The answer to this question is pretty simple – pretty much all businesses, which are organized as pass-through entities qualify for the new deduction – with a bunch of caveats.
For the purposes of the new deduction, a pass-through entity is a business treated for tax purposes as a sole proprietorship, partnership, or S corporation. Yes, sole proprietorships count even though they technically aren’t separate entities for tax purposes. Only C corporations are excluded. They got their own tax break.
If your total income from all sources is less than $157,500 for single taxpayers or $315,000 for married taxpayers, you get a deduction of 20% of the taxable income from your business. If your total income is above those thresholds, you have some potential limitations.
First, if your business provides services in the following fields, your deduction phases out over $157,500 – $207,500 for single taxpayers or $315,000 – $415,000 for married taxpayers:
- Actuarial science
- Performing arts including athletics
- Financial services
- Any service business where the principal asset is the skill and reputation of one or more employees.
Second, if your income exceeds the threshold amount, but you are not in one of the above businesses, your deduction is limited to the greater of 50% of the gross W-2 wages paid by your business or 25% of gross W-2 wages plus 2.5% of your undepreciated assets under ten years of age. If those amounts exceed your 20% deduction, you get the full 20% deduction.
Is this complex enough for you yet?
Let’s discuss whether you are in one of the disqualified businesses above. Specifically, let’s discuss 7 and 8. Keep in mind that these business owners still qualify for the deduction, but it phases out based on the income ranges above.
Based on the new tax law, I expect Webster will remove the word “consulting” from the dictionary. You should grab your dictionary from the bookshelf and cut the word out. For some reason, Congress has always hated consultants, even though that’s where most of them end up after being dragged kicking and screaming from office.
The tax definition of consulting is providing advice or counsel. You can tell your mother-in-law to shut up or lose her section 199A deduction.
Consider whether your business is really a consulting business, despite your company name. If you own an IT “consulting” business, do you really provide advice or counsel or do you really provide systems design or integration services? Maybe you perform project management services. You don’t provide consulting services. Trust me on this – not anymore.
Step one: Get “consulting” out of your company name. Yes, it sounds cool to be a consultant, but it will cost you money.
Step two: Look at your NAICS code and business description on your tax return. Change if the banished word appears in either.
Step three: Revise your web site to remove the offensive word. Yes, IRS auditors look at company websites.
Do this now with your 2018 tax returns to build a history without the banned word. Don’t wait for an auditor to notice that you changed your company name or description just in time for an audit.
Next, let’s consider whether your business is a service business where the principal asset is the skill and reputation of one or more employees. Doesn’t that pretty much describe all small businesses?
The IRS recently finalized rules on this and came to a surprising conclusion. This provision applies primarily to businesses that receive royalties or appearance fees. Who says the IRS never gives us a break.
Be proactive this tax season considering how to best structure your business to get all of the deduction for which you qualify. Yes, this is complex and will require substantial additional effort, during tax season, on your part and the part of your tax preparer. Getting this right will cost money, but getting it wrong could cost a lot more.
There are many other provisions to the new deduction. If you not sure if your business qualifies, give me a call at 703-802-2309.
Thanks for reading! Frank Stitely, CPA, CVA, skcpas.com
Areas of Practice
- Certified Public Accountant with 17 years of tax experience
- Certified Valuation analyst with 10 years of experience in business valuation
- Serves small businesses and individuals in the areas of taxation, business valuation, financial reporting and software support services
- Graduated Summa Cum Laude from Clarion University
- Received the Elijah Watt Sells certificate in recognition of performance in the CPA exam
- American Institute of Certified Public Accountants
- Virginia Society of Certified Public Accountants
- Previous President of the Association of Professional Accounting Software Consultants
- Member of the Sage Software Small Business Certified Consultants’ Steering Committee
- Member of the National Association of Certified Valuation Analysts
- Chair of the Audit Committee on the Board of Directors for Christian Relief Services
- Maryland Society of Accountants
- National Society of Tax Professionals