What Are Some of the Basic Concepts Involved in Applying Section 199A – Qualified Business Income Deduction

By George Grzywacz, CPA, JD – Shareholder, Doeren Mayhew

With the enactment of Section 199A (applicable for tax years beginning after 2017 and before 2026), Congress has once again put taxpayer’s on a quest in search of a newly created deduction which they eventually may or may not be able to utilize. As with most congressional tax simplification strategies, this code section creates more complexity then simplicity, and will therefore be a source of consternation for taxpayers, and advisors alike, for years to come.

Who is Eligible to Claim the Deduction?

• Any individual taxpayer who carries on a qualifying U.S. trade or business in the form of a sole proprietorship, partnership or S corporation.
• Taxpayers whose trade or businesses are in the service industry (such as attorneys, accountants and doctors, etc.) are eligible until reaching the certain taxable income thresholds.
• Estates and trusts holding these types of business interest are also eligible to claim the deduction.

How Much of a Deduction Can Be Claimed?

A taxpayer who’s taxable income does not exceed certain thresholds may claim a deduction equal to 20 percent of qualified business income (comprised of certain items of income, gain, deduction or loss) generated by the qualifying business. However, once those taxable income thresholds are exceeded, then the calculation becomes much more complex, as it may be adjusted by wages paid, property owned or losses incurred.

The deduction may also be limited to 20 percent of the taxpayer’s taxable income with adjustments made for capital gains and qualified cooperative dividends, if this amount is less than the deduction calculated as described above.

The deduction calculation is made at the taxpayer (owner’s) level, which subjects the allocation of the components that make up qualified business income to the same allocation percentages as the partnership or S corporation allocates them at to the taxpayer.

What Are Some of the Ancillary Issues Surrounding the Application of Section 199A?

As with any new tax legislation, there is limited guidance as to how the Internal Revenue Service (IRS) will interpret and or apply this new law — leaving taxpayers and CPAs somewhat on their own as to its application.

Ancillary issues include, but are not limited to:

• Does the term “trade or business” include all types of rental real estate activities?
• The calculation will need to be done on a business-by-business basis, so related or integrated businesses cannot be combined, which may require some taxpayers to undertake multiple deduction calculations producing some unfavorable results depending on the wages paid or property owned by each business.
• By claiming the deduction, a taxpayer agrees to reduce the percentage for the substantial understatement of income tax penalty from a 10 percent to a 5 percent threshold, which may expose the taxpayer to the penalty even if the additional tax was caused by something other than by claiming the deduction.

The Section 199A deduction poses significant ambiguities and application uncertainties, which will require interpretive guidance from the IRS. However, Doeren Mayhew stands ready to help you better understand the deduction’s intricacies, calculation and impact on you and your business.  To gain perspective if your business is eligible under Section 199A and if you will be able to claim the deduction, contact our tax advisors for further analysis.

Want to reach the author? Email George Grzywacz or contact him at 248.244.3415.