The Tax Cuts and Jobs Act of 2017, enacted in 2018, has many complex provisions, credits, and deductions that are still being figured out by financial and tax professionals today. One of those deductions is now known as the Section 199A deduction for pass-through small businesses like sole proprietorships, S-corporations, and certain types of partnerships. It can also allow some real estate investors to take advantage of the deduction.
What Does the Section 199A Deduction Accomplish?
For small business owners who have companies that use pass-through taxation, Section 199A allows you to deduct 20 percent of your taxable income or qualified business income (QBI) – whichever is lower. This can be a boon to many entrepreneurs, but not all. To qualify for this treatment, you have to be a married joint tax filer with $315,000 or less in taxable income. For those filing as singles, you cannot make more than $157,000 to take advantage of the Section 199A deduction in this manner.
Starting at $315,001 in taxable income for a married couple filing jointly, this deduction begins gradually phasing out until a couple reaches $415,000 in combined taxable income. For single filers, the top threshold is $207,500.
One of many confusing parts about the Section 199A deduction is how qualified business income is figured. For the purposes of this specific deduction, income from real estate investment trusts and publicly traded partnership income also qualify as QBI. Income generated from renting out tangible property is also counted as QBI in this context.
Specified Service Trade or Businesses
Another twist to the Section 199A deduction is the caveat concerning service-oriented businesses (mostly white collar). This includes “a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, or dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.”
If any of those descriptions match your company and the work you do, you will have a more difficult time taking advantage of the Section 199A deduction because it is what the law refers to as a “Specified Service Trade or Business.” Any income generated from services is generally not designated as QBI, but other income generated from the sale of tangible goods is.
So, for example, let’s say you own a veterinarian clinic that also sells toys, treats, and other goods. For the sake of entity optimization, you could create a company through which you provide veterinary services and another through which you exclusively sell goods. This would open up the latter revenue stream for a Section 199A deduction.
Conclusion
This blog is only intended to serve as a general overview of this IRS section. Your situation is entirely unique and needs the personalized attention of an attorney experienced in tax planning. Attorney Tyler Q. Dahl is one of fewer than 100 attorneys in the country who is also a Certified Tax Coach; to see the value he can bring to you and your finances, reach out to schedule a consultation.
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