The New Section 199A Business Income Deduction

2018 brings many new changes in the tax law for our Colorado businesses.  One of these changes that will help many local, small businesses in Denver is the Section 199A business income deduction. This section provides taxpayers who are not corporations a deduction of 20% of qualified business income earned in a qualified trade or business. This is an additional 20% deduction from taxable income and helps offset the cost of self-employment taxes these businesses generate, which total 15.3% of the company’s taxable income. Section 199A can be a beneficial deduction for Schedule C proprietorships, partnerships, s-corporations, trusts, and estates, however the keyword up above to observe is “qualified”. It is an ambiguous adjective that was intentionally included to limit who gets to take the deduction.

business income deduction

What is a qualified business income (QBI)? Qualified business income is the net income, after all ordinary business expense deductions, from any qualified trade or business. Please note that this excludes items such as capital gains and losses, investment income such as dividends and interest, and extraordinary items or other comprehensive income. For most local business, this is basically your taxable income reported on your company’s schedule C or page 1 on the Form 1065 and 1120S.

What is a qualified trade or business? This is any trade or business that does not meet one of the two exceptions noted by the IRS as follows:

  1. Specified Service Trade or Business (SSTB) is any trade or business where the principal asset is the reputation or skill of one or more of its employees. SSTBs include services in the fields of law, accounting, health, actuarial science, performing arts, consulting, athletics, financial and investing services, and investment management services. Companies whose industries fall in this category are excluded from taking the deduction.
  2. Performing services as an employee will exclude you from taking the deduction.

While there are specified trades that are identified as excluded, other service industries may still be excluded under the ambiguous “reputation or skill of one or more employees” clause. Does the mean businesses such as a cleaning service that sounds like they would in normal situations get to take the deduction, be excluded if one of the owners was known as the best cleaner in town and therefore generated more customers. Unfortunately, I feel this is an answer we will see tax courts having to addressing in the very near future.

Now there is an important exception to the SSTB exception. The SSTB rules only apply to taxpayers whose taxable income exceeds $315,000 for married filing joint and $157,500 for all other tax statuses. What this means for you is if you own a trade or business that meets one of the above-excluded industries, but your taxable income is less than $315,000/$157,500, then you get to take the deduction as well. This can significantly help startup companies in these industries even though they may eventually lose the deduction due to earnings. Also, please note that for pass-through entities such as partnerships and s-corporations, the deduction is taken at the individual level and not the business level since they do not pay tax.

An additional limitation to the deduction is the 50% W-2 wage limitation. If the taxpayer’s income exceeds $315,000/$157,500 then the deduction is also limited to 50% of the total wages paid by the business. For any qualified company whose taxpayer income exceeds the income limitation and if their Company paid no wages, then they too will be excluded from getting the deduction.

What does this all mean? There is a significant deduction available to taxpayers that can save them a substantial amount in income taxes this year, but significant caveats. Let the knowledgeable staff at GCK Accounting, LLC help guide you through Section 199A and determine if you and your company can take advantage of this amazing tax break as well as the many other new options in the 2018 tax code.