TAX CUTS & JOB ACTS
The Tax Cuts and Jobs Act -- signed into law on December 22, 2017 — gave birth to a brand new provision: Section 199A, which permits owners of sole proprietorships, S corporations, or partnerships to deduct up to 20% of the income earned by the business. The motivation for the new deduction is clear: to allow these business owners to keep pace with the significant corporate tax cut offered by the Act.
Income earned by a C corporation is subject to double taxation; first at the entity level, and then a second time at the shareholder level when the corporation distributes its income as a dividend. As part of the Act, the entity-level tax imposed on C corporations was reduced from a top rate of 35% to a flat rate of 21%. While the Act retained the top rate on dividend income of 20%, the dramatic decrease in the corporate-level tax lowered the top combined federal rate on income earned by a C corporation from 48% to 36.8%.
Contrary to C corporations, income earned by a sole proprietorship, S corporation or partnership is subject to only a single level of tax. There is generally no tax at the entity level; instead, the owner of the business reports his or her share of the income of the business directly on his or her tax return, and pays the corresponding tax at ordinary rates. The Act reduced the top rate on ordinary income from 39.6% to 37%, and the enactment of Section 199A further reduced the effective top rate on income earned by owners of sole proprietorships, S corporations and partnerships to 29.6%.
Thus, after the passage of the Act, owners of sole proprietorships, S corporations and partnerships who qualify for the new deduction retained the same sizeable federal tax rate advantage over owners of a C corporation that they enjoyed prior to the enactment of the new law.
How Does it Work?
Effective for tax years beginning after December 31, 2017 and before January 1, 2026, a taxpayer other than a corporation is entitled to a deduction equal to 20% of the taxpayer’s “qualified business income” earned in a “qualified trade or business.” The deduction is limited, however, to the greater of:
Example: In 2018, A, a married taxpayer, has $100,000 of qualified business income, $100,000 of long-term capital gain, and $30,000 of deductions, resulting in taxable income of $170,000. A’s Section 199A deduction is limited to the lesser of $20,000 (20% of $100,000) or $14,000 (20% of $70,000, the excess of taxable income of $170,000 over net capital gain of $100,000).
Who Can Claim the Deduction?
The Section 199A deduction is available to any taxpayer “other than a corporation.” This includes:
What is a Qualified Trade or Business?
In General
A taxpayer must be engaged in a “qualified trade or business” in order to claim the Section 199A deduction.
Section 199A defines a qualified trade or business by exclusion; every trade or business is a qualified business other than:
Example. A is an employee, but not an owner, in a qualified business. A receives a salary of $100,000 in 2018. A is not permitted to a Section 199A deduction against the wage income, because A is not engaged in a qualified business.
Specified Service Business
This second category of disqualified businesses serves the same purpose as the first, to prevent the conversion of personal service income into qualified business income. This latter category, however, takes aim at business owners, rather than employees, prohibiting the owner of a “specified service business” from claiming a Section 199A deduction related to the business. .
Section 199A(d)(2) defines a specified service business in reference to Section 1202(e)(3)(A), which includes among the businesses ineligible for the benefits of that section:
…any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
Section 199A modifies this definition in two ways: first, by removing engineering and architecture from the list of prohibited specified services businesses, before then amended the final sentence to reference the reputation or skill of one or more of its “employees or owners” rather than merely its “employees.”
Section 199A(d)(2)(B) then adds to the list of specified service businesses any business which involves the performance of services that consist of investing and investing management, trading, or dealing in securities, partnership interests, or commodities.
https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs
Basic questions and answers on new 20-percent deduction for pass-through businessesBelow are answers to some basic questions about the new 20-percent deduction for pass-through businesses. Also known as the section 199A deduction or the deduction for qualified business income, the deduction was created by the 2017 Tax Cuts and Jobs Act.
Q1. What is the Qualified Business Income Deduction?
A1. Section 199A of the Internal Revenue Code provides many taxpayers a deduction for qualified business income from a qualified trade or business operated directly or through a pass-through entity. The deduction has two components.
Q2. Who may take the section 199A deduction?
A2. Individuals, trusts and estates with qualified business income, qualified REIT dividends or qualified PTP income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives may be required to reduce their deduction. The IRS will be issuing separate guidance for co-ops.
Q3. How do S corporations and partnerships handle the deduction?
