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Section 199A Deduction
What Pass-Through Business Owners Need to Know Before Tax Time
The tax law updates outlined in the Tax Cuts and Jobs Act (TCJA) of 2017 will come into play this year, changing the way many businesses file their 2018 returns. One of the major adjustments the TCJA brought into effect is the "pass-through" tax Section 199A deduction, which provides a substantial tax break to most businesses.
What Types of Entities and Income Are Eligible?
Section 199A allows qualifying businesses to deduct up to 20 percent of their net qualified business income (QBI), provided it was earned through a "pass-through entity." In a pass-through entity, the business's earnings are reported on an individual's tax returns, as opposed to on a corporate tax return. Examples of pass-through entities include S corporations, partnerships and limited liability companies that will be taxed as partnerships, as well as individuals and sole proprietors.
The IRS defines qualified business income for the purposes of the deduction as income, gains and deductions from a U.S. business or trade. You may not include interest earned, capital gains and some dividends in the qualified business income amount.
Income that passes through a real estate investment trust (REIT) may be eligible. In addition, certain REIT dividends passed through to taxpayers who own shares in a mutual fund may be eligible for the pass-through deduction.
Do You Qualify for the Deduction?
Not all types of trades or businesses qualify for the full Section 199A deduction through the Tax Cuts and Jobs Act. The IRS stipulated that patrons of agricultural and horticultural cooperatives may not be eligible for the full 20 percent, as they'll be subject to other guidelines. Employees may not claim the deduction at all. Business owners in the fields noted below are ineligible for the pass-through deduction if they earn above $415,000 for filers who are married filing jointly and $207,500 for those filing separately or individually.
These fields include:
- Actuarial science.
- Performing arts.
- Investing and investment management.
- Financial services.
The law also excludes businesses in which "the principal asset is the reputation or skill of one or more of its employees."
Taxpayers with qualifying income from businesses other than those listed above will still have to contend with the income limitations. Those with earnings above the thresholds will be eligible to deduct the lesser of three amounts: the 20 percent deduction, or the greater of half the company's W-2 wages or 25 percent of the W-2 wages plus "2.5 percent of the unadjusted basis immediately after acquisition of all qualified property." The unadjusted basis is a complex calculation that generally refers to the cost of tangible property before it's fully depreciated. These provisions have the effect of boosting the pass-through deduction for labor-intensive businesses and businesses that are investment-heavy, like real estate.
Section 199A offers a second deduction, this one up to 20 percent of qualified REIT dividends and income earned from a publicly traded partnership (PTP). If you qualify for both the QBI and REIT/PTP deductions, you would add those together to determine the full amount you may claim on your return.
How a Wealth Advisor Can Help
The 199A deduction is notoriously complex, and reviewing a more in-depth perspective on it could be worth your while. Also, you may want to consult a wealth management advisor to help you make sense of it. Whether you are eligible for the deduction — and how much you can claim — depends on the type of business you run, as well as your 2018 income amounts and sources. Not all forms of real estate income will be deductible, so you'll need to carefully parse any amount you've taken in from your property investments as well.
A tax professional can validate specific tax exemptions or deductions and help you understand what you can claim and how that number will impact your return. Working with a professional will help you maximize your return amount and strategize how you can use it to benefit your business in the coming year.
A Boston Private representative can help with any questions you have when it comes to managing your businesses financial planning.
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