The Tax Cuts and Job Act, signed into law in December of 2017, made quite a few changes to the tax laws that took effect in 2018. Among these were a tax rate cut, an increase in the standard deduction, and elimination of the personal exemptions. The biggest change, however, was the 199A deduction, which gives a 20-percent tax break to businesses with qualified business income (QBI).
QBI It does not include amounts received as an employee, nor does it include reasonable compensation you may receive as a shareholder of an S corporation. It also does not include guaranteed payments received by a partner for services you provide.
What a lot of people don’t know is that Congress did not write the law and simply have the IRS implement it. The IRS had to go through and write out the regulations for how someone can take the tax deduction. In mid-January, they finalized the regulations and published them to the world, putting out a 274-page book of regulations on the deduction.
Who is eligible for the 199A deduction?
So who can get this 199A deduction? You are eligible if you:
- Operate as a sole proprietorship or a partnership.
- Are an S corporation shareholder.
- Have an estate or trust, or are the beneficiary of either.
- Have qualified PTP (publicly traded partnership) income.
- Have qualified REIT (real estate investment trusts) dividends.
Calculating the 199A deduction
As a business owner, if you file taxes as “married filing jointly” and your taxable income is less than $315,000, or file using another status and your income is less than $157,500, the calculation is relatively straightforward.
If your income is above those thresholds, talk to an accountant. There are a lot of rules that come into play to calculate what deduction you can take. You are better off having someone walk you through the issues than attempting to do this on your own.
Depending on how high your income was during the year, you might not be able to take the deduction at all as there is an income ceiling ($415,000 for married filing jointly, $207,500 for all others). In addition, there are certain types of businesses that do not qualify to take these deductions — such as CPAs, lawyers and architects.
How the calculation works
Let’s say your income is below the $315,000 married filing jointly/$157,500 all other statuses. How would you calculate your deduction?
- Take the income from your businesses, less any amounts paid for self-employed health insurance as well as one-half of your self-employment tax, and multiply that sum times 20 percent. If you had a loss, you don’t get a deduction, but you can carry forward the loss to next year.
- Add together any income from REIT or PTP, and multiply it by 20 percent. If you have losses from either item, then the loss is carried forward to the next tax year and reduces next year’s income from these sources.
- Add the total from steps 1 and 2.
- Subtract from your taxable income any net capital gains, which is any capital gains less any capital losses. Multiply this total by 20 percent.
- Your 199A deduction is the lesser of what you got in step 3 and 4.
For example, let’s say you brought home $45,000 from selling duck decoys, and your spouse made $50,000 at their job, where they have health insurance that covers the family. You also sold some stock and made $1,000 in capital gains. You had self-employment tax of $6,885 ($45,000 times 15.3 percent). Your total income would be $96,000 ($45,000 + $50,000 + $1,000). This is below the married filing joint threshold of $315,000, so you qualify for the deduction.
Here is the calculation:
- Income from your business of $45,000, less one-half of your self-employment tax of $3,343 (half of $6,885 rounded) is $41,657. You multiply this amount by 20 percent to get $8,331.
- No REIT or PTP income, so nothing to do here.
- Step 1 plus step 2 equals $8,331.
- Subtracting the $1,000 of net capital gains from your total income of $96,000 gives you $95,000. Twenty percent of $95,000 is $19,000.
- The lesser number of the calculations in steps 3 and 4 is the $8,331 calculated in step 3.
While the 199A deduction will end up reducing the tax burden of quite a few people, the calculation itself can be quite cumbersome even at the lower income levels.
If you have a significant amount of income, you would be better served to go to an experienced CPA who can guide you through the deduction.
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.