The political process can be hard to follow. Different proposals flow back and forth as possible legislation slowly takes shape. But even as the picture gains clarity, it’s hard to predict for certain what will happen. Bills constantly change through negotiation with different groups, and it’s not guaranteed that the final bill will pass.
As a small business owner, the most you can do is stay alert and informed and prepare yourself for the possible changes coming down the line. One specific legislative debate you should be aware of at this point is a possible change to the 199A pass-through tax deduction. If you’re educated on the issues, you also have an opportunity to take a position and speak up.
What Is the 199A Pass-Through Deduction?
The 199A pass-through deduction is a significant tax deduction that came out of the 2017 Tax Cut and Jobs Act. A major piece of the TCJA was an overall reduction in corporate tax rates. 199A was an attempt to offer similar tax relief to small businesses.
Most of which are pass-through entities, which means that income is not taxed at the level of the business or corporation but is passed through to be taxed at the individual taxpayer level. This includes sole proprietorships, partnerships, S-corporations, and LLCs.
This measure offers a deduction of up to 20% of qualified business income for pass-through businesses out of their taxable income.
Does 199A Reduce Taxable Income?
Tax credits pay part of the tax you owe, whereas tax deductions reduce your overall taxable income. The 199A deduction is a significant small business tax deduction that may reduce your total taxable income by up to 20% of your business income.
The deduction lowers your income before taxes are applied, which decreases the corresponding taxes you will owe.
How Do You Calculate the 199A Deduction?
There are a couple of steps to calculating the pass-through deduction, along with several other stipulations and limits, especially for businesses and individuals with incomes beyond certain thresholds.
1. Calculate Your Qualified Business Income
Before you can count the deduction, you must add up the relevant income. Qualified business income for this deduction includes the net total of all your company’s income, gains, losses, and deductions over the given tax period.
However, you should subtract from your QBI any earnings that come from investments or other unqualified income from commodity or currency trading.
If you have multiple businesses, you should keep the income totals separate and calculate the deduction for each.
2. Determine If Your Taxable Income Crosses Thresholds
Individuals at higher income levels and in certain professions are limited in their use of the pass-through deduction. Where you fall in these requirements depends not on your QBI but on your total taxable income from all sources. Find out what category you fall under:
- Income below $164,900 (single) or $329,800 (married filing jointly)
- Non-SSTB with income below $214,900 (single) or $429,800 (married filing jointly)
- Non-SSTB with income greater than $214,900 (single) or $429,800 (married filing jointly
- SSTB with income below $214,900 (single) or $429,800 (married filing jointly)
- SSTB with income greater than $214,900 (single) or $429,800 (married filing jointly
An SSTB under the provisions of the Tax Cuts and Jobs Act is a specified service trade or business, which primarily describes professions where you offer a service and your primary asset is your own reputation or skill. This includes professionals in the fields of investing, accounting, health, law, and more.
3. Calculate Your Total Deduction
If your total taxable income is low enough (A), then you qualify to deduct a full 20% of your business income from your taxable income.
For businesses with higher income, it will depend if you fall under the SSTB category or not. For non-SSTBs, there is a limitation of the total deduction where your deduction is capped at a percentage of your share of W-2 wages disbursed by your business. This cap is phased in gradually (B) until your total income is $50,000 (single) or $100,000 (married filing jointly) over the initial cap (C).
For SSTBs, the deduction is phased out with a similar limitation for incomes just above the initial cap (D) and eliminated entirely for higher-income ranges (E).
What Possible Changes Could Be Made to the 199A Deduction?
It remains to be seen what exactly will happen to the 199A pass-through deduction and how it might change. Currently, the deduction is already a temporary measure set to expire at the end of 2025.
One proposal would further limit the deduction at higher income levels and entirely phase out the deduction for business owners with a total taxable income above $400,000 (single) or $500,000 (married filing jointly), which would effectively add an additional cap for non-SSTBs in group C listed above.
On the other hand, possible changes include easing limitations on SSTBs. Some legislators have proposed expanding eligibility for those service businesses so that the deduction is not so quickly eliminated for them at higher income levels.
Wondering How These Changes Could Affect Your Business? Contact an Accountant Today
Existing tax policies and regulations are already obscure and complex at the best of times. Adding in speculation about new policy proposals and debated changes is a whole new layer of difficulty. If you’re uncertain about claiming this deduction or you’re worried about what proposed changes might mean for you, consult with an accountant and get guidance from a professional.
The professionals at 1-800-Accountant are ready to work alongside you and your company, guide you through the challenge of your small business taxes, and help you to prepare for whatever might be coming in the future.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.