What is the section 199a deduction?
One of the most significant changes from the Tax Cuts and Jobs Act of 2017 was the creation of an income tax deduction for nearly all businesses that operate in the United States. This deduction is available to most taxpayers, except C-Corporations, equaling 20% of the qualified business income (QBI) of a business or trade for the tax years 2018 to 2025.
All owners of pass-through entities and sole proprietors are eligible. However, income from a specified service trade or business is qualified for the deduction only if the taxpayer is below an applicable income threshold. For 2019, income from specified service trades or businesses (SSTB) will be subject to the phase-out amounts when taxpayers taxable income is above $160,700 filing single or $321,400 filing married. A specified service business is a business that involves the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing, and investment management or trading, dealing in securities, partnership interests or commodities, or any business whose principal asset is the reputation or skill of one or more of the owners or employees.
Does rental activity qualify for the QBI deduction?
A taxpayer who meets the safe harbor rules can treat income from a rental property as QBI. To be eligible for safe harbor, taxpayers must pass an hours of service test. They must have at least 250 hours of rental related services performed each year for the rental property. This may include but is not limited to advertising to rent the property, collecting rents, or managing daily operations. If the taxpayer doesn’t meet the safe harbor rules, the rental property may still qualify for QBI if it meets the definition of a trade or business. The safe harbor test includes aggregation rules, minimum hours of service rules, a definition of rental services, and contemporaneous records rules. To use the safe harbor, the taxpayer must attach a statement to the tax return that the requirements of Section 3.03 of Revenue Procedure 2019-7 have been met. The statement must be signed by the taxpayer or the pass-through entity’s authorized representative, under “penalties of perjury.”
How is it calculated?
The maximum deduction allowed is 20% of qualified business income. However, there is another test when taxable income exceeds the phase-out amounts indicated above. The qualified business income from an eligible business (that is not a specified service business) will be limited to the lesser of:
- 20% of the taxpayer’s qualified business income with respect to a qualified trade or business, and
- the greater of
- 50% of the W-2 wages with respect to the qualified trade or business, and
- the sum of 25% of the W-2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property
So what does this all mean?
The qualified business income deduction involves a number of complex rules. There is not one set of rules that fits all taxpayers. We highly encourage our clients to contact us to determine if they are eligible for the QBI deduction as this can represent thousands if not tens of thousands of dollars in potential tax savings.