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The New 199A Deduction - Your Questions Answered

January 8, 2019
Taxes

What is it the new 199A Deduction?  

Simply put, the 199A deduction is a tax break for business owners that will entitle you (the taxpayer) to a pass-through deduction of up to 20%. This deduction applies to qualified business income (QBI), qualified real estate investment trust (REIT) dividends or qualified publicly traded partnership (PTP) income. Of course, the IRS is involved so there are exceptions and limitations.

There are limitations to this deduction based on taxable income, the amount of W-2 wages paid, type of business and the unadjusted basis held by the business.

The deduction is the lesser of:

  • 20% of the taxpayer’s QBI amount, plus 20% of the taxpayer’s REIT dividends and PTP income,
    or
  • 20% of the taxpayer’s taxable income minus taxpayer’s net capital gain.

Why Was It Passed?

This law was created to promote job creation and encourage employers to pay higher wages. This difference is one of the figures taken into consideration if taxable income goes above the threshold and phased-in amounts.

Who qualifies for it?

Business owners with qualified business income of a Sole Proprietorship, LLCs, rental properties (for business), Partnerships and S-Corporations. Each company must earn a profit to qualify for the deduction. The deduction is determined separately for each separate business; it cannot be combined with multiple companies owned by the same person.

Qualified business income does not include investments income, reasonable compensation paid for S-Corporations or guaranteed payments paid to a partner. Only items included in taxable income are counted and must be connected with a U.S. trade or business.

A phaseout is in place for specified service businesses to prevent the conversion of personal service income into qualified business income. If the company is a specified service business, the deduction is not allowed once they surpass the phase-in amounts.

Specified Service Businesses:

  • Traditional service professions such as doctors, attorneys, accountants, actuaries, and consultants
  • Performing artists who perform on stage or studio
  • Paid athletes
  • Anyone who works in the financial services or brokerage industry
  • Any trade or business where the principal asset is the reputation or skill of the owner (excluding engineers and architects)


When will you see the deduction?

The 199A deduction starts in 2018 and ends in 2025. This deduction is taken on your personal tax return, but it doesn’t lower your self-employment taxes; instead, it reduces your total tax bill. The deduction applies to both itemizers and non-itemizers alike.

How does it work?

This deduction allows the taxpayer with qualified business income (QBI) to save up to 20% of the net business income before being taxed.

Remember, there are thresholds, limitation phase-in amounts, and business types to consider that are limiters to potential deductions.

  • Threshold amounts: MFJ $315,000 and all other taxpayers $157,500
  • Phase-in amounts: MFJ $415,000 and all other taxpayers $207,500

You may fall in three categories for income such as:  under threshold amount, above phase-in amounts and in-between threshold and phase-in amount.

 

Example (Income below threshold amounts):

If your taxable income is below the threshold amounts, it does not matter what type of business you are; you will take the deduction (the lesser of the two):

  • 20% of the taxpayer’s QBI amount, plus 20% of the taxpayer’s REIT dividends and PTP income, or
  • 20% of the taxpayer’s taxable income minus taxpayer’s net capital gain

A married taxpayer has a taxable income of $310,000. Capital gain of $10,000 and $280,00 QBI from an S-Corporation.  Qualified Business income deduction is $56,000.  ($280,000 x 20% = $56,000) or 20% of taxable income less capital gain $60,000 ($310,000 - $10,000 = 300,000 x 20% = $60,000)

This couple will take the lesser of the two, which is $56,000


If the taxpayer has income above the phase-in amounts, two limitations come into place. The business is not treated as qualified business income, and the income of the business of the taxpayer will not be included in QBI.

  1. Type of business- if you are a specified service trade or business, you no longer qualify for the deduction.

Specified services, trades, and businesses include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing, investment management or any business where the principal asset is the reputation or skill of the owner(s).

If your business is a non-service specified service business, your deduction is limited to the greater of:

  1. 50% of the W-2 wages paid by the qualified company, or
  2. The sum of 25% of the W-2 wages paid by the qualified business, plus 2.5% percent of the unadjusted basis of all qualified property.

Qualifying Property is a tangible, depreciable property, held by or available for use in the business at the close of the tax year. Used in production of QBI at any time during the year and for which the depreciable period has not ended before the close of the tax year.

Example (Income above phase-in amounts):

A husband and wife filing a joint tax return with taxable income of $450,000 - ordinary income of $300,000 from an S-Corporation Non-Specified service business.  Wages paid by business were $80,000, and unadjusted business basis in the qualified property is $600,000.

  1. 50% of wages = $40,000 (50% x 80,000)
  2. Sum of 25% of wages plus 2.5% of qualified property = $35,000

{$20,000 (25% x 80,000) plus 2.5% of qualified property $15,000 (2.5% x $600,000) = $20,000 + $15,000}

According to this test limitation, they qualify for $40,000 deduction; the greater of A or B.

