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 25% of the gross W-2 wages paid by your business or 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 the 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 any more.
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 web sites.
Do this now with your 2017 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 to file your 2018 tax returns.
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. This is probably the most stupid and likely to be the most litigated provision in the new tax law. Let’s go back to our example of an IT services company.
I believe the law is squarely aimed at any business with highly skilled and paid employees. Is an IT business dependent on the knowledge of its employees? Almost certainly yes, or it’s not a very competent IT company. IT companies would seem to be subject to the phase out of the deduction.
However, what decent companies aren’t dependent on the skills of one or more of their employees? If they don’t need employees, they don’t hire them. Aren’t doggie waste pickup companies dependent on employees skilled at handling doggie do do? I’m not skilled in that regard.
The IRS will write rules on this, and we will all hate the rules. Expect a decade of tax court litigation over this unless Congress rationalizes the rule.
Don’t hold your breath waiting on new rules.
Let’s 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 our part. Getting this right will cost money, but getting it wrong could cost a lot more.
There are many other provisions to the new deduction. I’ll cover them in future posts. Bookmark our blog page.
Thanks for reading!
Frank Stitely, CPA, CVA