The Tax Cuts and Jobs Act (TCJA) created a new section of the tax code, Section 199A, which allows certain business owners to avoid tax on 20 percent of their business profits. There’s a lot of information to unpack around the new Section 199A deduction, including a number of eligibility criteria, so here are some fundamental considerations for business owners hoping to maximize this new tax reform benefit.
Is my business caught in the specified service provider definition?
Language in Section 199A explicitly prohibits service professionals from taking the 20 percent qualified business income deduction. This includes professionals in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.
Pass-through business owners should closely review the NAICS codes on their 2017 tax returns to make sure they are not misrepresenting the services provided.
There is still hope for professionals within these excluded fields. Section 199A makes an exception to the specified service trade or business based on taxable income. If a taxpayer’s taxable income from all sources (not adjusted gross income) for a given year is less than the below threshold amounts, plus $50,000 for single filers and $100,000 for joint returns, the taxpayer is eligible to take the Section 199A deduction.
- Taxable Income Threshold: $157,000 for individuals, $315,000 for married filing jointly
- Phase-Out Limit: $207,500 for individuals, $415,000 for married filing jointly
Your RKL advisor can help assess the impact of these thresholds and phase-outs on your personal financial circumstances.
Are wages from a business I own set at the optimal level?
In addition to the category of trade or business, another factor determining eligibility for the Section 199A deduction is wages. In the most basic terms, a business owner’s deduction under Section 199A is limited to the greater of 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of all qualified property used or held by the business.
In order to fully avail themselves of this deduction opportunity, business owners should make sure their wages are set at an appropriate level. The tax code defines W-2 wages as the sum of wages subject to withholding, elective deferrals and deferred compensation paid by the partnership, S corporation or sole proprietorship during a given tax year. Keep in mind this does not include independent contractor or management fees.
The same taxable income threshold and phase-outs applied to specified services also apply here, so companies with taxable income under the amounts below may ignore the limitations on W-2 wages.
- Taxable Income Threshold: $157,000 for individuals, $315,000 for married filing jointly
- Phase-Out Limit: $207,500 for individuals, $415,000 for married taxpayers
Consult your RKL advisor for assistance at setting compensation and wages at the optimal levels to maximize your eligibility for the Section 199A deduction.
How can I reduce my taxable income to qualify for Section 199A?
Here are a few things business owners could consider to satisfy the taxable income and wage optimization requirements of Section 199A:
- Hire independent contractors as employees.
- Make self-employed retirement plan contributions.
- Consider bunching itemized deductions.
Your RKL tax advisor can evaluate these and other methods to maximize Section 199A eligibility within the context of your unique circumstances.
Beyond the items mentioned above, there are a number of other uncertainties and ambiguous aspects of Section 199A that will be addressed in regulatory guidance from the U.S. Treasury. RKL will continue to monitor developments around this new deduction and continue to highlight ways pass-through business owners can mitigate disqualifying factors and maximize the benefit of this new deduction. Contact your RKL advisor or one of our local offices with any questions about this new tax code section.
Visit RKL’s Tax Reform Resource Center for more information and insights.
