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  • The Tax Cuts and Jobs Act of 2017 has been a hot button topic for over a year now, and many people still do not understand what the benefit of it was. Most taxpayers have seen their paychecks get bigger due to favorable withholding rates for the middle class. However, one area most taxpayers do not truly understand is a new business deduction worth up to 20% of your business income, or also known as Section 199A or the Qualified Business Income deduction to tax professionals.

    The technical term for this deduction is a below-the-line deduction to the adjusted gross income, or AGI, which means it is calculated on page two of the old tax form after the income is calculated on page one. It is a direct deduction to your taxable income, and while there is a cap for higher income earners, most small business owners, especially those have a full-time W2 job, will see a nice reduction of their business income. In fact, the deduction is worth 20% of qualified business income, which is most income and will greatly help small business pay less in taxes.

    How Do You Qualify for the Section 199A Deduction?

    First of all, your business has to be structured a certain way. Again, this is meant to be a deduction to directly help small businesses, so C corps are disallowed. The following business types do qualify:

    • Schedule C filers, or sole proprietorships
    • LLCs (single or multiple member)
    • S corporations
    • Schedule E real estate investors
    • Estates and trust, co-ops and REITs

    Most businesses, especially those with revenues or incomes of under $100K, will fall into this category and thus be allowed to take this deduction. There is not a cap on this deduction, but there are a lot of different rules that could make you subject to a cap. Certain professions and income types will limit the amount of your deduction. The IRS has defined the professions as a Specified Service Trade or Business as the following:

    • Professional service providers such as accountants, lawyers, actuaries, consultants, and doctors
    • Professional athletes
    • Performing artists
    • Financial service industry professionals
    • Any trade or business where the principal asset is the reputation or skill of the owner

    Income Limitations on Section 199A Deduction

    To see if you qualify for the deduction, you need to add up all the income on your tax return. This means all income from every source, not just your business. If you have a spouse that works a W2 job, that income is included. If you also work a W2 job, that is also included too. Any income source needs to be included.

    The tax bracket limitations are similar to other credits, as those filing Single start to phase out the deduction at $157,500 and it is completely phased out at $207,500. This income level is also the level where the tax rate goes from 24% to 32%. To me, this is in line with what the tax break really means. It is meant for the middle class and by phasing it out at this level, that shows that this is for them. For those Married Filing Jointly, the income phase-out starts at $315,000 and is phased out at $415,000.

    What This Means

    The main takeaway here is that you need to know whether or not you qualify for these deductions. This is why tax planning is so crucial with a tax professional. One huge advantage that I can see here is taking advantage of the corporate structures. For example, only S corps can actually issue a W2 to the owner, so if an S corp makes too much and would be over the income limit, an S Corp owner could keep the profits in the S Corp and pay themselves less than the deduction phase-out. A sole proprietor has to pay tax on all their income, whether they withdraw it from the business or not. Knowing the tax breaks and how to maximize your savings is something a tax professional can do for you. Contact us today if you would like to know more and to see if your business qualifies.