CARL WATTS & ASSOCIATES

October 01, 2018

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The Qualified Business Income
Deduction
Individuals, trusts and estates with qualified business income, qualified real estate investment trust dividends or qualified publicly traded partnership income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives may be required to reduce their deduction. Separate guidance for co- ops will be issued by the IRS.

S corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of qualified business income, W-2 wages, unadjusted basis immediately after acquisition of qualified property, qualified real estate investment trust dividends and qualified publicly traded partnership income on Schedule K-1 so the shareholders or partners may determine their deduction.

Qualified business income is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted.

In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.



A qualified trade or business is any trade or business, with two exceptions:

  • Specified service trade or business, which includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.

  • Performing services as an employee.

The specified service trade or business limitation does not apply if a taxpayer’s taxable income is below $315,000 for a married couple filing a joint return and $157,500 for all other taxpayers; the deduction is the lesser of:

  1. 20 percent of the taxpayer’s qualified business income, plus 20 percent of the taxpayer’s qualified real estate investment trust dividends and qualified publicly traded partnership income;

  2. 20 percent of the taxpayer’s taxable income minus net capital gains.

If the taxpayer’s taxable income is above the $315,000/$157,500 thresholds, the deduction may be limited based on whether the business is a specified service trade or business, the W-2 wages paid by the business and the unadjusted basis of certain property used by the business.

These limitations are phased in for joint filers with taxable income between $315,000 and $415,000, and all other taxpayers with taxable income between $157,500 and $207,500.

The threshold amounts and phase-in range are for tax-year 2018 and will be adjusted for inflation in subsequent years.

Until now, the IRS have issued only proposed regulations on new 20 percent deduction for passthrough businesses, and a draft of the new Form 1040, U.S. Individual Income Tax Return, which is intended to replace not only the current form 1040 but also forms 1040A and 1040EZ.


As complicated as this deduction seems right now, the final regulations that we look forward too, may not make things any simpler. Therefore, no matter how small your business is, we urge you to enroll help from a tax professional to make sure you take advantage of all the credits and deductions you are entitled to.
This year is all about the Tax Cuts and Jobs Act approved by Congress on December 22, 2017 that has brought major changes affecting both individuals and businesses.

The tax treatment of businesses was certainly at the center of tax changes with the tax rate for corporations lowered to 21% while rates remained higher for individual taxpayers.


Conceived with the intention to bring tax break for sole proprietors and other owners of pass-through businesses as well, the Tax Cuts and Jobs Act Section 199A deduction, also known as the Qualified Business Income Deduction, is a deduction of 20% from the adjusted gross income to arrive at the taxable income, in other words, a 20% below-the-line deduction.

Section 199 (without the A) is the section covering Domestic Production Activities Deduction. Section 199A is apparently modeled after this with the mathematics and reporting similar for Section 199A and Section 199.

As you know, a pass-through business is a business that does not pay corporate income tax, and includes entities like sole proprietorships, partnerships, and S- corporations. About 95% of businesses in the U.S. are categorized as pass-throughs and they have traditionally paid a lower tax rate than big C-corporations.

The deduction is available for tax years beginning after Dec. 31, 2017. Eligible taxpayers can claim it for the first time on the 2018 federal income tax return they file next year.

The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers.

It is generally equal to the lesser of 20 percent of their qualified business income plus 20 percent of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20 percent of taxable income minus net capital gains.

Qualified business income includes domestic income from a trade or business. Employee wages, capital gain, interest and dividend income are excluded.


The deduction has two components:

  1. Eligible taxpayers may be entitled to a deduction of up to 20 percent of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate.

    For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction is subject to limitations such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition of qualified property held by the trade or business. Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.

  2. Eligible taxpayers may also be entitled to a deduction of up to 20 percent of their combined qualified real estate investment trust dividends and qualified publicly traded partnership income. This component of the section 199A deduction is not limited by W-2 wages or the unadjusted basis immediately after acquisition of qualified property.

The sum of these two amounts is referred to as the combined qualified business income amount. Generally, this deduction is the lesser of the combined qualified business income amount and an amount equal to 20 percent of the taxable income minus the taxpayer’s net capital gain.

The deduction is available, regardless of whether an individual itemizes their deductions on Schedule A or takes the standard deduction.
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