For many business owners and partners, one of the bright spots in the Tax Cuts and Jobs Act of 2017 (TCJA) is a significant new income tax deduction. Pass-through entities that meet certain requirements may deduct up to 20 percent of qualified business income (QBI) for a business tax break.
However, the deduction, called Section 199A, is somewhat complex. Here are four things you need to know:
1. Virtually any business is eligible, with some conditions
Whether you own a hardware store, law firm, dance studio, or medical practice, you may qualify for the business tax break deduction if your business:
- Operates domestically
- Is structured as a pass-through entity, such as a sole-proprietorship, partnership, S-corporation, limited liability company (LLC), or through a trust or estate
- Meets other thresholds and requirements
Individuals, trusts, and estates with QBI may be eligible for the business tax break. In addition, you may be able to take the deduction if you have qualified real estate investment trust (REIT) dividends or qualified publicly traded partnership (PTP) income. S corporations or partnerships should report income eligible for the deduction on a Schedule K-1 so partners or shareholders may take the deduction. And while C corporations are not eligible for the deduction, the TCJA cut their tax rate to 21 percent from 35 percent.
2. Income restrictions apply to some taxpayers
To find out if you qualify for the Section 199A deduction, you need to look at two additional factors: your taxable income and the type of business you own. If your taxable income falls below $315,000 and you file jointly with your spouse, or if taxable income is $157,500 in another taxpayer category, you’re another step closer to being eligible for the deduction.
However, if your income rises above those thresholds, the deduction phases out for certain types of businesses. These “specified service trades or businesses” (SSTBs) include:
|• Accounting||• Investing|
|• Actuarial science||• Investment management|
|• Athletics||• Law|
|• Consulting||• Performing arts|
|• Financial services||• Trading|
|• Health care|| |
Taxpayers may also be subject to income thresholds if they deal in certain assets or any trade or business where the principal asset is the reputation or skill of one or more employees. For example, if you are a hedge fund manager or a professional athlete whose business relies on your talent, you may be subject to the income threshold and ineligible for the deduction.
3. Calculating the business tax break can be complicated
Starting with the 2018 tax year, if you meet income and business eligibility requirements, you may deduct the lesser of 20 percent of your QBI or 20 percent of your taxable income, even if you don’t itemize your taxes on your Schedule A form.
From there, the calculations get more complicated. Once you reach income thresholds, the deduction phases out for owners of SSTBs. For joint filers, the phase-out range is from $315,000 to $415,000, while the range is $157,500 to $207,500 for all other filers. In 2019, these thresholds will rise to $321,450 to $421,450 for married couples filing jointly and $160,700 to $210,700 for all other taxpayers. You are also not eligible for the deduction if you performed the services as an employee.
4. Other restrictions may apply
Even if your business is not an SSTB, you may be subject to other restrictions if you exceed income thresholds. For example, for owners of non-service businesses who are married with an income greater than $415,000 and file jointly, their deduction is equal to the lesser of:
- 20 percent of QBI, or
- The greater of 50 percent of their W2 wages or 25 percent of their W2 wages, plus 2.5 percent of the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business
Even if you exceed the thresholds for the full deduction, careful planning or reorganization of your business income may make you eligible. For example, service businesses may consider splitting income derived from service sources and non-service sources to qualify for the 20 percent deduction. And business owners or real estate investors with multiple properties might realize tax advantages by adopting a REIT structure for their properties.
Section 199A Deduction in Action
Still confused about the Section 199A deduction? Here are some examples to show you how it works.
Example 1: Mark is an independent business consultant (service business) with clients around the country. He earned $150,000 in taxable income last year. He is eligible for a $30,000 deduction as long as his taxable income is below $157,500 as a single tax filer.
Example 2: Lisa is a partner in a top law firm (service business) earning $350,000 in taxable income last year. Her husband is a school principal earning $150,000 in taxable income. Because their joint income is above the income limit for service businesses, Lisa is not eligible for a deduction.
Example 3: Kathleen owns a small chain of retail stores. She and her husband file their taxes jointly and had $1,000,000 in taxable income last year from her business. She is eligible for a $200,000 deduction.
Example 4: Sebastian is a real estate investor who owns a dozen rental properties in town. His net business income is $500,000 for last year, which entitles him to a $100,000 deduction on this qualified business income. Sebastian elects a safe harbor provision to ensure that his real estate business qualifies for the deduction based on 250 or more hours of services performed.
Heavy Duty: Garden State Tax Changes to Note
As we settle up our 2018 tax bills, you may recall a few important changes that will be affecting how much we pay. Negotiations between New Jersey legislators and Governor Phil Murphy’s office avoided a government shutdown and led to a new budget being passed on June 30, 2018. Within the pages of the document were two important tax changes for corporations and high-income earners.
Multi-millionaire’s tax. Those making $5 million or more per year will see their income tax rate rise to 10.75 percent from 8.97 percent. In his budget address on March 5, 2019, Murphy said he would seek to impose that tax on those making more than $1 million per year in the upcoming 2019 budget.
Corporate tax bump. Corporations with net income exceeding $1 million will have a roller coaster ride of increasing and decreasing taxes in the coming years. Careful planning will be essential to minimize the tax bite and ensure accurate remuneration to the state (see below).
New Jersey Corporate Taxes
Corporate Tax Rates on Income Over $1 Million
| NJ Corporate |
|2022 and beyond||9%|
As we approach the June 30, 2019, deadline for the state budget, the negotiations over taxes will surely continue. We will follow Trenton’s tax talks closely and keep you updated on how they may affect your business and personal finances.
Changes to the Business Meals & Entertainment Deduction
Entertaining customers or contractors on the company dime just got a little more expensive. Prior to January 1, 2018, companies and organizations could deduct 50 percent of business entertainment costs if they were directly related to doing business. Did you close a big sale in box seats at a football game or during a customer ski trip? Up to half of what you spent could be written off.
However, the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the business tax break for business entertainment, amusement, or recreation expenses. Your company can no longer write off those excursions or events, even if business is being done at the same time or immediately before or after. Half of the cost of business meals can still be deducted, provided they meet certain criteria:
Keep the right company: At least one company owner, partner, or employee must be present at the meal. And those in attendance must have a business relationship with your company. Customers, prospects, consultants, or similar business contacts qualify.
Mind the menu: Lavish or extravagant meals or beverages are not deductible, so lobster and champagne at a posh eatery likely won’t help reduce your tax obligation.
Remember separate checks: When entertaining clients or prospective clients, try to separate the meal from the event you are attending. If the food and beverages are purchased separately from the event they will not be deemed entertainment.
More guidance is expected from the Department of the Treasury and Internal Revenue Service (IRS) about both business meal deductions, as well as clarifying what, exactly, “entertainment” means in terms of expense write-offs. In the meantime, if you have any questions about this or other tax- or financial-related issues, don’t hesitate to contact us.
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