Who Qualifies for the Section 199A Deduction?
Recently, the IRS released Reg § 1.199A-1-6, the final regulations on the much-publicized Section 199A deduction.
Let’s back up for a moment: The Section 199A deduction is afforded to a pass-through company, which is a sole proprietorship, partnership, S-Corporation or certain trusts and estates.
In the final overview, the IRS states:
In general. This section provides operational rules for calculating the section 199A(a) qualified business income deduction (section 199A deduction) under section 199A of the Internal Revenue Code (Code). This section refers to the rules in §§1.199A-2 through 1.199A-6. This paragraph (a) provides an overview of this section. Paragraph (b) of this section provides definitions that apply for purposes of section 199A and §§1.199A-1 through 1.199A-6. Paragraph (c) of this section provides computational rules and examples for individuals whose taxable income does not exceed the threshold amount. Paragraph (d) of this section provides computational rules and examples for individuals whose taxable income exceeds the threshold amount. Paragraph (e) of this section provides special rules for purposes of section 199A and §§1.199A-1 through 1.199A-6. This section and §§1.199A-2 through 1.199A-6 do not apply for purposes of calculating the deduction in section 199A(g) for specified agricultural and horticultural cooperatives.
These regulations go into effect for taxable years ending after February 8, 2019. However, the final one can also be relied on for the calculation of the Section 199A deduction, in its entirety, for tax year 2018.
Conceivably, we all should know that the Section 199A deduction is limited to the qualified business income (QBI) of certain companies. For example, physicians, attorneys, accountants and the like are excluded from being able to take it. Further, it leaves out those whose adjusted gross income (AGI) is above a certain amount.
Now, we need to define what QBI is. According to the final regulations:
Qualified business income (QBI) means the net amount of qualified items of income, gain, deduction, and loss with respect to any trade or business (or aggregated trade or business) as determined under the rules of §1.199A-3(b).
1.199A-1(b)(6)(6) QBI component means the amount determined under paragraph (d)(2) of this section.
The deduction is determined for individuals with taxable income for the year that does not exceed the threshold amount by adding 20 percent of the total QBI amount (including the individual's share of QBI from a relevant pass-through entity ((RPE)) and QBI attributable to an specialized service trade or business ((SSTB))) and 20 percent of the combined amount of qualified real estate investment trust (REIT) dividends and qualified public ally traded partnership (PTP) income (including the individual's share of qualified REIT dividends and qualified PTP income from RPEs and qualified PTP income attributable to an SSTB).
That sum is then compared to 20 percent of the amount by which the individual's taxable income exceeds the net capital gain. The lesser of these two amounts is the deduction.
The regulations state that the QBI component is comprised by:
… QBI component is the sum of the amounts determined under this paragraph (d)(2)(iv)(A) for each trade or business (or aggregated trade or business). For each trade or business (or aggregated trade or business) (including trades or businesses operated through RPEs) the individual must determine the lesser of—
1.199A-1(d)(2)(iv)(A)(1)(1) 20 percent of the QBI for that trade or business (or aggregated trade or business); or
1.199A-1(d)(2)(iv)(A)(2)(2) The greater of—
1.199A-1(d)(2)(iv)(A)(2)(i)(i) 50 percent of W-2 wages with respect to that trade or business (or aggregated trade or business); or
1.199A-1(d)(2)(iv)(A)(2)(ii)(ii) The sum of 25 percent of W-2 wages with respect to that trade or business (or aggregated trade or business) plus 2.5 percent of the UBIA of qualified property with respect to that trade or business (or aggregated trade or business).
Basically, Section 199A provides a deduction of up to 20 percent of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. It may be taken by individuals and some estates and trusts.
However, a Section 199A deduction is not available for wage income or for business income earned through a C corporation (as defined in Section 1361(a)(2)). For taxpayers whose taxable income exceeds a statutorily defined amount (threshold amount), Section 199A may limit the deduction based on (i) the type of trade or business engaged in by the taxpayer, (ii) the amount of W-2 wages paid with respect to the trade or business (W-2 wages) and/or (iii) the UBIA of qualified property held for use in the trade or business (UBIA of qualified property). These statutory limitations are subject to phase-in rules based on taxable income above the threshold amount.
Section 199A also allows individuals and some trusts and estates (but not corporations) a deduction of up to 20 percent of their combined qualified REIT dividends and qualified PTP income, including qualified REIT dividends and qualified PTP income earned through pass-through entities. This component is not limited by W-2 wages or UBIA of qualified property.
The Section 199A deduction is the lesser of (1) the sum of the combined amounts described in the prior two paragraphs or (2) an amount equal to 20 percent of the excess (if any) of taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for the taxable year.
Additionally, Section 199A(g), as amended by the 2018 Act effective as of January 1, 2018, provides that specified agricultural or horticultural cooperatives may claim a special entity-level deduction that is substantially similar to the domestic production activities deduction under former Section 199. The Treasury Department and the IRS intend to issue a future notice describing proposed rules for applying Section 199A to specified agricultural and horticultural cooperatives and their patrons.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...