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IRC 199A Small Business Deduction

  • It will apply to all business income except W-2 income and guaranteed payments.

  • It will apply to all types of entities except C Corporations since they are already received the reduced tax rate.

  • It will be deducted on individual and trust returns right after itemized deductions.

  • The calculation is determined on each business separately i.e. Each S Corporation, LLC, Partnership, rental, Schedule C, etc. unless a grouping is in place.

  • You will need to determine if the income is generated from a service business. Service businesses include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, any business where the principal asset is the reputation or skill of one or more employees or owners. Engineers and architects are excluded.

  • The calculation is very complex and subjection to various limitations. Below is a summary of the calculation.

    1. Calculate the initial deduction which is 20% of qualified business income (QBI)

    2. Calculate the taxable income limitation. Multiply taxable income before the deduction times 20% (excluding capital gains). If that number is smaller than #1, that will be your new initial deduction.

    3. Determine if you are at or below the phaseout threshold

      Phaseouts

      Filing Status Phaseout range Size of phaseout range
      MFJ $315,000-$415,000 $100,000
      All other filing statuses $157,500 $50,000
    4. If you are below the phaseout range, your deduction is not limited further. If you are in the phaseout range, your deduction is limited based upon the amount you are over. If your income is from a service business and you are over the phaseout range, stop, you will not get a deduction.

    5. If you have income from a nonservice business, there is an additional limitation calculation, but you will not necessarily lose the entire deduction.

    6. This additional limitation is the greater of: 50% of W-2 wages or 25% of W-2 wages plus 2.5% of unadjusted basis of depreciable assets. (This number cannot exceed 20% of the QBI).

    7. If you don't pay wages and you are over the phaseout range, you will probably not get a deduction. Another reason to get independent contractors on payroll.

    8. The 2.5% of depreciable asset calculation was put into place for rental activities.

    9. Reasonable compensation will become a bigger issue.

    10. Partnerships, LLCs, and sole proprietorships have a disadvantage over S Corporations. The guaranteed payments do not count as wages but reduce qualified business income. Sole proprietors cannot pay wages to themselves.

    11. The IRS is supposed to start issuing regulations in June to provide more guidance on the above calcuations.