Figure 5-Deduction for pass-through income
The bill created new IRC Section 199A which allows taxpayers to subtract 20% of sole proprietorship, partnership or S corporation qualified business income to arrive at taxable income. The deduction is to be calculated separately for each trade or business.
Business net income eligible for the subtraction does not include any guaranteed payments paid to a partner, nor wages paid to an S corporation shareholder.
How is the deduction calculated?
Step 1: Determine “combined qualified business income”. This is the lesser of:
- 20% of the taxpayer’s qualified business income with respect to the qualified trade or business, or
- The greater of:
- 50% of the taxpayer’s share of allocable wages of the qualified business; or
- 25% of the taxpayer’s share of allocable wages of the qualified business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified
Plus: 20% of the aggregate amount of the qualified REIT dividends and qualified publicly traded partnership income of the taxpayer for the taxable year.
Step 2: The above figure is then brought into the main part of the deduction calculation:
The deduction is calculated as the sum of:
- The lesser of:
- the combined qualified business income amount (from step 1 above), or
- 20% of the excess, if any, of taxable income over the sum of the net capital gain and the aggregate amount of the qualified cooperative dividends of the taxpayer;
- Plus the lesser of:
- 20% of the aggregate amount of qualified cooperative dividends, or
- Taxable income, reduced by net capital
The wages and investment limitation does not apply in the case of a taxpayer with taxable income exceeding $315,000 MFJ or $157,500 single. The limit phases in as taxable income increases from $315,000 to $415,000 MFJ or from $157,500 to $207,500 single.
Qualified cooperative dividends are defined in Section 199A to include any patronage dividend, any per- unit retain allocation, and any qualified written notice of allocation, or any similar amount received from a cooperative and which is includible in gross income
In the case of a partnership or S corporation, the deduction is applied at the partner or shareholder level and each partner or shareholder takes into account their allocable share of each qualified item of income, gain, deduction, and loss, and each partner or shareholder is treated as having W-2 wages and unadjusted basis immediately after acquisition of qualified property in an amount equal to such person’s share of the wages and basis of the partnership or S corporation.
Qualified property is tangible, depreciable property held by and available for use in a qualified trade or business at the close of the year. Qualified property is included in the 2.5% computation until the later of (1) the end of its recovery period; or (2) ten years.
The term “qualified trade or business” means any trade or business other than—
- a specified service trade or business, or
- the trade or business of performing services as an employee
Specified service business rules
The term “specified service trade or business” means any trade or business which is described in section 1202(e)(3)(A). This includes trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Architect and engineering services are included in the same code section, but are specifically excluded from the definition for these purposes. As such, architectural and engineering service business income qualifies for the 20% deduction.
The 20% deduction does not apply to specified service business income over the threshold levels mentioned above ($315,000 MFJ and $157,500 single). To the extent taxable income is $315,000 or less ($157,500 single), the full deduction is allowed. The deduction phases out for service business income over a $100,000 income range ($50,000 range for single) as taxable income exceeds $315,000 ($157,500 single).
There are other miscellaneous items to consider in reference to Section 199A. Please reach out to Christianson with any questions or for more information.