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This calculation determines the §199A Deduction for a Specified Service Trade or Business("SSTB") and a non-Specified Service Trade or Business ("non-SSTB").
It calls for all of the items that go into this calculation on the side of the Relevant Passthrough Entity (RPE), including (1) status as SSTB or non-SSTB; (2) total taxable income (TTI); (3) modifications to income for capital loss and capital gain, dividends, and interest; (4) W-2 wages; (5) undepreciated basis immediately after acquisition for qualified property (UBIA); (6) REIT dividends; and (6) income from Publicly Traded Partnerships (PTP).
It also calls for all of the items that go into this calculation on the side of the Taxpayer, including (1) the RPEs TTI, REIT, and PTP (automatically carried forward from the RPE data entry); (2) other income; (3) modification to income for net capital gain, qualified dividends, deductible contributions to charity or a retirement plan; (4) standard or itemized deductions.
In this article:
Relevant Passthrough Entity (RPE)
A Relevant Passthrough Entity (RPE) can be any of the following:
- S Corporation
- Schedule C business
- Schedule E business/activity
- Schedule F farm
- Estate or Trust (treated as an "Individual" for threshold purposes)
- LLC (single-member or one that does not elect to be taxed as a corporation)
C Corporations Not Eligible
§199A specifically makes income from a C Corporation ineligible for a passthrough deduction. First of all, it is not a "passthrough" entity because it is taxed at the corporate level. Second of all, it already got a huge tax break when the marginal corporate rate of 35% was reduced to a flat rate of 21%.
Leveling the Playing Field
The entire point of §199A is to level the playing field between a Corporation (21% flat rate) and passthrough entities (taxed at a Taxpayer's individual rate, which can be as high as 37% in the top bracket). By providing a 20% deduction on income that a Taxpayer receives from passthrough entities, Congress in effect lowered the marginal rate from 37% to 29.6% (37% x 20% = 7.4%; 37% - 7.4% = 29.6%).
Playing Field Not Fully Level
The §199A deduction does not reduce a Taxpayer's marginal rate to 29.6% in all circumstances:
- A Taxpayer might be in any of the following marginal brackets: 12-22-24-32-35-37%
- In Zones #2 and #3, the Wage and Capital tests can limit the amount of the §199A deduction
- In Zone #3, an SSTB loses the §199A deduction entirely
- A Taxpayer might be subject to the 3.8% Net Investment Income Tax (NIIT), so that the marginal rate could actually go up (29.6% + 3.8% = 33.4%).
Total Tax on C Corporation Income Could Be 21% or Higher
- $100 of Line 30 Taxable Income will generate $21 of corporate income tax
- The untaxed $79 may or may not be distributed to shareholders as dividends
- A shareholder might die before ever getting any or all of the dividends
- Whatever portion of the $79 is distributed to shareholders will be taxed at the maximum capital gains tax of 0%, 15%, or 20% (or some combination), depending on where in the Taxpayer's income tax bucket the corporate dividends land (coming in on top of all other income)
- If all $79 is distributed to shareholders, and if all of it is taxed at the 20% rate, then additional tax of $79 x 20% = $16.80 is incurred.
- The total tax on the same $100 is now $21 + $15.80 = $36.80 = 36.8%.
- Some or all of the corporate dividends might be subject to the 3.8% Net Investment Income Tax (NIIT).
- Thus, total federal income tax (C Corporation + Taxpayer) on the original $100 of corporate income could be 36.8% + 3.8% = 40.4%.
- Tax Year: Enter the year for which the federal income tax is being calculated. The program handles from year 2018 onwards. For future years, the program will default to the current year.
- Specified Service Trade or Business (SSTB)?: Select "Yes" if the entity is an SSTB. This entity involves the performance of services in one or more of the following fields: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management trading, or dealing in securities, partnership interests, or commodities, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more its employees or owners.
- Total Taxable Income: Is determined for each qualified trade or business of the taxpayer. For any taxable year, qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. The determination of qualified items of income, gain, deduction, and loss takes into account these items only to the extent included or allowed in the determination of taxable income for the year.For example, if in a taxable year, a qualified business has $100,000 of ordinary income from inventory sales, and makes an expenditure of $25,000 that is to required to be capitalized and amortized over 5 years under applicable tax rules, the qualified business income is $100,000 minus $5,000 (current-year ordinary amortization deduction), or $95,000. The qualified business income is not reduced by the entire amount of the capital expenditure, only by the amount deductible in determining taxable income for the year. If the net amount of qualified business income from all qualified trade or businesses combined during the year is a loss, it is carried forward as a loss from a qualified trade or business in the next taxable year.
- Capital Losses: Enter the capital losses that are a part of the RPE Total Taxable Income. These are entered as a positive number to modify the Total Taxable Income in order to determine the QBI deduction.
