Rock Talk

An Expert Explains: Section 199A of the New Tax Law

Last updated on October 7, 2019 at 01:54 pm

There are significant changes in the 2018 Tax Cuts and Jobs Act, specifically for owners of S Corporations, sole proprietorships and partnerships. For now, we’re going to focus on Section 199A of the new tax law and its impact on owners of these companies.

What’s Different Now?

Under Section 199A of the new tax law (Qualified Business Income), the owners of these types of flow-through businesses (including stand-alone rental properties reported on Schedule E and a trust or estate), will now be able to take a deduction of 20% against their income from the business. The result will bring a reduction in the effective top rate for this type of business income from 39.6% under previous law to 29.6% under the new law.

While many of these companies (S Corps, sole proprietorships and Partnerships) are considered to be small to mid-size organizations, the reality is that both small and large United States businesses operate as flow-through entities. That’s why the impact of this deduction is important for flow-through businesses, enabling them to maintain their competitive advantage over the double taxation that can occur with a C corporation.

How Will the Deduction for Pass-Through Entities Work?

For tax years beginning after December 31, 2017 and before January 1, 2026, the Section 199A, non-corporate tax payers are allowed an additional deduction based on the following criteria:

  • In general, there is a 20% deduction based on Qualified Business Income.
  • Qualified Business income (QBI) is typically defined as the net amount of qualified items of income, gain, deduction and loss, relating to any qualified trade or business of the taxpayer.
  • The 20% deduction is NOT allowed in computing adjusted gross income (AGI) but IS allowed as a deduction reducing taxable income.

What are the Limitations?

Given all the complex issues that accompany any new Act, it is important to be educated and informed. With that in mind, please consider that or pass through entities, other than sole proprietorships, the deduction CANNOT exceed the greater of:

  • 50% of the W-2 wages with respect to the qualified trade or business
  • 50% of the W-2 wages with respect to the qualified trade or business
    • For a partnership or S Corporation, each partner or shareholder is treated as having W-2 wages for the tax year in an amount equal to his or her allocable share of the W-2 wages of the entity.
  • The sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.”

What Doesn’t Apply?

  • W-2 wage limit does NOT apply in the case of a taxpayer with taxable income not exceeding $315,000 for married individuals filing jointly and $157,500 for other individuals.
  • The deduction does NOT apply to specified service businesses.
  • Service business limitation does NOT apply in the case of a taxpayer whose taxable income does not exceed $315,000 for married individuals filing jointly or $157,500 for other individuals, both indexed for inflation after 2018.

Conclusion

To fully understand how this deduction will work for you and your business, please consult your tax expert. Please also feel free to email me at Kenneth.bagner@SobelCoLLC.com.

And remember – the benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for joint filers and $50,000 for other individuals!

Ken Bagner is a Member in Charge of Sobel & Co. LLC. He is a member of the American Institute of Certified Public Accountants and the New Jersey Society of Certified Public Accountants. Plymouth Rock Assurance in NJ is proud to partner with NJSCPA to bring you valuable tips about your financial health. Qualified members of the NJSCPA can receive a discount on their car insurance through Plymouth Rock Assurance in New Jersey.

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