A3. S corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends and qualified PTP income on Schedule K-1 so the shareholders or partners may determine their deduction.
Q4. What is qualified business income (QBI)?
A4. QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.
Q5. What is a qualified trade or business?
A5. A qualified trade or business is any trade or business, with two exceptions:
Q6. How is the deduction for qualified business income computed?
A6. The SSTB limitation discussed in Q&A 5 does not apply if a taxpayer’s taxable income is below $315,000 for a married couple filing a joint return and $157,500 for all other taxpayers; the deduction is the lesser of:
A) 20 percent of the taxpayer’s QBI, 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 the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property 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. The threshold amounts and phase-in range are for tax-year 2018 and will be adjusted for inflation in subsequent years.
Q7. I have income from a specified service trade or business. How does that affect my deduction?
A7. The SSTB limitation does not apply to any taxpayer whose taxable income is below the $315,000/$157,500 threshold amounts discussed in Q&A #6. For taxpayers whose taxable income is within the phase-in range discussed in Q&A #6, the taxpayer’s share of QBI, W-2 wages and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB. The threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years.
Q8. In 2018, I will report taxable income under $315,000 and file married filing jointly. Do I have to determine if I am in an SSTB in order to take the deduction? Is there any limitation on my deduction?
A8. No, if your 2018 taxable income is below $315,000, if married filing jointly, or $157,500 for all other filing statuses, it doesn’t matter what type of business you are in. You will be able to deduct the lesser of:
a) Twenty percent (20%) of your QBI, plus 20 percent of your qualified REIT dividends and qualified PTP income, or
b) Twenty percent (20%) of your taxable income minus your net capital gains.
Q9. In 2018, I will report taxable income between $157,500 and $207,500 and file as single. I receive QBI. Does it matter if it is from an SSTB?
A9. Yes, because your taxable income is above the threshold amount, your section 199A deduction with respect to any SSTB will be limited. However, because you are within the phase-in range, you may be allowed some section 199A deduction with respect to an SSTB. In addition, for taxpayers above the threshold amount, the section 199A deduction with respect to any trade or business, including an SSTB, may be limited by the amount of W-2 wages paid by the trade or business and the UBIA of qualified property held by the trade or business. The phase-in range is $315,000 to $415,000 for joint filers and $157,500 to $207,500 for all other filing statuses. Section 1.199A-1 of the proposed regulations provides additional information.
Q10. In 2018, I am single and will report taxable income over $207,500. My only income is from an SSTB. Am I entitled to the deduction with respect to the SSTB?
A10. No. The same is true for a married couple filing a joint return whose taxable income exceeds $415,000. However, you may be entitled to a deduction for QBI earned from another trade or business that is not an SSTB or from qualified REIT dividends or qualified PTP income.
Q11. In 2018, I am single and will report taxable income over $207,500. I am NOT in an SSTB. Am I entitled to the deduction?
A11. Yes, if you have QBI, qualified REIT dividends or qualified PTP income. For eligible taxpayers with total taxable income in 2018 over $207,500 ($415,000 for married filing joint returns), the deduction for QBI may be limited by the amount of W-2 wages paid by the qualified trade or business and the UBIA of qualified property held by the trade or business. The proposed rulesprovide additional information on these limitations. The IRS also issued a notice of proposed revenue procedure providing methods for determining W-2 wages for purposes of the limitation.
Q12. How do co-ops qualify for the 199A deduction?
A12. The IRS will be issuing separate guidance for co-ops.
Disclaimer
These FAQs are not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.
Income earned by a C corporation is subject to double taxation; first at the entity level, and then a second time at the shareholder level when the corporation distributes its income as a dividend. As part of the Act, the entity-level tax imposed on C corporations was reduced from a top rate of 35% to a flat rate of 21%. While the Act retained the top rate on dividend income of 20%, the dramatic decrease in the corporate-level tax lowered the top combined federal rate on income earned by a C corporation from 48% to 36.8%.
Contrary to C corporations, income earned by a sole proprietorship, S corporation or partnership is subject to only a single level of tax. There is generally no tax at the entity level; instead, the owner of the business reports his or her share of the income of the business directly on his or her tax return, and pays the corresponding tax at ordinary rates. The Act reduced the top rate on ordinary income from 39.6% to 37%, and the enactment of Section 199A further reduced the effective top rate on income earned by owners of sole proprietorships, S corporations and partnerships to 29.6%.