- Capital Gains, Divs, Int, Other: Enter the capital gains, dividends, interest or other portions of the RPE Total Taxable Income. These are entered as a negative number to modify the Total Taxable Income in order to determine the QBI deduction.
- Qualified REIT Dividends: Do not include any portion of a divident received from a REIT that is a capital gain dividend [ defined in §857(b)(3)] or a qualified dividend [defined in §1(h)(11)].
- Pub. Tr. Pship Inc (Publicly Traded Partnership, or PTP): The sum of the (a) net amount of the taxpayer's allocable share of each qualified item of income, gain, deduction, and loss that are effectively connected with U.S. trade or business and are included or allowed in determining taxable income for the taxable year and do not constitute excepted enumerated investment-type income, and not including the taxpayer's reasonable compensation, guaranteed payments for service or §707(a) payments for services from a publicly traded partnership not treated as a corporation, and (b) gain recognized by the taxpayer on disposition of its interest in the partnership that is treated as ordinary income.
- W-2 Wages Paid: Enter the amount of W-2 Wages paid to employees of the business. Include W-2 Wages paid to shareholder-employees of an S corporation. Do not include guaranteed payments to partners of a partnership. Sole proprietors are not paid W-2 Wages from their own sole proprietorship. W-2 Wages refers to the amounts described in paragraphs(3) and (8) of §6051(a) which are paid by a person with respect to employment of employees by the person during the calendar year ending during that taxable year. §6051(a) is "the total amount of wages as defined in §3401(a)" and §6051(a)(8) is "the total of amount of elective deferrals." §3401(a) provides that generally "wages" means all remuneration for services performed by an employee for his employer.
- Unadjusted Basis (UBIA): Tangible property of a character subject to depreciation that is held by, and available for use in, the qualified trade or business at the close of the taxable year, and which is used in the production of qualified business income, and for which the depreciable period has not ended before the close of the taxable year. The depreciable period with respect to qualified property of a taxpayer means the period beginning on the date the property is first placed in service by the taxpayer and ending on the later of (a) the date 10 years after that date, or (b) the last day of the last full year in the applicable recovery period that would apply to the property under §168.
- Filing Status: Choose the applicable filing status - Choose the applicable filing status - Single, Joint, Separate, Head of Household, or Estate or Trust.
- Other: Enter other net income received by the taxpayer, such as Wages, Interest, Dividends, Social Security, IRA, etc.
- Net Capital Loss: Enter the net capital gain for the taxpayer. These are entered as a negative number to modify the Total Taxable Income in order to determine the deduction.
- Qualified Dividends: Enter the qualified dividends for the taxpayer. These are entered as a negative number to modify the Total Taxable Income in order to determine the deduction.
- Char, Ret. Plan Contr.: Enter the amount of charitable gifts or retirement plan contributions. This should be entered as a negative number, to determine the modified taxable income used in determining the §199A deduction.
- Standard, Itemized Deductions: Enter the amount of standard or itemized deductions as a negative number.
This module calculates the §199A deduction for a single business trade or business operated through a Relevant Passthrough Entity (RPE) owned, in whole or in part, by a Taxpayer.
The Combined QBI represents the sum of the Taxpayer/owner's proportionate share of:
- RPE Modified Taxable Income, determined as follows:
- RPE Total Taxable Income
- plus: Capital Losses
- less: Capital Gains, Dividends, Interest, and Other (catch-all)
- Qualified Real Estate Investment Trust (REIT) Dividends
- Qualified Publicly Traded Partnership (PTP) Income
Taxpayer Modified Taxable Income
This represents the sum of:
- Total AGI (Form 1040, Line 7)
- Sum of RPE Total Taxable Income (TTI), REIT, PTP*
- Other Income
- less: Net Capital Gain
- less: Qualified Dividends
- less: Contributions to Charities and/or Qualified Retirement Plans
- less: Standard or Itemized Deductions
T: Taxpayer Modified Taxable Income x 20%
* (1)(a) above is not the same as Combined QBI. Combined QBI reflects several modifications to RPE Total Taxable Income (an increase for capital losses and decreases for capital gains, dividends, interest, and other). Combined QBI is used solely for purposes of the RPE 20% test. The Taxpayer is actually getting unmodified RPE Total Taxable Income plus REIT and PTP income as a starting point for the Taxpayer’s own Modified Taxable Income which is multiplied by 20% for purposes of the other major 20% limitation.
Taxpayer Taxable Income (Unmodified)
For purposes of computing eventual tax, Taxpayer will report Modified Taxable Income without the modifications but with a reduction for the ultimate §199A deduction.
