Section 199A Deduction

The Tax Cuts and Jobs Act of 2017 enacted several complex provisions, credits, and deductions that many financial and tax professionals are still trying to figure out. One such provision is Section 199A, which provides small business owners with a 20 percent deduction of qualified business income (QBI). This new deduction is available for companies that use pass-through taxation and can benefit self-employed people. But there are also some limitations and restrictions that should be considered during the planning process.

One of the most important considerations is how QBI is figured. In addition to income from sole proprietorships and S corporations, the deduction includes income from real estate investment trusts and publicly traded partnerships. The deduction can even include rental income from tangible property, such as buildings or equipment. However, this deduction is not unlimited and can be reduced by taxable income over a threshold amount.

Section 199A Deduction is limited by rules that exclude or reduce certain items and limits based on W-2 wages and the unadjusted basis immediately after the acquisition (UBIA) of qualified property. These statutory limitations are subject to phase-in rules based on a taxpayer’s taxable income over a threshold amount. Taxpayers should plan accordingly and consider aggregating their trades or businesses to avoid these limitations. This will help them maximize the benefits of the 199A deduction. The IRS’s proposed regulations on this issue can be found in proposed SS 1.199A-4 and proposed SS 1.199A-6.

Section 199A Benefits

Section 199A substantially benefits owners of pass-through entities, such as sole proprietorships, partnerships, S corporations, and trusts. However, claiming the deduction is more than just a reduction in the tax rate; it is also a complicated, multifaceted, and compliance-intensive provision with significant limitations and pitfalls. In addition, it requires the gathering and sharing of new information by each pass-through owner. Consequently, it is unsurprising that many taxpayers encounter problems implementing this tax code provision.

While the Tax Cuts and Jobs Act contains a number of changes that will help pass-through business owners, a few key issues still need to be addressed. The most pressing concerns include how to treat fiscal-year businesses and the netting of income and losses. In addition, there are questions about the treatment of leases and contract manufacturing arrangements.

The first issue involves netting income and losses between fiscal-year and calendar-year businesses. Under current law, the netting rule only applies to calendar-year companies. But the final legislation expands the netting rule to fiscal-year businesses, making it easier for taxpayers to maximize their deductions and avoid a negative impact on their tax liability.

The second issue concerns the attribution of direct and indirect expenses to DPGR. Incorrectly matching these expenses will reduce the amount of DPGR that can be claimed. This problem often stems from a failure to understand the revenue stream generated by different business lines within the company.