Preface: This blog is for entrepreneurs who are hereby advised to apply appropriate tax planning for their businesses activities to optimize the tax benefits and nuances of the new Section 199A tax laws, beginning with the 2018 tax year.
A Summary of the New Tax Laws For Section 199A
Tax Implications and Planning Features with the Qualified Business Income Deductions
Credit: Donald J. Sauder, CPA, CVA
Minted the Tax Cuts and Jobs Act, the newest business tax legislation relevant to the 2018 tax year, appears to have unique tax characteristics that are intentionally vague for taxpayers with regards to certain IRS code section interpretations. The summarized IRS tax code relevantly exemplified specifically to this blog are for the Section 199A or the Qualified Business Income Deduction.
To be confidentially advised towards IRS audit proof tax planning decisions for the 2018 tax year, it is imperative to understand how the new tax law of Section 199A are applicable to certain qualifying entrepreneurial activities and corresponding tax positions e.g. tax laws for service and non-service businesses, exact definitions of qualified business income (QBI) and individual tax filing threshold limits on Section 199A.
The new Section 199A tax code permits individual tax filers to deduct as much as 20% of qualifying 199A income for tax filing purposes beginning with the 2018 tax year. The qualifying Section 199A income includes qualified business income (QBI) from say partnerships, sole proprietorships, or S-Corporation. As with most new tax laws, Section 199A section has numerous tax planning nuances that we will outline in the following paragraphs.
A Section 199A Outline
So, what is Section 199A? It is a tax deduction akin to the prior Domestic Production Activity Deduction under Section 199. With the unique modifications to Section 199A (Section 199 called DPAD in prior years, was capped at 9% of qualifying income or 50% of W-2 wages), for the current tax year, business tax planning will encompass an entirely new level of tax variables with the introduction of this tax law modification.
The Section 199A deduction begins with the tax year 2018 and is currently legislated now, until 2025. Firstly, Section 199A is a standard 20% deduction of QBI from unadjusted income, with a threshold limit on individual taxpayer earnings, e.g. exceeding $315,000 MFJ or $157,500 otherwise. The Section 199A deduction limit phases out over $415,000 MFJ or $207,500 filing otherwise. Above these individual filing threshold’s, the Section 199A is limited to 1) the greater of the 50% of timely filed W-2 business wages, or 2) the combined sum of 25% of W-2 wages plus 2.5% of unadjusted qualifying business property.
The obviously unique characteristics of Section 199A from prior Section 199 DPAD also include capital gains, say from sales of stocks or bonds, being entirely deducted from QBI as non-qualifying income, and permitting a potential deduction for businesses that have zero W-2 income yet substantial unadjusted basis in property, i.e. in-service fixed assets.
Here’s how Section 199A works. If your taxable income is less than $315,000 MFJ or below $157,500 filing single, you receive a standard 20% Section 199A deduction from taxable income. Below the threshold level the Section 199A is a standard applicable 20% deduction for both service and non-service businesses, e.g. all entrepreneurs can supposedly participate in the tax benefits below that threshold.
Example: Bob and Brenda are married filing jointly. Brenda has QBI from a non-service business of $30,000. Their joint income is $375,000 for the tax year. Brenda receives a wage allocation of $40,000 from the business. The 50% of W-2 wages is $20,000. The $20,000 of wages are reduced from the $30,000 of QBI by the $60,000/$100,000 or 60% (excess of income from $315,000 threshold) equaling $12,000. So, the Section 199A is the $30,000 QBI subtracting the $6,000 threshold limit, equaling $2,400 of Section 199A tax benefits. Interesting math say?
End of Segment I — to be continued.