If your taxable income is above the threshold amount, but below the phase-in amount: your deduction is limited to a reduction ratio. Which is then multiplied by the excess amount, so you would receive a partial deduction.

  • The Reduction Ratio is figured as an excess of taxable income above the threshold, divided by $100,000 for MFJ or $50,000 for all other taxpayers (the difference between phase-in amount and threshold amounts).

Example (Income in between threshold and phase-in amounts):

Married taxpayers filing jointly have a taxable income of $365,000. From S-corporation QBI of $355,000.   Net Capital Gains of $10,000 and paid W-2 wages of $20,000, the business unadjusted qualified property is $60,000.

To find prorated deduction amount:

  1. Figure out the max deductible amount of QBI at 20% = $71,000 (20% x $355,000)
  2. Figure reduction ratio = 50%. Take taxable income less threshold amount divided by difference between phase-in amount and threshold amount for MFJ.    ($365,000 - $315,000 = $50,000 / $100,000 = 50%)
  3. Figure limitation (the greater of) when income is greater than threshold:
  1. A) 50% of wages = $10,000 (50% X 20,000), or        
  2. B) Sum of 25% of wages plus 2.5 of qualified property (25% X 20,000 = $5,000 Plus 2.5% x $60,000 = $1,500) = $6,500
  3. Greater of A or B is A = $10,000
  1. Figure out excess amount over threshold = $61,000.  Take the max deductible amount $71,000 less the greater of limitation deductible above threshold amounts $10,000.
  2. Figure your reduction to QBI = $30,500.   ($61,000 excess amount x 50% reduction ratio)
  3. Your max deduction of $71,000 less reduction to QBI $30,500 equals your Section 199A deduction of $40,500 for Non-Serviced Business


For Specified Service Businesses additional calculations must be done:

  1. 50% = (1 – 50% reduction rate) Figure applicable percentage of phase out to QBI
  2. $35,500 ($71,000 x 50%) QBI multiplied by applicable percentage of phase out
  1. $5,000 = ($10,000 x 50%) greater of A or B wages and assets multiplied by applicable percentage
  2. $30,500 = ($35,500 - $5,000) difference between QBI and greater of wages and assets
  3. $15,250 = ($30,500 x 50%) reduction to QBI
  4. $20,250 = ($35,500 – 15,250) max of QBI less reduction to QBI
  5. For Specified Service Business the deduction is $20,250


Example (Income in between threshold and phase-in amount):

A single taxpayer has taxable income from QBI of $185,000; the business paid $20,000 in wages and had a business unadjusted qualified property of $30,000.

  1. Figure out max deductible of QBI = $37,000 ($185,000 x 20%)
  2. Figure reduction ratio = 55% ($185,000 - $157,500 / 50,000)
  3. Figure limitation when income is greater than threshold:
  1. A. 50% of wages = $10,000 ($20,000 x 50%), or
  2. B. 25% of wages plus 2.5% of qualified property = $5,750 ($5,000 + {30,000 x 2.5%})
  3. Greater of A or B is A = $10,000
  1. Figure out excess amount over threshold = $27,000 ($37,000 - $10,000) Max QBI less limitation of income greater than threshold
  2. Figure reduction to QBI = $14,850 ($27,000 x 55%) excess amount x reduction ratio
  3. Deduction for Non-Serviced Business = $22,150 ($37,000 - $14,850) max QBI less reduction amount to QBI


For Specified Service Business additional calculations must be done:
45% (1 – 55% reduction rate) = Figure applicable percentage of phase out to QBI  

  1. $16,650 = ($37,000 x 45%) 20% of QBI x applicable percentage
  2. $4,500 = ($10,000 x 45%) greater of A or B wages and assets multiplied by applicable percentage
  3. $12,150 = ($16,650 - $4,500) difference between QBI and greater of wages and assets
  4. $6,683 = ($12,150 x 55%) reduction to QBI
  5. $9,968 = ($16,650 – 6,683) max of QBI less reduction to QBI

For Specified Service Business the deduction is $9,968


Deciphering the 199A deduction can be time-consuming and frustrating if you don't know precisely what you're looking for unfamiliar with determining the amounts. If you are a small business owner, Halon Tax can take care of all of this for you. With small business returns starting at only $249 for a limited time, we'd be happy to help you cross 'filing your taxes' off your to-do list.


Yesenia Brown

Yesenia is a tax accountant at Ragain Financial. She has been preparing taxes for 15 years.  In her free time, she enjoys spending time with her family. She is a second-degree Tae Kwon Do black belt and recently has discover the love for yoga.


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