This week we are going to dive even deeper into the new Section 199A deduction. If you missed last week’s article on who qualifies for the deduction, I would recommend reading it before you begin this one. This article will cover the complicated mechanics of calculating the Section 199A deduction that begins with the 2018 tax year. Again, the IRS will be providing additional guidance on certain sections of this new deduction, so the below is subject to change.
Types of Qualifying Income (QBI)
As discussed in last week’s article, qualifying income includes business income from Pass-Thru entities, such as partnership, S Corporations, and sole proprietorships. On top of this, qualified dividends from cooperatives, real estate investment trust (REITs), and certain income from publicly traded partnerships also may qualify. I will be focusing on business income in this article, so if you do have these other types of income on your taxes, I would be happy to discuss this with you in more detail directly.
Please note that qualifying income must come from U.S. sources and does not generally include investment income (capital gains/losses, dividends, and interest) and nor does it include guaranteed payments from a partnership.
How Much Can I Deduct?
First things first, please see last week’s article to see if your business(es) qualifies. The reason I say business(es) is because each business you own will qualify for the deduction in general. Once you determine the total QBI from your business(es), the deduction is calculated as 20% of this amount.
Limitations on the QBI Deduction
So, you thought the IRS would make the deduction calculation this easy for us? Of course not! As always, there are complicated limitations on the amount that is ultimately deductible each year.
The first limitation on the deduction is based upon the business’s W-2 wages. The deduction cannot exceed the greater of:
- 50% of the W-2 wages from the business or
- 25% of the wages from the business PLUS 2.5% of the unadjusted basis of depreciable assets of the business.
Unadjusted basis refers to the gross cost of depreciable assets before depreciation. Please note that if there are multiple owners/partners/shareholders of the business, each owner would take their allocable share of wages and unadjusted basis to determine the limitation on his or taxes.
The second limitation is based on taxable income. The deduction cannot exceed 20% of taxable income on your personal taxes that is in excess of net capital gains (capital gains plus qualified dividends).
Where Is the QBI Deducted?
The deduction is taken on your personal taxes. It will be reported after the calculation of Adjusted Gross Income (AGI) and before itemized deductions on page 1 of your Form 1040. It is also deductible against Alternative Minimum Tax (AMT) income as well.
A couple of negatives about the deductions it that it will not affect certain deductions and tax credits that get phased out due to certain levels of AGI. Additionally, it does not reduce your self-employment taxable income.
What If I Have a Business Loss?
If the net QBI is less than zero, it will get carried forward to the next year and included in that year’s calculation. For example, if you determine that your 2018 QBI is a loss of $25,000 but your 2019 QBI is $75,000, then your net 2019 QBI is $50,000. The net deduction on your taxes is 20% of $50,000, or $10,000.
Hopefully this article helped clarify some things on the way this new deduction will work on your taxes. Calculating your potential QBI for your quarterly taxes will be imperative this year so you do not over-pay on your estimates. Please start talking about this deduction with your tax advisor as soon as possible. If you have any questions for me, please feel free to contact me directly!