The tax reform law includes a new Section 199A which creates a deduction for Qualified Business Income (QBI). For tax years 2018 through 2025, an individual Taxpayer may deduct 20% of QBI from a partnership, S corporation, or sole proprietorship. QBI is the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the Taxpayer. QBI does not include any guaranteed payments or amounts paid by an S corporation as reasonable compensation. Moreover, it does not include specified investment-related income, deductions, or loss. The deduction is taken “below the line”, reducing taxable income but not AGI. It is therefore available regardless of whether Taxpayer itemizes deductions or utilizes the standard deduction.
Section 199A treats a specified service trade or business differently. A specified service trade or business means any trade or business involving the performance of services in the fields of:
Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and 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.
Law firms and accounting firms are clearly delineated as service businesses, and the news is not good for their owners. The deduction is not fully available to these owners unless taxable income is less than $157,500 Single and $315,000 MFJ. For taxable income for a service trade or business between $157,500 to $207,500 Single and $315,000 to $415,000 MFJ, the deduction phases out. Therefore, at $207,500 Single and $415,000 MFJ, all the net income from the service trade or business is excluded from QBI, and there is no deduction. The result is clear. Professional service firms with higher paid owners potentially will be unable to benefit from the §199A deduction.
The bad news for accountants reading this is that the ability to take the 20% deduction is completely phased out once income hits $207,500 Single/$415,000 MFJ. However, the bright side lies in the incredible complexity of §199A. There are numerous phase ins and phase outs. W-2 and depreciable property limitations apply. Confusion abounds as to income qualifying as QBI. As such, accountants will have plenty of billable hours of work advising their clients as to this new deduction for pass-through income.
Get fully up-to-speed on this complex aspect of the Tax Cuts and Jobs Act at the new live CPE webinar, Understanding Section 199A: The 20% Deduction for Pass-Through Entity Owners and Investors in Real Estate (DEPT), with many airings throughout January. This 4-credit course, led by Michael J. Tucker, Ph.D., LL.M., J.D., CPA, and Bob Lickwar, CPA, will provide numerous examples illustrating how this deduction works. To learn more about all of our upcoming webinars on tax reform, click here.
Nick Spoltore is Senior Director of Tax & Advisory Content for Surgent CPE. Mr. Spoltore is a graduate of the University of Notre Dame and of Delaware Law School. Before joining Surgent, he practiced tax and business law at the firm of Heaney, Kilcoyne in Pennsylvania and also in Delaware.
