In this summary, we will cover:

  • What a qualified trade or business is.
  • The various limitations relating to the qualified business income deduction.
  • The practical application of the qualified business income deduction.
  • The meaning of a specified service trade or business.

Takeaways:

  • Specified service trade or business (SSTB). A specified service trade or business is any business that offers services relating to accounting, health, actuarial, law, athletics, performing arts, financial services, training, investing and investment management, whereby the principal asset of the trade or business is the skill or the reputation of the owner or an employee of the business.
  • Section 199A subjects the qualified business income deduction to certain limitations. They revolve around the type of business, taxpayer’s income level, W-2 Wages paid by the business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property owned by the business.
  • Certain taxpayers who qualify for the Section 199A deduction could end up with a maximum of 20% of their combined qualified publicly traded partnership income and their real estate investment trust (REIT) dividends. In this case, the deduction will not be subjected to the W-2 Wages or unadjusted basis immediately after acquisition (UBIA) of qualified property.
  • If the taxable income of a given taxpayer is above $315,000 or $157,500 limits and is a specified service trade or business, the deduction will now be based on the W-2 Wages paid by the business, and the unadjusted basis of a given property utilized by the business.
  • A qualified property is a tangible property that warrants some form of depreciation under section 167. To qualify for the deduction, the property must be held by the business at the close of the taxable year and must have been used to generate the qualified business income.

Summary

Since Dec 31, 2017, taxpayers other than corporations have been entitled to receive a deduction of up to 20% of the Qualified Business Income generated from a qualified trade or business.

A qualified trade or business, in this case, means any business or trade except:

  1.   Specified service trade or business (SSTB). A specified service trade or business is any business that offers services relating to accounting, health, actuarial, law, athletics, performing arts, financial services, training, investing and investment management, whereby the principal asset of the trade or business is the skill or the reputation of the owner or an employee of the business.

     The Qualified Business Income Deduction, in this case, will only apply if the income of the taxpayer is more than $315,000 for a jointly filed return of a married couple and $157,500 for all other taxpayers.

  1.   The services performed by an employee.

As mentioned at the start of this post, qualified businesses may attain a deduction of up to 20% if a taxpayer’s income exceeds $315,000 for married individuals and $157,500 for all other taxpayers.

Section 199A subjects the qualified business income deduction to certain limitations. They revolve around the type of business, taxpayer’s income level, W-2 Wages paid by the business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property owned by the business.

Certain taxpayers who qualify for the deduction could end up with a maximum of 20% of their combined qualified publicly traded partnership income and their real estate investment trust (REIT) dividends.

In this case, the deduction will not be subjected to the W-2 Wages or unadjusted basis immediately after acquisition (UBIA) of qualified property.

Essentially, the applicable deduction, in this case, is the lesser of the combined qualified business income amount and an amount equal to 20% of the taxable income less the net capital gain of the taxpayer.

This deduction is applicable only after Dec 2017 and available to qualified taxpayers whether or not they list the deductions on Schedule A or take the standard deduction.

Here is how the deduction works for a specified service trade or business.

The first thing you need to remember is that the specified service trade or business will not apply if the taxable income in question is below £315,000 for a married taxpayer filing returns jointly, and $157,500 for all other taxpayers.

The deduction will be the lesser of:

1)   20% of the qualified business income of the taxpayer plus 20% of the qualified dividends from real estate investment trust (REIT) and qualified publicly traded partnership income.

2)   20% of the taxable income of the taxpayer less net capital deductions.

If the taxable income of a given taxpayer is above $315,000 or $157,500 limits and is a specified service trade or business, the deduction will now be based on the W-2 Wages paid by the business, and the unadjusted basis of a given property utilized by the business.

Point to note: The limitation for the income range for the respective categories of married and all other taxpayers relate to the 2018 tax year and may be adjusted for inflation in the years to come.

Qualified Business Income

This is one of the limitations that Section 199A subjects qualified business incomes to in order for a taxpayer to benefit from the deduction.

Consider this…

If an accounting firm has a taxable income of $500,000 with a married partner who has an allocable share in the firm’s income of $300,000, the partner will not be entitled to any deduction. On the other hand, if his taxable income was $320, 000, then he could get a deduction of 20% of his taxable income i.e. (20% X 320,000= $64,000).

But if the same partner was on a different industry where the principal asset of the business was not the skill of the owners or employees, such as in real estate business, he would be eligible for a full deduction. However, limitations to do with the wages paid and property of the business may still apply. We discuss this limitation in the next section of this article.

Wages and Property Limitation

Now, let’s delve a bit into a qualified property to give you a better understanding of the wages and property limitation.

A qualified property is a tangible property that warrants some form of depreciation under section 167.

To qualify for the deduction, the property must be held by the business at the close of the taxable year and must have been used to generate the qualified business income.

The unadjusted basis of qualified property taken into consideration cannot be reduced by depreciation deductions.

Consider this example…

A certain taxpayer owns 90% of an engineering company which is in form of a registered partnership.

Assume that the net income of the firm for 2018 is $4 million.

Further, assume that the taxpayer in his returns reports that his is a non-specified service business and gets an acknowledgment from the relevant tax body for that.

The business pays $1 million in W-2 Wages and the unadjusted basis of its property is $100,000.

The taxpayer is allocated 90% of all the items in the partnership.

The preliminary Qualified Business Income Deduction of the taxpayer is 20% X 90% X 4,000,000=$720,000.

The qualified business income deduction, however, is restricted to the higher of:

a)   50% of all his allocable share of W-2 Wages, 50% X 90% X $1,000,000=$450,000 OR,

b)   25% of his allocable share  of W-2 Wages, 25% X 90% X $100,000=$22,500, PLUS 2.5% of his share of the unadjusted basis of qualified property, 2.5% X 90% X $100,000=$2,250 totalling of $24,250.  

Therefore, the taxpayer’s qualified business income deduction would be $450,000, which is the higher of the two values but lower compared to the preliminary qualified business income deduction of $720,000.

Don’t do it alone..

As you can see, Section 199A is quite complex.

It may take a great deal of time and research to comprehend some of the issues in this section and how exactly they apply to specific business scenarios.

It is, therefore, advisable to engage a qualified tax consultant or an accountant to correctly interpret and apply relevant clauses in the Section to the specific areas of your business.

That said, should you need any help as far as Section 199A (Qualified Business Income Deduction) is concerned, don’t hesitate to drop us an inquiry and we will be more than happy to offer our expert assistance.

Finally, do you have any insights regarding Section 199A that you feel should have been included in this article? Let’s keep the conversation going in the comments section.