When congress passed the Tax Cuts and Job Acts on December 17 last year, media headlines espoused the reduced corporate tax rate. C-Corporations went from a graduated maximum rate of 35% down to a flat 21%. In response, big promises were made to move money back from oversea tax shelters. And many CEOs, now flooded with new money to spend, turned around and bought back company shares.
This was all good and great for entities operating as a C-Corporation, which encompasses most of corporate America, but what about other small businesses? How did this new tax law affect sole proprietorships, LLCs, and S-Corporations?
Enter Section 199A – a deduction meant to provide a similar tax benefit to non-corporate businesses.
Section 199A Simplified
In most basic terms, the section 199A deduction is 20% of your qualified business income (QBI). It’s a significant new tax deduction that we want to take full advantage by the end of the 2018 tax year.
While the premise of the 199A deduction sounds simple enough, the complicated part deals with calculating QBI. It’s a multi-step process that may phase out some, or even all, of the deduction.
Bottom Line: Expect to take advantage of the 199A deduction this tax season, but probably not the full 20%.
What to Expect
Applying the 199A deduction depends on your unique situation. For now, we will save you from the nitty-gritty details of the law here. Let’s just say, it’s complicated and regulations are still being clarified.
But maybe you’re wondering right now why you may not qualify for the full 20% deduction? The reason is due to a phase-out clause tied to a taxable income threshold for those in a professional service business (Doctors, Lawyers, Accountants, Consultants, Investment Management, etc.).
In short, the calculation of a taxpayer’s section 199A deduction depends on whether the taxpayer’s taxable income is (1) below a lower taxable income threshold ($157,500, or $315,000 if filing a joint return), (2) above a higher taxable income threshold ($207,500, or $415,000 if filing a joint return), or (3) between the lower and higher taxable income thresholds.
Taxable Income Thresholds
Below the Threshold (<$157,500 S / $315,000 MFJ)
If your taxable income is below the threshold, the calculation becomes relatively straightforward. Your deduction would equal the lesser of the following two options:
- 20% x QBI
- The overall deduction limitation (20% x taxpayer’s taxable income in excess of any net capital gain)
Above the Threshold (>$207,500 S / $415,000 MFJ)
If your taxable income is above the threshold, you’re again subject to one of two options:
- Disqualified for the deduction, if you are a professional service business
- Your QBI is subject to more complicated calculations related to W-2 wage and capital limitations
Within the Threshold
If your taxable income falls within the threshold, then you can expect to receive a portion of the 199A deduction. At a high level, the deduction calculation involves a ratable phase-in of the wage and capital limitations.
Conclusion
The 199A tax deduction is new for everybody this year. There are rules and exceptions that lawyers and accountants alike are still working to clarify.
But the bottom line is that the 199A deduction was meant to provide a tax relief to qualified sole-proprietorships, LLCs, and S-Corporations. We need to do our due diligence to understand this new law and maximize it’s intended benefits.
Make sure you have someone that you trust that will help you apply the 199A deduction to your 2018 tax return.
Leave a Reply