The Tax Cuts and Jobs Act was enacted on December 22, 2017 and applies to tax years beginning after December 31, 2017. A major component of this legislation was to reduce the tax rate for corporations from a top rate of 35% to a flat 21%.  The stated purpose of this permanent rate reduction includes encouraging investment in the United States and discouraging profit shifting. It is said by its proponents that “as additional investment grows the capital stock, the demand for labor to work with the new capital will increase, leading to higher productivity, output, employment, and wages over time.”[i] Others believe that the reduced tax will only lead to greater income disparity.

So, did the legislation included comparable provisions to address the interest of the non-corporate tax filers? Yes, and it is in the form of Sections 199A. This “new” deduction is aimed at providing a reduction in the tax rate for non-corporate tax filers in consideration of the reduction in the corporate rate reduction. This new deduction is available to qualified sole proprietors, partnerships, and other pass-through entities. Part of the intent of section 199A is to eliminate any tax rate bias toward incorporating as a preferred entity form.  But, unlike the corporate rate reductions, the Section 199A reduction is not permanent, and is set to expire December 31, 2026.

The Section 199A deduction is up to 20% of the Qualified Business Income (QBI) of the qualifying trade or business and may be limited based on trade or business type and taxable income levels.

Qualified trade or business under section 199A means a trade or business under section 162 (section 162 trade or business) other than the trade or business of performing services as an employee. The deduction may also be limited for a Specified Services Trade or Business (SSTB), defines as “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, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees, [or owners].”

The term “qualified business income” means, for any taxable year, the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer conducted in the United States, and used in the determination of taxable income for the year.

The QBI deduction may be limited based on the tax filer’s taxable income. The limitation is based on whether, and by how much, the tax filers taxable income exceeds the threshold amount. The threshold amount for 2018 is $157,000 ($315,000 for joint filers) and is adjusted annually based on cost-of-living adjustments. The deduction is phased out for SSTBs as the amount that taxable income exceeds the threshold amount by more than $50,000 ($100,000 for joint filers).

The QBI deduction does not reduce net earnings from self-employment. Similarly, the deduction does not reduce net investment income.

There is currently no IRS form for calculating the QBI deduction, although the IRS provides some guidance in the instructions for Form 1040 for filers that do not exceed the threshold amount and in publication 535 (Business Expenses) for filers that exceed the threshold amount (including taxpayer’s that are patrons of specified agricultural or horticultural cooperatives)

IRC section 199A provides a tax savings opportunity previously unavailable to owners of pass-through activities; however, it is a complicated provision with limited current guidance beyond the statutory language of the code section and the final regulation (RIN 1545-B071). Contact your tax advisor or tax professional for assistance in determining how your trade or business may benefits from the Section 199A QBI deduction.

[i] York, Erica, “The Benefits of Cutting the Corporate Income Tax Rate”, Tax Foundation, August 14, 2018.