The Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017, gave some taxpayers a generous new provision: Section 199A, which permits owners of sole proprietorships, S corporations, or partnerships to deduct up to 20% of the income earned by their businesses. Last week, the IRS issued the long awaited regulations that while providing some clarity to the deduction, left many questions still unanswered. Here we do our best to offer some clarification of our own.
What is the 199A deduction?
Effective for tax years beginning after December 31, 2017 and before January 1, 2026, Section 199A states that a taxpayer other than a corporation is entitled to a deduction equal to 20%. However, the deduction is limited for taxpayers with taxable income in excess of a threshold to the greater of:
- 50 percent of the W-2 wages with respect to the qualified trade or business; or
- the sum of 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property.
The resulting deduction is then subject to a second limitation equal to 20% of the excess of the taxable income for the year over the sum of the taxpayer’s net capital gain for the year.
What do the new proposed regulations address?
The 199A regulations provide that all small business income below $315,000 for married couples filing jointly (and $157,000 for single filers) is eligible for the 20% deduction.
The new regulations also help provide clarity and flexibility for taxpayers with income beyond the above thresholds by:
- including “aggregation rules” for filers with pass-through income from multiple sources;
- issuing guidance relating to specified service, trade or business income above the thresholds, which may be subject to limitation for the purposes of claiming the deduction; and
- allowing a de minimis exception to avoid unnecessary compliance costs for businesses earning only a small percentage of SSTB income.
In addition, the regulations establish anti-abuse safeguards to prevent improper tax avoidance schemes, such as relabeling employees as independent contractors.
Qualified business income includes domestic income from a trade or business. Employee income, capital gains, interest, and dividend income are excluded from this deduction.
- Text of the proposed regulations (184 pages)
- Link to Notice 2018-64
- See the latest FAQs issued last week by the IRS related to the deduction.
We are planning on providing additional guidance on this important tax issue in the near future. In the meantime, if you have any questions, please do not hesitate to contact a member of our tax team.