The IRC §199A Qualified Business Income Deduction, a significant component of the Tax Cuts and Jobs Act (TCJA), may grant substantial tax savings to those who qualify. We are encouraging all eligible clients to take advantage of this opportunity. These new rules stipulate that owners of sole proprietorships, S-Corporations, and Partnerships may be able to claim up to a 20% deduction against their Qualified Business Income.
Which Businesses Qualify for this Deduction?
IRC §199A was designed to benefit labor and capital-intensive businesses. Lawmakers granted this sizable deduction to small business owners to compensate them for what they viewed as inequitable tax-cuts enacted to the advantage of large Corporations.
Despite these attempts to “even the playing field”, Section 199A limits the allowable deduction for businesses classified as specified service trades or businesses. Section 199A defines a specified service trade or business as a company that provides the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset of such trade or business is the reputation or skill of one or more of its employees. The IRS recently issued additional guidance in this area. The following clarifications pertaining to these trade/business categories are particularly relevant:
1) “Consulting” – The means by which an individual is compensated for his/her/their advice affect eligibility for the deduction. If a business owner provides advice while also selling products or other services, the individual in question is not considered a consultant. If an individual is compensated solely for the provision of advice, that individual is defined as a consultant.
2) “The Principal asset is the reputation or skill of one or more individuals” – This clause disqualifies businesses only if their owners provide product endorsement or earn “appearance fees” or “speaker fees”.
What is Qualified Business Income (QBI)?
QBI is defined by IRC §199A(c)(3) as ordinary income from a qualified business owned and operated by the taxpayer. Please note that the items listed below do not qualify as QBI:
- Reasonable compensation paid to S-corporation shareholders (W-2 wages)
- Guaranteed payments paid to partners of a partnership
- Income from foreign businesses
- Passive rental and investment activities
How Can I Claim this Deduction?
Once QBI is calculated for the taxpayer’s business(es), the taxpayer can calculate what is termed “combined qualified business income”. “Combined qualified business income” constitutes the deduction that the taxpayer will be allowed to claim. This calculation is the lesser of:
- 20% of QBI or;
- The greater of: (a) 50% of allocable W-2 wages* for the trade or business or (b) the sum of 25% of allocable W-2 wages* plus 2.5% of the unadjusted basis of qualified property.
*Wages are at the business level, not the taxpayer’s, but these are allocated to the taxpayer.
If the Taxpayer’s business falls under the category of a specified service business, but QBI does not exceed $157,500 on a single return, or $315,000 on a joint return, the Taxpayer will not be subject to the limits and can simply take a deduction for the lesser of:
- 20% of QBI or;
- 20% of the excess of taxable income over the sum of any net capital gain.
If the taxpayer’s taxable income exceeds the base threshold, the deduction is phased-out over the next $50,000 for single taxpayers, or $100,000 for those married filing jointly.
As you likely noticed, the details that define the deduction stipulated in IRC §199A are intricate. Although we have outlined the most important aspects of this new law, there are many other subtle nuances associated with this deduction that we have not included in this article. If you believe you may qualify for this deduction, we recommend that you contact us for an in-depth discussion of your unique business situation. The Realize team is committed to optimizing your business’ tax savings using IRC §199A and other available tax planning tools.
