There is lot of confusion among practitioners related to the new Sec. 199A deduction, how it is computed, and the limitations. This article is intended to provide a basic overview of the deduction. However this is not a substitute for a more in-depth study of the subject before attempting to compute the deduction.
To begin with, a taxpayer may have multiple sources of income that will each qualify for this deduction. Each source (business activity) must be put through the processes described below to determine the amount of the deduction for that particular business (source) and then added together with the 199A deduction from other businesses and combined with 199A deductions from REIT dividends, publicly traded partnerships, and cooperatives to determine the final total 199A deduction.
An important thing to remember is the limitations are applied at the taxpayer level, so not at the entity level for partners and S-corporation shareholders. Thus all limitations are based on the taxpayer’s taxable income before the Sec. 199A deduction. Where the deduction is coming from a partnership or S-corporation, some partners/shareholders may qualify for this deduction while others may not because of their taxable incomes.
Next, and a really important issue, is there are separate rules for specified service businesses and other businesses.
Specified Service Business - Specified service businesses are those described in Sec 1202(e)(3)(A) but excluding engineering and architecture. This category generally includes: Health, Law, Accounting, Actuarial Science, Performing Arts, Consulting, Athletics, Financial Services and Brokerage Services. The 199A deduction is a simple 20% of the pass-through income referred to as qualified business income (QBI). For a Schedule C the QBI would be the net profit. The deduction ratably phases out when the taxpayer’s taxable income is between $315,000 and $415,000 for married taxpayers and $157,500 and $207,500 for others. Thus for specified service businesses:
- If the taxpayer’s taxable income is below the $157,500 and $315,000 taxable income thresholds, the 199A deduction is the full 20% of QBI.
- If the taxpayer’s taxable income is above the $207,500 and $415,000 phase-out caps, the 199A deduction is zero.
- If the taxpayer’s taxable income is between the phase-out threshold and the cap, the 20% of QBI 199A deduction is ratably phased out between the threshold and cap amounts.
Other Types Of Businesses - For other types of businesses this is where the so-called wage limitation comes into play. There are 3 sets of circumstances that can apply:
- If the taxpayer’s taxable income is under the $157,500 or $315,000 threshold, the wage limitation does not apply, and the199A deduction is simply 20% of QBI.
- If the taxpayer’s taxable income is over the $207,500 and $415,000 caps, then the following computation must be used:
(a) Determine the greater of 50% of the wages paid by the business or 25% of the wages plus 2.5% of the unadjusted basis of all qualified property used in the business.
(b) The 199A deduction is the lesser of the amount determined in (a) or 20% of the QBI.
- If the taxpayer’s taxable income is between the phase-out threshold and the cap, the same calculation as used in 2 above applies except the amounts determined in (a) are ratably phased in (not out) between the thresholds and caps previously mentioned.
Farming Activities and Cooperatives – The original TCJA calculation for cooperatives and farming activities was substantially modified by a technical correction in the Omnibus Budget Bill. Without actually getting into the very complicated calculations, a 199A deduction is determined at the cooperative level and passed through to the farming activity along with per-unit retain allocations (product sales) and patronage dividends. The income is added to the farming activities other income and a 199A deduction, adjusted for the QBI used to establish the coop’s 199A deduction, determined. The farming activity 199A deduction and the coop’s 199A deduction are then added together for a total 199A deduction for the farming activity.
Final Note: the 199A deduction does not apply to the trade or business of being an employee.
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