As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation.  As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS.  This is the first blog in a series which will explore what some tax professionals describe as the best small business tax break of the last half-century—the Section 199A Qualified Business Income Deduction (the “Deduction”).

Background

The Tax Cuts and Jobs Act of 2017 (the “TCJA”) added the Deduction, which is enacted to apply for tax years 2018 through 2025.  The Deduction comes in conjunction with a repeal of the Section 199 deduction, enacted under the American Jobs Creation Act of 2004.  The Section 199 deduction provided up to a 9-percent deduction based on the qualified production activities income for businesses that perform domestic manufacturing and other production activities.  Commentary surrounding the Deduction suggests that it is intended to provide tax relief to the owners of “pass-thru entities” that are unable to take advantage of the TCJA reduction to the corporate tax rate.

For purposes of the Deduction, the term “pass-thru entities” includes sole proprietorships, partnerships (including publicly traded partnerships), S corporations, certain real estate investors, and trusts and estates to the extent they own and operate a trade or business.  In certain circumstances the Deduction also applies to limited liability companies, real estate investment trusts, and qualified cooperatives.

How Much Is the Deduction Worth?

The Deduction offers its greatest impact on taxable income that would otherwise be treated as ordinary income and taxed at the highest individual tax rates (i.e., 32, 35, and 37-percent).  Owners of “pass-thru entities” have the potential to receive a deduction equal to 20-percent of the qualified business income (“QBI”).[1] For example, taxpayers taxed at the new 32, 35, or 37-percent individual tax rates have the potential to save $640, $700, or $740 for every $10,000 of pass-thru taxable income, respectively.  Thus, the higher the QBI and tax rate, the greater the tax savings.

Who Does the Deduction Apply To?

The Deduction generally applies without limitation. However, additional considerations and restrictions apply when a taxpayer’s taxable income exceeds a certain threshold or when QBI is generated from a specified trade or business (“STOB”), rather than from a qualified trade or business (“QTOB”).

For 2018, the taxable income threshold is $157,000 for single filers and $315,00 for joint filers (the “Threshold”).[2]  In essence, taxpayers with taxable income below the Threshold enjoy the full 20-percent deduction regardless of the QBI source.  But, when taxable income exceeds the Threshold either the “wage/investment” limitation (when QBI is sourced to a QTOB)[3] or the “Deduction phase-out” (when QBI is sourced to a STOB)[4] will apply. [NOTE: Both of these concepts will be further explained in later blog articles]

Start Planning Today In Order to
Take Advantage of the Deduction

In its commentary from the proposed regulations for Section 199A, the IRS discusses the significant work anticipated to implement the Deduction into the tax preparation process.  On average, the estimated additional annual burden is a combined 3 to 4 hours for taxpayers and the “pass-thru entities” that they own.[5] Certain taxpayers may need to make operational, legal, and or accounting changes in order to take advantage of the Deduction. Therefore, it is imperative to discuss the Deduction with a qualified tax professional today in order to maximize your potential benefit.

Although certain instances provide a clean application of the Deduction, other instances where a limitation or phase-out applies will require a greater understanding of the applicable tax and business law.  The tax and business attorneys at Nardone Limited have this understanding, and are prepared to discuss your Section 199A planning today.

[1] I.R.C. §§ 199A(a) and (b)
[2] I.R.C. § 199A(e)
[3] I.R.C. § 199A(b)(3)
[4] I.R.C. § 199A(d)(3)
[5] Preamble to the § 199A proposed regulations.