A 20% deduction can be claimed by the owners of S-Corporations, Partnerships, Sole Proprietorships, and beneficiaries of trusts (all, usually, do not pay tax at the entity level). The income is passed through to the owners.
IRC 199A does not usually pertain to business that provide services, such as doctors, lawyers, accountants, athletes, stock brokers, and many others.
The EXCEPTION to this rule: when the service provider has taxable income of less than $315,000.00 (married) or $157,500.00 (individual). This benefit begins to be phased out at these income thresholds. The deduction is completely phased out at $415,000.00 (married) and $217,500.00 individual. However, excluded from the long list of service providers are architects and engineers, meaning the deduction can be claimed by them without restriction.
The deduction is calculated as:
1. The combined Qualified Business Income of the taxpayer or
2. 20% of the excess of taxable income over the sum of any net capital gain.
Qualified Business Income (QBI) is defined as follows:
· 20% of the business owner’s QBI
· The greater of 50% of the W-2 wages of the business allocable to the owner OR
25% of wages of the business plus 2.5% of the unadjusted tax basis in property of the business allocable to the business owner.
To put it simply, profit from the active income and expenses from the operation of the passthrough business. That does not include passive income such as interest, dividends, and even capital gains. QBI also does not include the W-2 wages paid to the business owner. Therefore, if the business owner pays him/herself a wage in addition to receiving the profits of the business, the amount of QBI and the related deduction may be larger.
The 20% deduction does not apply if the business has a loss, due to the fact it is based on net income and profit. If the loss is carried forward, the loss in “year 1” will reduce the profit of “year 2” therefore reducing the amount of the 20% pass-deduction available to the business owner in “year 2.”
For real estate professionals there is still a lot of uncertainty surrounding this deduction for their business, in particular if they hold real estate in a separate entity such as an LLC. It is still unknown if they must apply all the tests as if they were one entity or if they are able to aggregate some or all of their real estate business to qualify. Therefore, we are still waiting on IRS guidance for this type of
scenario. Holding real estate for investment (not actively participating for the hours required to qualify as a real estate professional) does not qualify for the deduction.
Senior International Tax Consultant/ CAA
GPL Tax & Accounting