The Tax Cuts and Jobs Act, which was passed by Congress and signed into law by President Trump at the end of 2017, is a significant overhaul to the U.S. Tax Code. One area of particular interest is Section 199A – Qualified Business Income.
Section 199A details a new addition to the tax code that allows business owners—excluding corporations—to take a deduction of 20% of qualified business income earned from the business.
Who qualifies for this deduction?
Owners of qualified trades and businesses can take this deduction. Qualified business income comes from one of the following:
- Sole proprietorships reported directly on Schedule C
- Rental activity reported directly on Schedule E
- S corporations
Neither corporations nor employees can take a deduction for qualified business income. Additionally, above a particular income threshold, Section 199A excludes “specified service” trades and businesses from taking the deduction; these include a number of professional services, most notably law, accounting, and financial services.
How does the Qualified Business Income Deduction work?
Qualified business income (QBI) is the net of the following items with respect to a qualified trade or business: income, gain, deduction, and loss. Think of it as the regular, non-investment income brought in by a business (within the U.S.).
The deduction includes a threshold amount of $315,000 for married filing jointly ($157,500 for all other filers). Rules vary for those above and below this threshold.
For taxpayers with income below the threshold, Section 199A allows a deduction of the lesser of 20% of qualified business income from passthroughs or 20% of the filer’s taxable income less net capital gains.
Above the threshold, the deduction has more limitations. Business owners may deduct the lesser of the following:
- 20% of QBI,
- 50% of the total W-2 wages paid by the business, or
- 25% of the total W-2 wages plus 2.5% of Qualified Property owned by the business.
When taxable income exceeds an upper limit of $415,000 for married filing jointly ($207,500 for all other filers), additional criteria apply. In order to qualify for the deduction the business must not be considered a “specified service business” (see previous section) and must either pay wages or own property.
For more details, including information on limitations, phaseouts, thresholds, and special definitions, take a look at this summary from the BDO Alliance USA.
How will this new deduction effect taxes going forward?
This new deduction is likely to have a very large impact. It has the potential to decrease the effective business income tax rate for those in the top bracket from 37% to 29.6%—quite a significant benefit.
The QBI deduction will have a large impact on tax planning strategies. Business owners should consult their Blackman & Sloop tax advisors to develop an approach that optimizes this deduction.