Did you know your small business income may be eligible for up to a 20% deduction? Thanks to the Tax Cuts and Jobs Act, if you’re an owner of an eligible pass-through entity, a new tax break under Section 199A will allow you to save on qualified business income! This doesn’t apply to every small business, but this a huge deduction for anyone that qualifies. To see if your small business income allows you to take advantage, check out the rest of this article!
The Impact of the Tax Cuts and Jobs Act
In 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law. This act made significant changes for taxpayers, including tax rates and making deductions simpler to benefit from. The TCJA was signed in late December, which made most of the changes take effect the following year, 2018. Because of this, most of the actual changes from the TCJA are still being implemented.
One resulting impact from the TCJA is a new deduction for individual taxpayers. Under Section 199A, taxpayers engaged in pass-through entities are now eligible to deduct up to 20% of their qualified business income. Even making just $10,000 in qualified business income is worth using your deduction on. With a 10% tax rate, your 20% deduction shifts your tax bill from $1,000 to $800. The savings begin to drastically increase as your income and corresponding tax rate increase, but there’s definitely a limit to how much you can claim.
Who Will Qualify for a Deduction?
The important thing to note about Section 199A is that it only applies to qualified business income. This means that not all of your income is eligible for the Section 199A deduction, nor does it apply to the deduction limits. Income you earn from typical sources, like wages or salaries, are not qualified business income. Qualified business income strictly refers to income generated from pass-through entities. This includes sole proprietorships, S corporations, partnerships, and trusts/estates.
Once you know whether or not your income is qualified business income, you can determine just how much you can save. You’re primarily limited by how much money you generate from the entity, but the actual type of business it is will also influence your deduction. There’s also an important distinction for real estate activities and requirements for them to qualify as a trade or business. All three of these factors are crucial for determining how much (if any) of a deduction you will receive.
Arguably the most important thing limiting pass-through entity income is how much of it there is. If your total qualified business income (for a single filer) is less than $160,700, then you can claim a full 20% deduction on it, regardless of what type of business it is. If it exceeds $160,700, but is below $210,700, you will receive a reduced reduction.
At this point it is important to determine whether your business is a specified service trade and business or not. Specified service trades and businesses refer to industries where skilled service is provided, like athletics, financial advising, investment management, law, and other related fields. This distinction matters because if you exceed $210,700 in qualified business income, you won’t receive a deduction unless you are not involved in a specified service trade and business.
Qualified business income from specified service trades and businesses will get your deduction prorated based on how close you are to either $160,700 and $210,700. On the other hand, qualified business income from other pass-through entities can still receive a deduction.
Non-Specified Service Trades and Businesses
To determine how much of a deduction you can receive with a non-specified service trade and business, you’ll need to know how much you paid in W-2 wages and the price you paid for qualified property the business owns. You’ll want to find the larger figure between the following two calculations (regardless of whether your business owns qualified property or not):
- If the business doesn’t own any qualified property, then you’ll simply use 50% of W-2 wages.
- If the business does own property, you’ll use 25% of W-2 wages plus 2.5% of the price you paid for any qualified property the business owns.
Once you determine the larger value between the two calculations, you’ll compare it against what 20% of your qualified business income is. Whichever figure is smaller will be your Section 199A deduction if you are not involved in a specified service trade or business. This is important to know for tax planningbecause you can issue more W-2 income for a larger deduction.
What About Real Estate Activities?
The other important stipulation about this deduction is when real estate activities are concerned. It is unclear whether real estate activities are technically a trade or business, but the IRS made a simple workaround by creating a safe harbor rule. Exceptions from this rule include any rental properties you use as a residence and any property where a tenant is responsible for property taxes, utilities, and maintenance on top of rent.
As long as your real estate activities satisfy the following requirements, their resulting income will qualify for a Section 199A deduction:
- At least 250 hours of rental service work provided for the business.
- Individual books and service records made for each unique rental activity.
- Thorough documentation for maintenance, including what was done, when it happened, how long it took, and who did it.
Your Solution for Taking Advantage of Section 199A
The qualified business income deduction from Section 199A is quite significant, offering up to a 20% deduction at the maximum for pass-through entities. Depending on how much income you generate and whether or not the business is a specified service trade and business, your deduction can reduce or disappear entirely. With careful planning, you can actually receive a larger deduction by having a large W-2 wage figure to compare against 20% of your total qualified business income.
Financial planning and strategy is always difficult, but the experts at Evergreen CPAs understand it like nobody else. Evergreen CPAs specialize in strategies that save you money on taxes and mitigate any relevant risk. With years of experience working with clients of all income levels, Evergreen CPAs have the expertise to help you benefit most from the Section 199A deduction! Give us a call today to see how we can help you shape a prosperous future!