Tax Planning Tips for Businesses and the New Section 199A.

The IRS has recently issued 184 pages of regulations concerning a few provisions of the brand-new (in 2018) Section 199A of the Internal Revenue Code.  Given that this section affects nearly all businesses and their owners (except for C corporations), here are a few takeaways from the new regulations.

What is Section 199A?

This section provides eligible taxpayers with a deduction of up to 20% of qualified business income.  The deduction is claimed on the personal tax return and not on the business tax return.

What business entities qualify?

A domestic business operated as a sole proprietorship, a partnership, S corporation, trust or estate.  This would include a LLC as long as the LLC did not elect to be taxed as a C corporation.

What are the income limitations?

For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction is subject to limitations which are based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition of qualified property held by the trade or business.

There are complex planning opportunities available with this new section of the Internal Revenue Code.

What income does not qualify?

Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.

How is the deduction computed?

Generally, the deduction is the lesser of the combined qualified business income amount and an amount equal to 20% of the taxable income minus the taxpayer’s net capital gain. If this is confusing, join the club!

When is the deduction available?

The deduction is available for tax years beginning after Dec. 31, 2017, regardless of whether an individual itemizes their deductions on Schedule A (Itemized Deductions) or takes the standard deduction on Form 1040. Most eligible taxpayers will be able to claim it for the first time when they file their 2018 federal income tax return in 2019.

What is Qualified Business Income (QBI)?

QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted.

In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.

What is a qualified business?

A qualified trade or business is any trade or business that is not a C corporation, with two exceptions:

  1. Specified service trade or business (SSTB), which 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, 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. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
  2. Performing services as an employee.

What are the loopholes?

The SSTB limitation does not apply if a taxpayer’s taxable income is below $315,000 for a married couple filing a joint return and $157,500 for all other taxpayers.

If the taxpayer’s taxable income is above the $315,000/$157,500 thresholds, the deduction may be limited based on whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property used by the business. These limitations are phased in for joint filers with taxable income between $315,000 and $415,000, and all other taxpayers with taxable income between $157,500 and $207,500.

Note that these amounts will be indexed in the future to account for inflation.

The IRS will be issuing much guidance in the future about Section 199A, but until then these new regulations are the best we have with respect to how the IRS will be treating this very complicated section in future audits.  I will also be adding to this list once guidance starts to trickle in!