By John R. Steffee, CPA, CSEP
For those who own a small business, Section 199A of the tax law that passed in December 2017 includes a provision for a personal income tax deduction equal to 20 percent of the small business’s income. This section was further defined by an IRS regulation in August 2018: it reinforced the basic simplicity of the deduction, but it also left open a great many questions about the finer details.
Here’s the simple part. If you are a married couple filing a joint return and your taxable income is less than $315,000 ($157,500 for everyone else), then, if applicable, you will be able to take a deduction equal to 20 percent of either the total income included on your return from a sole proprietorship, an S corporation, a partnership, and/or real estate rental income or your total taxable income, whichever is less.
If your income exceeds the limits shown above, well, let’s just say it’s not simple. At this level of income there are two exceptions to the basic rule.
The first exception to the limit is for Specified Service Trade or Business (SSTB) entities. An SSTB is any business involving services performed in health care, law, consulting, athletics, financial services, brokerage services, or any trade or business where the business’s principal asset is the reputation or skill of one or more of its employees or owners. This last catch-all phrase will most likely result in many disputes between taxpayers and the IRS that will take years to work through the courts before we know exactly who qualifies as an SSTB and who does not. We do know that engineering and architectural services are specifically not included in the definition of an SSTB.
The second exception to the limit – performing services as an employee – is more straightforward, although it may intensify the conflict between classifying workers as independent contractors or employees.
Both these exceptions are phased in as your married filing jointly income increases from $315,000 to $415,000, ($157,500 to $207,500 for everyone else). A deduction will be limited based on whether your business qualifies as an SSTB, the W-2 wages paid by the business, and the unadjusted basis of property used in the business.
Basically, here’s how the exceptions will affect your tax return. If you are included in the SSTB definition, then your Section 199A deduction will be phased out as your income goes from $315,000 to $415,000. If you are not included in the SSTB definition, as your income approaches and exceeds $415,000 your Section 199A deduction will be limited to either 50 percent of the amount of your payroll or 25 percent of the amount of your payroll plus 2.5 percent of the cost of certain assets you use in your business.
Sound complicated? You’re right. It would be in your best interest to seek out and follow the guidance of a professional to make sure you are taking full advantage of this new and confusing small-business tax provision.
John R. Steffee, CPA, CSEP, is a partner with Simon Lever in Wormlesyburg, Pa., and a member of PICPA’s CPA Image Enhancement Committee.