May 21, 2019
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Pass-Through Income Deduction (IRC § 199A)
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Section 199A of the Internal Revenue Code permits non-corporate taxpayers to deduct up to 20 percent of their qualified business income, including 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. Income must be sourced from a qualified trade or business operated directly or through a pass-through entity. However, income earned through a C corporation or by rendering services as an employee is not eligible for the deduction.
Qualified Business Income
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Qualified Business Income is defined as the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including sole proprietorships, partnerships, and S corporations. The pass-through deduction is available to some trusts and estates. In order for your business income to qualify for QBI, it must be effectively connected with the conduct of a trade or business within the United States - only items that are included in taxable income for the tax year are counted. If the net of all your qualified items of income for the tax year is a net loss, the loss is carried-over to the next tax year. The QBI deduction allowed in the following tax year is reduced by 20 percent of the carried-over loss, not to be reduced below zero.
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The pass-through deduction does not include income items such as reasonable compensation from an S corporation, guaranteed payments made to a partner from a partnership, or a partnership's payments to a partner for services that are treated as made to a non-partner under Code Sec. 707(a). Qualified items of income, gain, or loss exclude capital gains or losses, certain dividends, and interest as these amounts are not properly allocable to a specific business activity.
Qualified Trade or Business
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Generally, a qualified trade or business is any trade or business that may deduct business expenses under Code Sec. 162. Interestingly enough, the term "trade or business" is not defined in the Internal Revenue Code. Basically, if the activity is carried on for a livelihood or for profit, then generally speaking it is considered a qualified trade or business. However, your business is not a qualified trade or business if you perform services as an employee or are characterized as a specified services trade or business (SSTB) under IRC § 1202(e)(3)(A).
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Specified Service Trade or Business
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Under Section 199A, an SSTB is defined as any trade or business that provides services involving investing and the management of investments, trading, or dealing in securities, partnership interests, or commodities. Also included in the definition of an SSTB are services in the fields of health, law, accounting, agricultural science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business whose principal asset is the reputation or skill of one or more of its employee/owners.
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Qualified Property
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Qualified property of a qualified business is defined as being depreciable tangible property used during the tax year to produce QBI. The qualified asset must be held by the business and used at some point during the tax year.
Conclusion
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The intended goal of the QBI deduction is ultimately to reduce the tax rate on qualified business income to a rate that is more in-line with the new corporate tax rate. Clearly understanding the qualified business income deduction will increase your business acumen. For more information and professional consulting for your business, contact us today.
