Tammy Neel Maps Out the Brand-New 20% Qualified Business Income Deduction (QBID)
Tammy Neel Pessmeg is a CPA and tax principal at Clifton, Larson, Allen, the ninth largest accountancy firm in the U.S. She has been handling tax issues for 20 years.
Today, Tammy and I discuss Section 199A of the tax code, better known as the “Qualified Business Income Deduction” (QBID) or the “Pass-Through Deduction.” Unlike the other three topics—Employee retention tax credit, entertainment and meal deductions, and Section 179 deductions—the QBID is an entirely new section of the tax code!
Tammy will explain what this all-new tax provision is and how it might save you thousands of dollars per year!
What’s the deal with Section 199A?
Ed: Good afternoon, Tammy. Thanks for taking the time to sit down with me today. We’re going to talk about Section 199A of the IRS tax code, more commonly referred to as the “Qualified Business Income Deduction.”
Unlike many other aspects of the Tax Cuts and Jobs Act, this one didn’t just change an existing statute, it created a whole new one. That means most people won’t have heard of “qualified business income” or the corresponding deduction. Can you give us a quick run down on what this new provision is all about?
Tammy: The “qualified business income deduction” is the way Congress is trying to help equalize the tax benefit that they gave to C corporations by lowering their tax rate to 21%.
So, for businesses that qualify, they’ll be eligible for a 20% deduction of their qualified business income, abbreviated QBI, which is just ordinary income less ordinary deductions. To put that in perspective, if the taxpayer is in the highest bracket at 37%, it would equal effectively a 29.6% tax bracket on that income.
QBI must come from a “qualified business.” This is a bit tricky at the moment since the law only defines what a qualifying business is not. It is not a professional service business or any business where the income is generated based on the knowledge and reputation of the person performing the services.
Ed: Wait, so lawyers, accountants, and doctors, for example, are ineligible for this new deduction?
Tammy: Well, yes and no. Fortunately, there’s an exception built in: If the taxable income of the taxpayer is under $315,000 (married filing jointly) or $157,500 (single, head of household, or married filing separately), it doesn’t matter what business type it is, the taxpayer is entitled to the 20% of the QBI deduction, including doctors, lawyers, accountants and other service providers.
Let’s say myself as an accountant and partner in a tax firm, or you as an attorney and shareholder of a firm, generate taxable income of $300,000 (and we’re married filing joint taxpayers). It doesn’t matter at that point that we’re in a professional services business because we’re under the $315,000 threshold. We would get a 20% qualified business income deduction.
Now, in practice it’s more complicated, there are wage limitations once you reach the “threshold amount,”—$315,000 for married filing jointly, half that for everyone else—and phase out periods after that, but that’s the gist of it.
Ed: To sum up, then, if you make under $315,000 married filing jointly, and you’re either a sole proprietor, shareholder of a S corporation, or a member of an LLC that is electing S corporation or general partner tax status, you’re entitled to this deduction no matter the type of business your company engages in?
Tammy: Correct. The wage and asset limitations only come into play once the taxpayer’s income gets above that threshold.
Ed: And, before we move on, when you say “taxpayer,” Tammy, are you talking about the actual business or the owner of the business?
Tammy: Usually it’s the owner of a pass-through entity that owns the business—so, a partner in a partnership, a shareholder of a S corp., or a member of an LLC. Of course, it could also be a sole proprietor.
Ed: Thanks for clearing that up. Let’s talk about the wage limitations. So, what are they and when do they matter?
Tammy: When you get above that $315,000 threshold for married filing jointly (or half for everybody else), then the wage limitation comes into play. At that point, the QBID is limited to the lower of:
- 20% of QBI, or
- The greater of:
- 50% of W-2 wages or
- 25% of W-2 wages plus 2.5% original cost of depreciable property of the business
Now, for these W-2 wages, the wages paid to owners do not count. That’s important to keep in mind.
Again, it’s all quite complicated, and, as I said earlier, we’re waiting for more regulations and guidance to be issued by the IRS and Congress.
Ed: And what happens to a professional service business when the taxpayer’s income exceeds $315,000?
Tammy: Between $315,000 and $415,000, there is a phase out of the deduction. But once the taxable income is above $415,000, the taxpayer that owns a service business is not eligible for the QBI deduction at all.
During this phase-out period, the same QBID limitations apply that other businesses would use above the $315,000 threshold: 50% of W-2 wages 25% of W-2 wages plus 2.5% of assets.
Ed: What about selecting small business entities—LLC versus Corporation and the tax status of any of those. How is what we’ve been talking about today going to affect that? Is there anything that a new business owner should be considering?
Tammy: That depends a lot on the long-term goal for the business. For a professional services business, I would recommend an LLC entity taxed as an S corporation. Unfortunately, unless they’re under the $315, they’re not going to get this deduction.
But, I’ll tell you, the C corp is definitely back in the ballgame because of the favorable tax rate. Again, it just depends on what the long-term goals of the business are.
As you can see, this brand-new section of the tax code is complex, but understanding and taking advantage of 20% QBI deduction can save you tens of thousands of dollars in taxes! By seeking out advice from professionals, you will ensure that you take full advantage of these tax benefits.
We would love to speak with you more about your business needs and learn how we here at Alexander Abramson can help you grow and manage your business.
Call us at 407-649-7777.