Thus, Taxpayer Taxable Income consists of:
- Taxpayer Modified Taxable Income
- plus: net capital gain
- plus: qualified dividends
- less: §199A deduction
Taxpayer Income Zone
Taxpayer Modified Taxable Income, as computed above, then determines which one of the three (3) possible income zones applies to the Taxpayer.
- #1 "Go" Zone: up to $315,000 (married/joint) or $157,500 (everyone else). The $315,000 or $157,500 amount is known as the "threshold amount". This is the least complicated zone, where only two numbers are compared, and you get to deduct the lesser of those two numbers (see below).
- #3 "No" Zone: over $415,000 (married/joint) or $207,500 (everyone else). This is the least favorable zone. In this zone, the wage and capital limitations have fully phased in. Furthermore, no §199A deduction is available to the Taxpayer if the RPE is a "specified service trade or business" (SSTB).
- #2 "Twilight" Zone: between $315,000 and $415,000 (married) or $157,500 and $207,500 (everyone else). This is the most complicated zone. It is known as the "phase-in range," a $100,000 range (married) or $50,000 (everyone else). In this zone, the wage and capital limitations are gradually phased in. But more ominously for an SSTB, the §199A deduction is gradually phased out. In effect, for an SSTB, this zone has a double phase-out until the §199A deduction phases out entirely at the top of the "Twilight Zone"/bottom of the "No Zone" ($415,000 or $207,500).
Note: these thresholds will go up slightly in 2019 but the "phase-in range" will remain at $100,000 or $50,000.
RPE Combined QBI is multiplied by 20% (limitation B).
Taxpayer Modified Taxable Income is also multiplied by 20% (limitation T)
#1 Go Zone (all RPEs)
The only limitations are Combined QBI x 20% (B) vs. Taxpayer Modified Taxable Income (T). Lesser of B or T.
Note: "Combined QBI x 20%" is the same thing as "Combined Qualified Business Income Amount" as defined in the statute. The only difference between "Combined QBI" and the latter defined term is the addition of the word "Amount", which means "Combined QBI" x 20%. Zone #1 (Go Zone) is the only zone where this defined amount is used directly in a calculation. It is compared to Taxpayer Modified Taxable Income x 20%, and the lesser of the two results in the §199A deduction.
In the Zones #2 and #3, Combined QBI x 20% is subjected to additional tests:
#2 Twilight Zone:
- Both: wage and capital test (gradual phase-in from 0% to 100%)
- SSTB only: gradual phase-out (from 100% to 0%)
#3 No Zone:
- Non-SSTB only: wage and capital test (fully phased in)
- SSTB only: the SOL test (nothing, rien, nichts, niets, niente, nada, etc.)
#2 Twilight Zone (non-SSTB and SSTB)
#3 No Zone (non-SSTB only)
Other limitations now come into play (Wages and Capital).
- W-2 Wages ("Wage Test")
W-2 Wages paid by the RPE to its employees (including shareholders of S Corporations) are multiplied by two percentages:
- 50% (limitation C)
- 25% (limitation D)
- UBIA (Unadjusted Basis Immediately After Acquisition) ("Capital Test")
UBIA is multiplied by:
- 2.5% (limitation E)
Apply the Limitations
- F: add D (Wages x 25%) plus E (UBIA x 2.5%)
- G: greater of C (Wages x 50%) or F (Wages x 25% + UBIA x 2.5%)
#3 No Zone (non-SSTB only)
WC ("Wage/Capital Base"): lesser of B (Combined QBI x 20%) or G
#2 Twilight Zone (non-SSTB)
- H: "Excess Amount" = B (Combined QBI x 20%) less WC (Wage/Capital Base)
- J: Applicable Percentage (the percentage of the phase-in range of $100,000 or $50,000 that has not been consumed by Taxpayer modified taxable income). This is the portion of the
- K: $ Portion of H (Excess Amount) that is available for the §199A deduction
- L: §199A deduction (WC Wage-Capital Base + K Portion of H Excess Amount available for deduction)
#2 Twilight Zone (SSTB)
- M: Applicable Percentage (J) (100% if non-SSTB)
- N: Tentative QBI Deduction = L (non-SSTB §199A deduction) x M (Applicable Percentage)
Note: Step N is a much simpler way to compute the §199A deduction for an SSTB in the phase-in zone than the method used by the IRS in the Final Regulations. It simply takes the result for a non-SSTB, and multiplies it by M (Applicable Percentage).
- P: Sum of REIT and PTP income x 20%
Tentative QBI Deduction + Tentative REIT/PTP Deduction
- R: Add N (Tentative QBI Deduction) + P (REIT/PTP x 20%)
Section 199A Deduction
- Lesser of R (Tentative QBI/REIT/PTP Deduction) or T (Taxpayer Modified Taxable Income x 20%)