New 20% Deduction for Business
Certain businesses can take a deduction of up to 20% for qualified business income from a qualified trade or business operated directly or through a pass-through entity. There are two components to the deduction:
1) Sole proprietorships, partnerships, S corporations, trusts and estates may be entitled to a deduction of up to 20 percent of qualified business income (QBI). Married couples filing jointly with taxable income over $315,000 and single taxpayers with taxable income over $157,500 will have their deduction subjected to limitations. These limitations vary depending upon things such as: a) the type of trade or business; b) the taxpayer’s taxable income; c) the amount of employee wages paid by the qualified trade or business; and d) the non-adjusted basis immediately after acquisition of certain assets.. C corporation earnings are not eligible for the deduction.
2) Dividends of a qualified real estate investment trust (REIT) and income from a qualified publicly trade partnership (PTP)may also be eligible for a deduction of up to 20%. The deduction for such income is not limited by W-2 wages or the basis of certain property.
These two deduction classifications are referred to as the combined qualified business income amount. The deduction is the lesser of: 1) the combined qualified business income amount or; 2) 20 percent of the taxable income less the taxpayer’s net capital gain. Taxpayers will be able to claim it for the first time when they file their 2018 federal income tax return in 2019. The deduction is available, regardless of whether an individual itemizes their deductions on Schedule A or takes the standard deduction. Individuals, trusts and estates may qualify for the deduction. Shareholders of S corporations and partnerships will determine their deduction, since the entities themselves are not generally taxpayers.
Qualified business income (QBI) is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business that is part of a U.S. trade or business—certain types of income such as capital gains, some dividends and interest are excluded.
Not all business can take the 20% deduction—the following are specifically excluded:
Businesses that perform services in the fields of health, law, accounting, actuarial science, consulting, financial services, investing, trading, etc. or any business where the reputation or skill of one or more of its employee is its principal asset. These business are referred to as Specified Service Trade o Businesses. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers. Therefore, taxpayers in the above-mentioned service businesses may be eligible for the 20% deduction, if their taxable income is below $315,00 for a married couple filing jointly or $157,500 for other taxpayers. Also, excluded are those who perform services as an employee
The business deduction is the lesser of:
A) 20 percent of the taxpayer’s qualified business income, plus 20 percent of the taxpayer’s qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income;
B) 20 percent of the taxpayer’s taxable income minus net capital gains.
If the taxpayer’s taxable income is above the $315,000/$157,500 thresholds, the deduction may be limited based on whether: a) the business is in the above-referenced services businesses (e.g., health, law, accounting, etc.); b) the W-2 wages of the business; and, c) the non-adjusted basis of certain assets used by the business. These limitations are phased in for joint filers with taxable income between $315,000 and $415,000, and all other taxpayers with taxable income between $157,500 and $207,500. These threshold amounts are for tax-year 2018. The amounts will be adjusted future years to take inflation into account.
Bowman Law Firm, Huntsville Alabama
Tax Attorney, CPA