20% Deduction on Business Income
Section 199A, also known as the 20% pass-through deduction is effective for tax years beginning after December 31, 2017 and before January 1, 2026.
The 20% pass-through deduction grants an individual business owner along with some trusts and estates, a deduction equal to 20% of the taxpayer's qualified business income. Business owners with taxable income in excess of $213,300 or $426,600 in the case of taxpayers filing jointly, there is no deduction allowed against income earned in a "specified service trade or business."(see list of SSTBs businesses HERE) However, the deduction against income earned in an eligible business is limited to the greater of:
50% of W-2 wages with respect to the qualified trade or business or
The sum of 25% of the taxpayer's share of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of qualified property
When each separate deduction is calculated, they are added together and then subjected to another limitation, equal to 20% of the excess of:
The taxpayer's taxable income for the year (before allowing for the Section 199A deduction) above
The sum of net capital gains, including qualified dividend income taxed at capital gains rates, as well as any unrecaptured Section 1250 gain taxed at 25% and any collectibles gain taxed at 28%
Steps to Determine your 199a Deduction
Step 1: Is the business Section 162 trade or business (see definition below)
Step 2: For each Section 162 trade or business, calculate the qualified business income
Step 3: Stop- Is the business owner's taxable income for the year less than $163,300 or $326,600 for taxpayers married filing jointly, if so, all you do is take 20% of qualified business income and add 20% of qualified REIT dividends and publicly traded partnership income, apply the limit based on taxable income----You’re all done!
Step 4: If the taxable income is over $163,300 or $326,600 for taxpayers married filing jointly, you will need to identify if any of the businesses are a specified service trade or business (SSTB), which are not eligible for the deduction. See definition of SSTBs
Step 5: For businesses that are not SSTBs, you will now decide whether or not to aggregate any of the remaining businesses. If you aggregate the businesses, add the qualified business income, W-2 wages, and the unadjusted basis of qualified property immediately after acquisition (UBIA). If you own a pass-through entity that owns an interest in another pass-through and has aggregated at the entity level, you must use aggregation, but may be able to add one of your own businesses to the aggregation.
Step 6: If you do not aggregate, then you apply the netting rules for any qualified business income loss
Step 7: Once the businesses are netted or aggregated, calculate the deduction by limiting 20% of qualified business income to the greater of:
50% of W-2 wages paid by the business, or
25% of wages, plus 2.5% of the UBIA of qualified property
Step 8: Add 20% of qualified REIT dividends and publicly traded partnership income
Step 9: Apply the limit based on taxable income
Section 162 trade or business-- “the taxpayer must be involved in the activity with continuity and regularity. . . . A sporadic activity, a hobby, or an amusement diversion does not qualify.”
~Supreme Court (Groetzinger)