Tax Break for Closely Held Business
Updated: Feb 7, 2019
Section 199A creates a 20% deduction for business income that passes through to an individual from a pass-through entity to be taxed at individual tax rates.
The basic formula that most business owners will use to calculate the deduction is the lesser of 20% of your "Qualified Business Income" or 50% of the W-2 wages that can be allocated to your share of the business. Qualified business income is best thought of as the ordinary, non-investment income of the business. Limiting the deduction to 50% of W-2 wages means that a business that does not have true employees, and therefore pays little or no wages, is not eligible for 20% deduction. But the good news is there are a couple of key exceptions to that rule.
The first exception depends on your taxable income. Taxpayers with income below $315,000, if married filing jointly, or $157,500 for all other filers, are not subject to the wage limitation at all. The limitations phase in as income levels increase, with the full limitation kicking in at $415,000 for married filers and $207,500 for all other filers. Congress also made a last-minute addition to the tax bill that benefits pass-through entities that hold large amounts of depreciable property like real estate, but may have few or no employees. The deduction for these companies is limited to 25% of W-2 wages plus 2.5% of unadjusted basis in the property.
The new pass-through deduction is designed to benefit companies that produce things rather than provide services. For that reason, professional service firms are excluded from claiming the deduction. But there’s an exception to that rule as well. The Act allows the full 20% deduction for professional service providers if they are below the income thresholds previously mentioned ($315,000/$157,500). Above those income levels, the W-2 wage limits phase in just as they do for other business owners, but above the top end of the phase in ($415,000/$207,500), professional services providers qualify for no deduction. These limits prevent some higher earning service firms like doctors, lawyers, financial professionals or professional athletes from taking advantage of the change. However, there is a specific carve out in the Act for engineers and architects, who are able to claim the same benefits as a manufacturing company.
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. www.sipc.org 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000.