December 22, 2017, saw the birth of the most sweeping tax legislation in the US since the Tax Reform of 1986. Known as the Tax Cuts and Jobs Act(TCJA), it allows tax deductions for owners of pass-through entities while increasing individual alternative minimum tax(AMT) and estate tax exemptions. The Tax Cuts and Jobs Act also reduces the income tax rates for most individual tax brackets.
In certain cases, it can allow up to 20% tax deduction on an individual’s qualified business income. However, the rules associated with this particular tax law can get confusing for a lot of folks. There is also a certain sense of uncertainty and additional guidance is required from the government’s side, which doesn’t seem to be readily available. This can leave small business owners in the dark regarding the benefits associated with the same.
In the spirit of helping you understand the logistics of this deduction better and raising awareness, we present to you the following facts:
For taxpayers except for corporations, starting from the 31st December 2017, are considered eligible for a tax deduction equal to the cumulative sum of:
- The lower amount out of (a) taxpayer’s “combined qualified business income” or (b)20% of the excess of taxpayer’s taxable income for the taxable year over any net capital gain plus the aggregate amount of qualified corporate dividends.
- The lesser amount of the following – (a) 20% of the aggregate amount of the qualified corporate dividends for the taxable year or (b) taxpayer’s taxable income sans the net capital gain
Qualified Business Income(QBI) is the sum of (i) 20% of the taxpayer’s QBI with respect to each qualified trade or business, and (ii) 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership(PTP) income.
However, the amount deductible from an individual’s QBI is subject to a number of limits, such as:
- The deduction cannot exceed the greater of (i) 50% of their share of the W-2 payments made by their employer or (ii) the sum of 25% of his W2 deduction added to 2.5% on the unadjusted basis of qualifying property.
More specifically, it allows owners of pass-through businesses – S corporations, partnerships, and LLPs to take up to a 20% deduction on their qualified business income. This gets complicated because if the business is specified to belong to one sector such as health, law, bill, consulting, athletics, actuarial science, financial services, or brokerage services, the deduction is phased out on the basis of the owner’s income.
This deduction is specifically phased out for joint filers between the range of $315, 000 and $415,000. For single filers, the phase-out range goes further up to $157, 500 to $207, 500. This however leaves out the rest of the filers, earning more than the upper limit of the said ranges, hanging dry.
Thus, the 199A deductions can only benefit a very limited group of business owners.