Internal Revenue Code Section 199A, introduced by the Tax Cuts and Jobs Act of 2017, has arguably given rise to more speculation and discussion than any other provision of the act.
Section 199A introduces a set of complex rules and formulae that determine when a taxpayer qualifies to deduct up to 20% of certain income from “pass-through” trades or businesses. The Treasury issued much-anticipated final regulations governing Section 199A in January of 2019.
The General Rule
Section 199A generally provides individuals, trusts and estates with a deduction equal to the lesser of
- 20% of the taxpayer’s “Combined Qualified Business Income,” or
- an amount equal to 20% of any excess of a taxpayer’s taxable income over the taxpayer’s net capital gain.
The phrase “Combined QBI” is generally defined as the aggregate of the taxpayer’s “deductible amount” – described below – with respect to each “qualified trade or business” of the taxpayer.
Qualified Business Income
QBI is statutorily defined to include the net amount of “qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.” This amount includes all such items – income, gain, deduction, and loss – to the extent they are “effectively connected” with the conduct of a trade or business within the United States and included or allowed in determining taxable income for the year.
It specifically excludes, however, qualified investment income, including dividends, capital gain or loss, investment interest, commodities gains or losses, foreign currency gains or losses and certain annuity amounts; REIT dividends, qualified cooperative dividends and qualified publicly traded partnership income; reasonable compensation paid to the taxpayer for services for the trade or business; Section 707(c) guaranteed payments paid to the taxpayer for services performed for the trade or business; and Section 707(a) payments to the taxpayer for serviced performed for the trade or business.
The Deductible Amount
The “deductible amount” for each “qualified trade or business” is generally equal to the QBI with respect to the qualified trade or business, although such amount cannot exceed the greater of
- 50% of W-2 wages with respect to the qualified trade or business, also called the “W-2 Wage Limitation,” 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, also called the “Alternative Limitation.”
In other words, the deductible amount for each trade or business cannot exceed the greater of these two limitations.
Qualified Service Trade or Business
Generally, the phrase “qualified trade or business” does not include a “specified service trade or business” or the trade or business of performing services as an employee. While income from a SSTB is therefore generally not eligible for the section 199A deduction, there is an important exception for taxpayers with taxable income below certain threshold amounts. Detailed discussion of that exception is beyond the scope of this article. However, as a general rule, income from a SSTB is not eligible for the 20% deduction under Section 199A.
An SSTB is any trade or business that involves the performance of services in the fields of health, law, 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. An SSTB also includes any trade or business that involves the performance of services that consist of investing and investment management, trading or dealing in securities (as defined in Section 475(c)(2)), partnership interests, or commodities (as defined in Section 475(e)(2)).
Jason Freeman is a dual-credentialed attorney-CPA, law professor and trial attorney. He is the founder and managing member of Freeman Law in Dallas.