Section 199A Deductions: What every business owner should know
About 50 million U.S. business owners are eligible for new Internal Revenue Code section 199A tax deductions. If your business is not taking advantage of section 199A deductions, then you potentially are not maximizing your deductions and are paying more in federal taxes than you should.
Attorney John Cunningham specializes in assisting clients in maximizing their section 199A deductions and is a noted expert in this area. He is the author of Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A, a comprehensive explanation of section 199A.
Overview of section 199A
1. What are the effective date and expiration date of section 199A?
Section 199A became effective on January 1, 2018. By its terms, it will expire at the end of 2025, but there is a good chance that before then Congress will extend it indefinitely.
2. What are the types of section 199A deductions?
Section 199A provides deductions to owners of pass-through businesses, to investors in real estate investment trusts, and publicly traded partnerships, and to farmers, horticulturists, and farm and horticultural cooperatives. However, for most Americans, the most important section 199A deductions are pass-through deductions.
3. What are pass-through businesses?
Pass-through businesses consist of sole proprietorships, S corporations, and entities taxable as partnerships. Most single-member LLCs are taxable as sole proprietorships or S corporations. Most multi-member LLCs are taxable as partnerships.
4. Who may receive pass-through deductions?
Persons eligible for pass-through deductions include individuals who are active or passive owners of pass-through businesses who are U.S. or foreign individuals subject to federal income tax, trusts, and estates. Individuals who are employees are not eligible for pass-through deductions.
5. What are “qualified trades or businesses” and “specified service trades or businesses”?
The section 199A pass-through deduction available to business owners may depend on whether their businesses are specified service trades or businesses or qualified trades or businesses. Specified service trades or businesses are, in general, professional businesses such as the practice of law, and businesses involving investments and the provision of investment advice. Qualified trades or businesses are all other types of business except the business of serving as an employee.
6. What is the cap on pass-through deductions?
In general, the section 199A pass-through deduction available to eligible taxpayers is capped at 20 percent of their taxable income less the amount of any net capital gains they have realized in the relevant taxable year.
7. Which factors determine the amount of pass-through deductions?
Four key factors determine the amount of the pass-through deduction available to business owners:
- Their taxable income for the relevant year
- Their “threshold amount” (defined below)
- Their “phase-in range” (defined below)
- The federal tax structure of their business
8. What are threshold amounts and phase-in ranges of married individuals filing jointly?
For married individuals filing joint federal tax returns, the threshold amount is $315,000 and the phase-in range is between $315,000 and $415,000.
9. What are threshold amounts and phase-in ranges of all others?
For persons not filing joint returns, the threshold amount is $157,500 and the phase-in range is between $157,500 and $207,500.
10. What are the rules governing the computation of pass-through deductions?
The rules governing the computation of pass-through deductions are complex (and subject to the above cap) but briefly:
- Persons whose taxable income for the relevant taxable year do not exceed their threshold amount can receive pass-through deductions of 20 percent of their business income (“Section 199A(b)(2)(A)” deductions).
- The pass-through deductions available to persons who own qualified trades or businesses and whose taxable income is within their phase-in range in the relevant taxable year will be determined at least in part by the amount of the W-2 wages their businesses pay to their employees and the cost of the depreciable real and personal property owned and used by these businesses (“Section 199A(b)(2)(B)” deductions).
- The pass-through deductions of owners of qualified trades or businesses whose taxable income exceeds their phase-in range will be the lesser of their Section 199A(b)(2)(A) deductions and their Section 199A(b)(2)(B) deductions.
- The pass-through deductions of owners of specified service trades or businesses whose taxable income is within their phase-in range will generally be less than those of owners of qualified trades or businesses.
- The owners of specified service trades or businesses whose taxable income exceeds their phase-in range in the relevant taxable year will receive no pass-through deductions.
11. Why do many business owners need to do substantial restructuring to maximize their pass-through deductions?
Although about 50 million American business owners are eligible for pass-through deductions, in order to maximize their pass-through deductions, many millions of these business owners must substantially restructure their personal, financial, business or federal tax arrangements. For example, in order to maximize their pass-through deductions:
- Millions of shareholders of S corporations must convert their businesses to single-member LLCs taxable as sole proprietorships or to multi-member LLCs taxable as partnerships.
- Millions of owners of sole proprietorships or entities taxable as partnerships must convert them to S corporations.
12. What about restructuring C corporations?
Shareholders of entities taxable as C corporations can receive pass-through deductions if they convert the federal tax regimen of their company to a pass-through regimen, and most of them should make this conversion.
13. Which business owners should consult a section 199A expert?
All U.S. business owners with significant business income should consult with a section 199A expert to determine how, if at all, they should restructure their business arrangements in order to maximize their pass-through deductions.
Attorney John Cunningham provides free initial consultations about section 199A and LLCs.