Apr 15, 2021Claiming the 199A Deduction: Am I Eligible?
Did you know that you can save 20% of your qualifying business income on your taxes? No, this isn’t clickbait. It’s the Section 199A deduction, and it can result in large tax savings for small businesses. The deduction was born in 2017 as part of the Tax Cuts and Job Act, so it’s one of the more recent deductions worth paying attention to if you’re interested in saving money on your taxes in 2021. This article will explain the deduction, who qualifies, and how it applies to you.
Deduction equals about 20%
Section 199A is a qualified business income (QBI) deduction that allows qualifying businesses to deduct 20% of their QBI along with 20% of their partnership, real estate investment trust, and publicly traded partnership income. This deduction is fairly significant, allowing a company the opportunity to drastically reduce its taxable income.
The actual deduction equals about 20% of QBI, but additional adjustments may need to be made if you also factor in PTP and REIT dividends. Even after those calculations though, the total will generally come out to 20% or slightly below. It just depends on the breakdown of your income type.
Only applies to qualified business income
QBI measures the net amount of income, gain, deduction, and loss for a qualified trade or business in the United States. However, some types of income aren’t classified as QBI. For example, income earned outside of the country, dividends, guaranteed payments to partners or LLC members, and certain types of investment-related income aren’t categorized as QBI. Determining QBI can be complex, so it’s best to consult with a tax professional.
Also note that businesses looking to claim this deduction must be located in the United States and be a sole proprietorship, partnership, S Corp, trust, or estate.
Be aware of differences for SSTBs
The deduction applies to taxpayers who are engaged in a “qualified trade of business.” Essentially, this means that everyone is eligible except for:
- The trade of business of performing services as an employee
- A specified service trade or business
Translation: If your income is from one of these service trade businesses (SSTB), you may find that your deduction is limited or unavailable completely.
In order to claim the full 20% deduction as an SSTB, you’ll either need to file a joint return with less than $315,000 in taxable income or a single return with less than $157,000 in taxable income. If your income is greater than these amounts, the 20% deduction will phase out slowly up to $415,000 and $207,500 for joint returns and single returns, respectively. If you don’t run an SSTB, and assuming you meet the other criteria listed below, you’ll be able to claim the full 20% deduction.
This category of service workers is fairly nuanced, so contact your accountant for a deeper look into your eligibility.
What if my income is more than the threshold amount and my business is an SSTB?
Eligible taxpayers with total taxable income over $207,500 for a single taxpayer and $415,000 for joint taxpayers may still be eligible for a deduction, but the method used to calculate the deduction is different. The deduction for QBI is limited by the amount of W-2 wages paid by the business and the UBIA (unadjusted basis immediately after acquisition) of qualified property.
This part can be complicated and involves calculating the sum of the business’s W-2 wages and calculating the UBIA amount to make sure that the deduction is applied to the appropriate amount of taxable income.
Doesn’t apply to income earned from capital gains
The deduction formula includes several limits. The most important one to be aware of is that the Section 199A deduction doesn’t apply to income earned from capital gains.
For example, if your taxable income is $100,000, which includes $30,000 of capital gains, you would deduct 20% of $70,000, not the entire taxable income amount.
QBI loss rolls over year to year
Whether you have one or multiple businesses, your QBI is your total income. If you report a cumulative loss one year, then that loss amount will be subtracted from the next year’s QBI before being able to apply the deduction. Basically, the overall income needs to be positive in order for you to use the 20% rate.
How to be sure I qualify?
No question about it, Section 199A is complicated. However, it’s not impossible. By checking your resources and consulting a qualified tax professional, you may save yourself considerable tax dollars. When tax planning and preparing, be sure that your financial advisor understands the importance and availability of this deduction so that they can secure you the best rates.
In the meantime, we’d love to answer any questions you have about 199A! Talk to us through the chat or on social media.