What You Need to Know About the New 20% Qualified Business Income Deduction

February 2019

Here’s the good news: as a small-business owner or independent contractor you may qualify for a 20% tax break when you file your return in 2019. The bad news is that it is really difficult to figure out if you qualify – even your accountant may not be entirely sure.

The 20% deduction is a feature of the Tax Cuts and Jobs Act, and it’s known as the “Qualified Business Income Deduction” or the “Section 199A Deduction”. According to the IRS, it allows “many owners of sole proprietorships, partnerships, trusts and S corporations to deduct 20 percent of their qualified business income.”

So, let’s unpack what that means in the real world:

When did this go into effect? The IRS says that the deduction is available for tax years beginning after Dec. 31, 2017. Eligible taxpayers can claim it for the first time on their 2018 federal income tax return.

Who qualifies? This is where it starts to get complicated. You probably qualify if:

  • If your business is a sole proprietorship, and you file your taxes under Schedule C
  • If you own a non-corporate farm, filing under Schedule F.
  • Or you get income from an S corporation, LLC, partnership or trust/estate

If you do meet the basic qualifications listed above, and if your 2018 taxable income is below $315,000 for joint returns and $157,500 for single – you may able to deduct the full 20% on your qualified business income.

What is “qualified business income”? Simply stated, it is income from a small business, or contracting work, from a domestic (U.S-based) trade or business. It would typically include your business revenues, investment trust dividends, publicly traded partnership income and other types of income. Things like wages paid to you from an employer, capital gain, interest and dividend income are not considered qualified income. The 20% deduction would apply to your profit, after you have deducted your business expenses.

Are all small businesses eligible for the deduction? No – and this is where it gets really, painfully complicated.

Congress specifically excluded particular industries, such as health, law, accounting, performing arts, consulting, sports or financial services or (take a deep breath!) “any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.”

The qualification about the “reputation or skill” of an employee or owner can be really problematic for small businesses, and even more so for sole proprietorships and consultants who often rely on their skills and reputations to get and retain customers/clients.

But, you might still be able to take the 20% deduction - even if you work in a disqualified field (and have skills and a good reputation) - if your taxable income falls below $315,000/$157,500 (joint/single filing). If your taxable income is between $315,000 and $415,000, you may still qualify but won’t be able to claim the entire deduction. And if your taxable income is more than $415,000 from one of the specified trades/services – you do not qualify.

Bottom-line - you need to talk to your financial advisor now: The Qualified Business Income Deduction is so complex that even the financial professionals are having problems figuring out specific details of the Act. That said, any good financial advisor, accountant or tax preparer should be able to figure out whether you qualify for the deduction, and help you file correctly. Even if you typically do not use a professional to prepare your taxes, it is highly advisable that you do so this year. Choose one that really understands the Tax Cuts and Jobs Act, you probably need more than a math whiz with access to tax software this year. It’s a significant amount of money, so if you do qualify you’ll want to take advantage of it.

One Park Financial is your partner in success. We work to help owners of small and mid-sized businesses understand their financial options and access the funding that they need to succeed. Visit oneparkfinancial.com or call 855.218.8819 to discover the options that make sense for you and your business.