If at all possible, you want to qualify for the 20 percent tax deduction offered by new tax code Section 199A to proprietorships, partnerships, and S corporations (pass-through entities).
If you own one business, you can run into some complications qualifying for the Section 199A deduction.
Basic Rules—Below the Threshold
If your taxable income is equal to or below the threshold of $315,000 (married, filing jointly) or $157,500 (single), follow the three steps below to determine your Section 199A tax deduction with multiple businesses or activities.
Step 1. Determine your qualified business income 20 percent deduction amount for each trade or business separately.
Step 2. Add together the amounts from Step 1, and also add 20 percent of:
- real estate investment trust (REIT) dividends, and
- qualified publicly traded partnership income.
This is your “combined qualified business income amount.”
Step 3. Your Section 199A deduction is the lesser of:
- your combined qualified business income amount, or
- 20 percent of your taxable income (after subtracting net capital gains).
Above the Threshold—Aggregation Not Elected
If you do not elect aggregation and you have taxable income above $207,500 (or $415,000 on a joint return), you apply the following additions to the above rules:
- If you have an out-of-favor specified service business, its qualified business income amount is $0 because you are above the taxable income threshold.
- For your in-favor businesses, you apply the wage and qualified property limitation on a business-by-business basis to determine your qualified business income amount.
The wage and property limitations work like this: for each business, you find the lesser of:
- 20 percent of the qualified business income for that business, or
- the greater of (a) 50 percent of the W-2 wages with respect to that business or (b) the sum of 25 percent of W-2 wages with respect to that business plus 2.5 percent of the unadjusted basis immediately after acquisition of qualified property with respect to that business.
If You Are in the Phase-In/Phase-Out Zone
If you have taxable income between $157,500 and $207,500 (or $315,000 and $415,000 joint), then apply the phase-in protocol.
If You Have Losses
If one of your businesses has negative qualified business income (a loss) in a tax year, then you allocate that negative qualified business income pro rata to the other businesses with positive qualified business income. You allocate the loss only. You do not allocate wages and property amounts from the business with the loss to the other trades or businesses.
If your overall qualified business income for the tax year is negative, your Section 199A deduction is zero for the year. In this situation, you carry forward the negative amount to the next tax year.
Aggregation of Businesses—Qualification
The Section 199A regulations allow you to aggregate businesses so that you have only one Section 199A calculation using the combined qualified business income, wage, and qualified property amounts.
To aggregate businesses for Section 199A purposes, you must show that:
- you or a group of people, directly or indirectly, owns 50 percent or more of each business for a majority of the taxable year;
- you report all items attributable to each business on returns with the same taxable year, not considering short taxable years;
- none of the businesses to be aggregated is an out-of-favor, specified service business; and
- your businesses satisfy at least two of the following three factors based on the facts and circumstances:
- The businesses provide products and services that are the same or are customarily offered together.
- The businesses share facilities or share significant centralized business elements, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources.
- The businesses operate in coordination with or in reliance upon one or more of the businesses in the aggregated group (for example, supply chain interdependencies).
As you can see, with multiple businesses you have much to consider. If you would like our team at Luster Tax Consulting to work through this with you, please use the following link to book your complimentary strategy call with your team at Luster Tax Consulting.