The Section 199A deduction, also known as the pass-through deduction, will be able to provide significant tax savings to business owners, that is, if they are able to claim it. The provisions and calculations for the deduction are very complicated. At its simplest, the deduction is 20% of qualified business income, QBI (ordinary business income, rental income, 1231 gains, etc.).
The calculation is subject to phase-outs and limitations; phase-outs begin at $315,000 of taxable income for married filing joint returns ($157,500 for other taxpayers). Once taxable income hits these thresholds, the calculation begins to consider the business’s W-2 wages and the unadjusted basis of its property (the cost of the depreciable property still being depreciated under MACRS or less than 10 years old).
Once taxable income hits the upper threshold of $415,000 for married taxpayers filing jointly ($207,500 for all others), the deduction is limited to lesser of:
- 20% of QBI, or
- The greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis of its property
Taxable income in the middle of the two thresholds ($315,000 and $415,000 for married filing joint) will gradually limit the deduction to the additional limitations listed above.
The deduction will be further limited if the business generating the deduction is a specified service business. Then, the deduction is ratably reduced for every dollar of taxable income over the lower threshold ($315,000 for married filing joint returns, $157,500 for all others), and the deduction is completely phased out once taxable income reaches the upper threshold ($415,000 for married filing joint returns, $207,500 for all others).
Essentially, if the business is a specified service business, the deduction is allowed in full if taxable income is below the lower threshold and completely disallowed if above the upper threshold.
To sum it all up, if you are below the lower threshold, the deduction may be simple to calculate, but as your taxable income increases, the deduction becomes more difficult to calculate. Believe me, I have come up with a spreadsheet to calculate the deductions and the formula was extremely lengthy. Keep in mind, while we recently received proposed regulations, there are still many issues outstanding. Keep returning to our blogs to stay up to date on developments.
Daniel J. Colonna