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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. 

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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 $232,100 or $464,200 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:

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  • 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

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When each separate deduction is calculated, they are added together and then subjected to another limitation, equal to 20% of the excess of: 

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  • 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%

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Steps to Determine your 199a Deduction  

Step 1: Is the business Section 162 trade or business (see definition below)

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Step 2: For each Section 162 trade or business, calculate the qualified business income

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Step 3: Stop- Is the business owner's taxable income for the year less than $182,100 or $364,200 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!

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Step 4: If the taxable income is over $182,100 or $364,200 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

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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.

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Step 6: If you do not aggregate, then you apply the netting rules for any qualified business income loss

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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

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Step 8: Add 20% of qualified REIT dividends and publicly traded partnership income

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Step 9: Apply the limit based on taxable income

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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)

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