Understanding and Calculating the New 199A Deduction

Understanding and Calculating the New 199A Deduction

The 2017 Tax Cuts and Jobs Act created a new deduction for pass-through business owners. Called the 199A deduction, or the Qualified Business Income Deduction, it allows taxpayers other than corporations – specifically S corporations, partnerships, and limited liability companies (LLCs) – a deduction of 20 percent of qualified business income earned (also referred to as “flow-through” income), subject to certain limitations. It is a significant tax benefit to rival the new, lower tax rate for C corporations. However, understanding and taking advantage of the 199A deduction is proving to be a complex endeavor. This article is meant to be a broad overview of the breakdown and calculation of the 199A deduction.

First, qualified trades and businesses do not include trades and businesses involving the performance of service in the fields of health, law, accounting, consulting, financial services, and several other specific fields, or where the business’s principal asset is the reputation or skill of one or more owners or employees, such as athletics and performing arts. For these trades and businesses, the deduction is phased out based on the owner’s income. For joint filers, the deduction is phased out between the range of $315,000.00 and $415,000.00. For single filers, the deduction is phased out between $157,500.00 and $207,500.00.

In order to calculate the 199A deduction, QBI (qualified business income) first needs to be determined, which is the net amount of items of income, gain, deduction, and loss of each of the taxpayer’s qualified business. And the deduction depends on whether taxable income is below a lower taxable income threshold ($157,500.00 to $207,500.00 if filing a single return) or above a higher taxable income threshold ($315,000.00 to $415,000.00 if filing jointly).

For taxpayers below the lower income threshold

Calculating Sec. 199A is relatively straightforward. First, calculate the deductible QBI amount for each qualified business and combine the deductible QBI amounts to determine the combined QBI amount. (If the taxpayer has only one qualified business, the combined QBI amount is the deductible QBI amount for that business.) Next, apply the overall taxable income limitation to the combined QBI. So, the 199A deduction is equal to the lesser of:

  1. the combined QBI amount or
  2. the overall limitation (20 percent times the taxpayer’s taxable income in excess of any net capital gain.

For taxpayers above the higher income threshold

The deductible QBI amount is subject to a W-2 wage and capital limitation, determined by one of two following ways of calculating the deduction:

  • the deductible QBI amount for the business is equal to the lesser of 20 percent of the business’s QBI or
  • the greater of either (a) 50 percent of the W-2 wages for the business, or (b) the sum of 25 percent of the W-2 wages of the business plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property (in other words, prior to any depreciation).

For taxpayers with taxable income between the lower and higher thresholds

A partial wage and capital limitation apply: 20 percent of QBI, less an amount equal to a reduction ratio* multiplied by an excess amount**.

*Reduction ratio: calculated as the amount of taxable income in excess of the lower threshold amount of $315,000.00 if filing jointly ($157,500.00 for single filers) divided by $100,000.00 ($50,000.00 for single filers).

**Excess amount: the amount of the difference between the deductible QBI amount of the qualified business with no wage and capital limitation (20% of QBI) and the deductible QBI amount of the qualified business with a fully phased-in wage and capital limitation (W-2 wages).

Other Aspects of 199A to Consider

  • The deduction is allowed for only federal income tax purposes, not payroll taxes.
  • Without congressional action to extend the 199A deduction, it will expire in 2026.
  • The deduction cannot be taken in loss years (if QBI is less than zero).
  • 199A is a below-the-line deduction, which means it will not impact various adjusted-gross-income thresholds.
  • 199A is accessible to itemizers and non-itemizers
  • The taxable income thresholds are indexed for inflation