Thus, after the passage of the Act, owners of sole proprietorships, S corporations and partnerships who qualify for the new deduction retained the same sizeable federal tax rate advantage over owners of a C corporation that they enjoyed prior to the enactment of the new law.
How Does it Work?
Effective for tax years beginning after December 31, 2017 and before January 1, 2026, a taxpayer other than a corporation is entitled to a deduction equal to 20% of the taxpayer’s “qualified business income” earned in a “qualified trade or business.” The deduction is limited, however, to the greater of:
- 50% of the W-2 wages with respect to the qualified trade or business, or
- 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.
- The taxable income for the year, over
- The sum of net capital gain (as defined in Section 1(h)).
Example: In 2018, A, a married taxpayer, has $100,000 of qualified business income, $100,000 of long-term capital gain, and $30,000 of deductions, resulting in taxable income of $170,000. A’s Section 199A deduction is limited to the lesser of $20,000 (20% of $100,000) or $14,000 (20% of $70,000, the excess of taxable income of $170,000 over net capital gain of $100,000).
Who Can Claim the Deduction?
The Section 199A deduction is available to any taxpayer “other than a corporation.” This includes:
- Individual owners of sole proprietorships, rental properties, S corporations, or partnerships, and
- An S corporation, partnership, or trust that owns an interest in a pass-through entity.
What is a Qualified Trade or Business?
In General
A taxpayer must be engaged in a “qualified trade or business” in order to claim the Section 199A deduction.
Section 199A defines a qualified trade or business by exclusion; every trade or business is a qualified business other than:
- The trade or business of performing services as an employee, and
- A specified service trade or business.
Example. A is an employee, but not an owner, in a qualified business. A receives a salary of $100,000 in 2018. A is not permitted to a Section 199A deduction against the wage income, because A is not engaged in a qualified business.
Specified Service Business
This second category of disqualified businesses serves the same purpose as the first, to prevent the conversion of personal service income into qualified business income. This latter category, however, takes aim at business owners, rather than employees, prohibiting the owner of a “specified service business” from claiming a Section 199A deduction related to the business. .
Section 199A(d)(2) defines a specified service business in reference to Section 1202(e)(3)(A), which includes among the businesses ineligible for the benefits of that section:
…any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
Section 199A modifies this definition in two ways: first, by removing engineering and architecture from the list of prohibited specified services businesses, before then amended the final sentence to reference the reputation or skill of one or more of its “employees or owners” rather than merely its “employees.”
Section 199A(d)(2)(B) then adds to the list of specified service businesses any business which involves the performance of services that consist of investing and investing management, trading, or dealing in securities, partnership interests, or commodities.
https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs
Basic questions and answers on new 20-percent deduction for pass-through businessesBelow are answers to some basic questions about the new 20-percent deduction for pass-through businesses. Also known as the section 199A deduction or the deduction for qualified business income, the deduction was created by the 2017 Tax Cuts and Jobs Act.
Q1. What is the Qualified Business Income Deduction?
A1. Section 199A of the Internal Revenue Code provides many taxpayers a deduction for qualified business income from a qualified trade or business operated directly or through a pass-through entity. The deduction has two components.
- Eligible taxpayers may be entitled to a deduction of up to 20 percent of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction is subject to limitations such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business. Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.
- Eligible taxpayers may also be entitled to a deduction of up to 20 percent of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This component of the section 199A deduction is not limited by W-2 wages or the UBIA of qualified property.
Q2. Who may take the section 199A deduction?
A2. Individuals, trusts and estates with qualified business income, qualified REIT dividends or qualified PTP income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives may be required to reduce their deduction. The IRS will be issuing separate guidance for co-ops.
Q3. How do S corporations and partnerships handle the deduction?
A3. S corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends and qualified PTP income on Schedule K-1 so the shareholders or partners may determine their deduction.
Q4. What is qualified business income (QBI)?
A4. QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.
Q5. What is a qualified trade or business?
A5. A qualified trade or business is any trade or business, with two exceptions:
- Specified service trade or business (SSTB), which includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. 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
- Performing services as an employee
Q6. How is the deduction for qualified business income computed?
