other than:
· The trade or business of performing services as an employee; and
· A specified service trade or business.
The first prohibition prevents an employee from claiming a 20% deduction against his or her wage income.
Qualified business income
Once a taxpayer has established that he or she is engaged in a qualified trade or business, the taxpayer must determine the "qualified business income" for each separate qualified trade or business.
Qualified business income is defined as the net amount of qualified items of income, gain, deduction, and loss with respect to a qualified trade or business20 that are effectively connected with the conduct of a business within the United States. Qualified business income does not include, however, certain investment-related income, including:
· Any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss;
· Dividend income, income equivalent to a dividend, or payment in lieu of a dividend described in Sec. 954(c)(1)(G);
· Any interest income other than interest income properly allocable to a trade or business;
· Net gain from foreign currency transactions and commodities transactions;
· Income from notional principal contracts, other than items attributable to notional principal contracts entered into as hedging transactions;
· Any amount received from an annuity that is not received in connection with the trade or business; and
· Any deduction or loss properly allocable to any of these bulleted items described above.
Determining the deductible amount
A taxpayer determines his or her deductible amount separately for each qualified trade or business. The taxpayer begins by computing a tentative deduction equal to 20% of qualified business income.
Reporting the deduction
The Sec. 199A deduction does not reduce a taxpayer's adjusted gross income. The deduction is taken after adjusted gross income is determined, but it is not an itemized deduction; rather, the deduction is available to both taxpayers who itemize deductions and those who claim the standard deduction. For purposes of determining a taxpayer's alternative minimum taxable income, qualified business income is computed without any adjustments or preference items under Secs. 56 through 59. As a result, a taxpayer's Sec. 199A deduction for alternative minimum tax purposes will be identical to the deduction against regular tax.
A bounty, with bewilderments
Sec. 199A provides a tremendous benefit to owners of sole proprietorships, S corporations, and partnerships. however, granting a 20% deduction to these business owners is far easier in concept than it is in execution. Questions abound in implementing Sec. 199A, from seemingly simple concepts such as the treatment of fiscal-year businesses and the netting of income and losses, to much more meaningful aspects like the definition of a specified service business. For further questions on this tax change, contact us at 931-648-4786.
Credit: aicpa.org/Tony Nitti, CPA