I wrote this article earlier this year, and after a year of practical application have gained a few insights. I highlighted those in italics.
The IRS released updated guidance on January 18, 2019 of one of the more complex, and possibly beneficial tax breaks for small pass-through businesses.
The first question most people ask, am I a pass-through? If you are a partnership, S-corporation, trust or estate, a single member LLC or sole proprietorship than you have pass through income.
What the IRS is allowing us to do is exclude from taxation 20% of our business income, sounds great, right? Well it gets complicated.
As long as you are not an accountant, attorney, doctor, consultant, athlete, stock broker or a member of several other specified service trade or businesses you are ok. If you are one of these unlucky professionals, you may be limited on what you can deduct based on your income, if your income exceeds $315,000 for married filing joint or $157,500 for all others.
But wait, there’s more. Even if you are not one of the unlucky professionals, your deduction could still be limited. If you have taxable income over $207,500 or $415,000 if married, the deduction is limited as well. It is limited by the sum of 25% of the W-2 wages your pass through pays to employees plus 2.5% of the property on your books that you are currently depreciating.
My analysis of this deduction is the intent of Congress was to reward those small businesses that have a large investment in employees or have recently purchased equipment; both activities that further stimulate the economy. It makes sense and it follows the logic of President Reagan’s supply side economic approach.
It also brings up a planning point for CPA’s to consider, if your client takes the section 179 deduction (immediate expensing of equipment) then the 199a deduction would not be available for those assets, hence no “double dipping”. I give a lot of credit to people writing the code, they put some thought into all the alternatives.
I was able to recently use the W-2 wage limitation to save a client an additional 10%, by paying an owner of a closely held entity a salary, you can increase the W-2 limitation that is placed on high income individuals, therefore making more of the credit available to the taxpayer. Again, I caution you, this works for some and not all, so you really need to consult with a knowledgeable tax practitioner to do a thorough analysis of your tax position.
There are other limitations with the 199a deduction and everyone’s situation is different, so it is best to consult with your tax professional to get it right.