A6. The SSTB limitation discussed in Q&A 5 does not apply if a taxpayer’s taxable income is below $315,000 for a married couple filing a joint return and $157,500 for all other taxpayers; the deduction is the lesser of:
A) 20 percent of the taxpayer’s QBI, 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 the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property 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. The threshold amounts and phase-in range are for tax-year 2018 and will be adjusted for inflation in subsequent years.
Q7. I have income from a specified service trade or business. How does that affect my deduction?
A7. The SSTB limitation does not apply to any taxpayer whose taxable income is below the $315,000/$157,500 threshold amounts discussed in Q&A #6. For taxpayers whose taxable income is within the phase-in range discussed in Q&A #6, the taxpayer’s share of QBI, W-2 wages and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB. The threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years.
Q8. In 2018, I will report taxable income under $315,000 and file married filing jointly. Do I have to determine if I am in an SSTB in order to take the deduction? Is there any limitation on my deduction?
A8. No, if your 2018 taxable income is below $315,000, if married filing jointly, or $157,500 for all other filing statuses, it doesn’t matter what type of business you are in. You will be able to deduct the lesser of:
a) Twenty percent (20%) of your QBI, plus 20 percent of your qualified REIT dividends and qualified PTP income, or
b) Twenty percent (20%) of your taxable income minus your net capital gains.
Q9. In 2018, I will report taxable income between $157,500 and $207,500 and file as single. I receive QBI. Does it matter if it is from an SSTB?
A9. Yes, because your taxable income is above the threshold amount, your section 199A deduction with respect to any SSTB will be limited. However, because you are within the phase-in range, you may be allowed some section 199A deduction with respect to an SSTB. In addition, for taxpayers above the threshold amount, the section 199A deduction with respect to any trade or business, including an SSTB, may be limited by the amount of W-2 wages paid by the trade or business and the UBIA of qualified property held by the trade or business. The phase-in range is $315,000 to $415,000 for joint filers and $157,500 to $207,500 for all other filing statuses. Section 1.199A-1 of the proposed regulations provides additional information.
Q10. In 2018, I am single and will report taxable income over $207,500. My only income is from an SSTB. Am I entitled to the deduction with respect to the SSTB?
A10. No. The same is true for a married couple filing a joint return whose taxable income exceeds $415,000. However, you may be entitled to a deduction for QBI earned from another trade or business that is not an SSTB or from qualified REIT dividends or qualified PTP income.
Q11. In 2018, I am single and will report taxable income over $207,500. I am NOT in an SSTB. Am I entitled to the deduction?
A11. Yes, if you have QBI, qualified REIT dividends or qualified PTP income. For eligible taxpayers with total taxable income in 2018 over $207,500 ($415,000 for married filing joint returns), the deduction for QBI may be limited by the amount of W-2 wages paid by the qualified trade or business and the UBIA of qualified property held by the trade or business. The proposed rulesprovide additional information on these limitations. The IRS also issued a notice of proposed revenue procedure providing methods for determining W-2 wages for purposes of the limitation.
Q12. How do co-ops qualify for the 199A deduction?
A12. The IRS will be issuing separate guidance for co-ops.
Disclaimer
These FAQs are not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.
2018 Income Tax Brackets
The tax reform bill keeps the same seven tax bracket structure, but most taxpayers will see lower tax rates.
The income thresholds were adjusted |
Individual |
Married Filing Separate |
Head of Household |
Married Filing Joint |
10% |
$0 - $9,525 |
$0 - $9,525 |
$0 - $13,600 |
$0 - $19,050 |
12% |
$9,526 - $38,700 |
$9,526 - $38,700 |
$13,601 - $51,800 |
$19,051 - $77,400 |
22% |
$38,701 - $82,500 |
$38,701 - $82,500 |
$51,801 - $82,500 |
$77,401 - $165,000 |
24% |
$82,501 - $157,500 |
$82,501 - $157,500 |
$82,501 - $157,500 |
$165,001 - $315,000 |
32% |
$157,501 - $200,000 |
$157,501 - $200,000 |
$157,501 - $200,000 |
$315,001 - $400,000 |
35% |
$200,001 - $500,000 |
$200,001 - $300,000 |
$200,001 - $500,000 |
$400,001 - $600,000 |
37% |
over $500,000 |
over $300,000 |
over $500,000 |
over $600,000 |