The New Business Income Deduction
The 2017 Tax Cuts and Jobs Act (TCJA) is one of the most consequential changes to U.S. tax law in decades. It features changes to individual rates, sweeping reforms to corporate taxation, and much more. One of the most important provisions of the new law is the new Section 199A deduction for Qualified Business Income (QBI). Any taxpayer receiving income from a domestic “trade or business” can potentially take a tax deduction for up to 20% of that income. Eligible taxpayers will be able to take the deduction for the first time on their 2018 personal income tax returns - Form 1040.
Understanding Qualified Business Income
Section 199A entitles individuals (also trusts) to take a deduction against income of 20% of qualified business income (QBI). QBI is defined as the net amount of income, gains, loss and deduction from a qualified trade or business. This trade or business can take the form of a sole proprietorship, a rental enterprise, or even a share in another entity, such as a partnership or S corporation, where the taxpayer receives a K-1 that reports items of income and deductions. Nearly all trades or businesses qualify under these rules, but wages earned as an employee are not counted.
Taxpayers with taxable incomes over certain thresholds ($315,000 for joint returns and $157,500 for other filers) can encounter limitations on the deduction for QBI, specifically a limitation based on the W-2 wages paid and the unadjusted basis of qualified property owned by the trade or business.
It’s not all bad news though – taxpayers who own multiple trades and businesses can potentially aggregate them into groups of related businesses to maximize the Section 199A deduction. In addition, taxpayers who earn income from a "specified service trade or business," including health, law, accounting, and consulting can qualify, but the deduction phases out as as taxable income increases. Proper tax planning, including accounting for multiple lines of business, is key to maximizing the deduction for qualified business income.
Remember, the QBI deduction is not available for wage income or for business income earned by a C corporation. C corporations are already realizing benefits from the TCJA via the reduced 21% flat tax rate.
Keeping Up With Provisions of The TCJA
As one of the marquee items of the Tax Cuts and Jobs Act, the deduction for qualified business income has attracted attention, comments, and questions from all manner of interested parties, including tax professionals, advocacy groups, industry leaders, and journalists. So it should come as no surprise, even as the IRS recently issued the much-anticipated Final Regulations on Sec 199A, that many questions still exist.
More to Come, We Can Help
As mentioned, the IRS has issued the final regulations and additional guidance to help implement the QBI deduction. The guidance includes a revenue procedure for determining W-2 wages for QBI deduction purposes. Another proposed revenue procedure provides a safe harbor for certain real estate enterprises that may be treated as a trade or business. This proposed procedure, included in Notice 2019-07, allows individuals and entities who own rental real estate directly or through a disregarded entity to treat a rental real estate enterprise as a trade or business and use the QBI deduction, if certain requirements are met. Taxpayers will be able to rely on this safe harbor until a final revenue procedure is issued.
We’ll have more tips and pointers regarding Sec 199A in future articles. If you need clarity about the new law or need help navigating this provision of the Tax Cuts and Jobs Act, please contact us.
Topics: Tax Topics