In our last blog, we discussed the new 20% pass-through deduction. This provision of the new tax law, codified in Section 199A of the IRS code, has created confusion around its application. Last week the IRS released 184 pages of regulations aimed at providing clarity and defining many of the issues, omissions, and contradictions surrounding this deduction.
The purpose of the deduction is to provide relief to businesses whose income is taxed at the usually higher tiered individual tax rate rather than the generally lower flat corporate rate. According to the code, in order to qualify for the deduction, a business entity must be a “qualified trade or business”. These are generally businesses that are not taxed as C-corporations such as sole proprietorships, individuals reporting income from rental property, LLC’s, trust and estates, Sub-S corporations and other entities that generate “qualified business income”.
But not all such businesses qualify. Businesses that perform services as an employee do not qualify. An employee of a qualified business, who receives a salary but is not an owner, is not permitted to participate in Section 199A deductions.
Income generated by a “Specified service trade or business”, is limited to the extent of its participation in the deduction. Included in this group are trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. Prior to the new law architects and engineers were included in this category. They are not subject to the income limitations place on the group. In order for this group to participate in the deduction, a taxpayer’s taxable income must not exceed $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
In our next blog, we will discuss what is “qualified business income” and how it is determined.
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