March 5, 2019
2019 Tax Filing Season (2018 Tax Year): Section 199A
Deduction for Passthrough Business Income
The 2017 tax revision (P.L. 115-97) added, under Section
determined separately for each of them; those amounts are
199A, a new deduction for passthrough business income. In
combined to determine her or his total QBI in a tax year.
design, the deduction is relatively simple: it is equal to as
much as 20% of qualified business income in a tax year.
QBI does not include short-term and long-term capital
Available evidence suggests that Congress created the
gains, dividends, interest income and annuity unrelated to a
deduction mainly to give noncorporate businesses a tax cut
qualified trade or business, certain income items described
comparable to the reduction in the corporate income tax
in Section 954, reasonable compensation paid to S
rate under P.L. 115-97 from a top rate of 35% to a single
corporation shareholders for services they performed for the
rate of 21%.
business, and guaranteed payments to partners under
Section 707(c) for services rendered to a partnership. Nor
A passthrough business falls into one of three legal
does it include income from the performance of services as
categories: a sole proprietorship, a subchapter S
an employee.
corporation, or a partnership (including a limited liability
company [LLC] electing to be taxed as a partnership). In
In general, the deduction for QBI in a tax year is equal to
each case, the items of income, loss, gain, deduction, and
the sum of
credit for the business are passed through to the owners
(whether distributed or not in the cases of S corporations
the smaller of (1) a taxpayer’s “combined qualified
and partnerships), and any profits are taxed at the owners’
income amount” for the year, or (2) an amount equal to
individual income tax rate. By contrast, the profits of a
20% of taxable income computed without the Section
subchapter C corporation are taxed twice: once at the entity
199A deduction, reduced by any net capital gain and
level, and a second time at the owners’ level when the
qualified cooperative dividends, plus
profits are distributed to them in the form of dividends and
the smaller of (1) 20% of qualified cooperative
long-term capital gains. A sole proprietor reports her
dividends, or (2) taxable income, reduced by any net
business profit or loss on Schedule C of Form 1040, while a
capital gain.
partner and an S corporation shareholder report their share
of their business’s profit or loss on Schedule E.
A taxpayer’s “combined qualified income amount” is the
sum of
Most U.S. businesses are organized as a passthrough
business. According to the Internal Revenue Service,
the deductible amounts of QBI from all qualified
passthrough firms filed 95% of the 33.4 million business
businesses she/he owns, and
tax returns for the 2013 tax year; sole proprietors filed 72%
20% of any qualified real estate investment trust
of the returns, followed by S corporations (13%),
(REIT) dividends and qualified income from publicly
partnerships (10%), and C corporations (5%).
traded partnerships she/he receives.
Summary of Current Law
The deductible amount from a qualified trade or business is
Section 199A allows individuals, estates, and trusts with
generally the smaller of
passthrough business income to deduct up to 20% of their
20% of a taxpayer’s QBI from all qualified trades or
qualified business income (QBI) in determining their
businesses, or
taxable income from 2018 to 2025. Owners of agricultural
and horticultural cooperatives may also claim the
a W-2 wages/qualified property limit, which is the larger
deduction. The deduction does not affect a taxpayer’s
of (1) 50% of a taxpayer’s share of total W-2 wages
adjusted gross income (AGI), as it is claimed below the
attributable to each qualified business in a tax year, or
line. Nor can a taxpayer claim the deduction as an itemized
(2) the sum of 25% of a taxpayer’s share of W-2 wages
deduction. Nonetheless, the Section 199A deduction may
plus 2.5% of her/his share of the unadjusted basis of all
be claimed by taxpayers who take the standard deduction
qualified property attributable to each business.
and those who itemize their deduction.
The deduction cannot exceed a taxpayer’s taxable income
A taxpayer’s QBI is defined as the net amount of items of
from all sources in a tax year, reduced by any net capital
qualified income, loss, gain, and deduction for each
gain. Use of the deduction hinges on four considerations:
qualified domestic trade or business he or she actively or
(1) the taxable income of a taxpayer with QBI, (2) the
passively owns, in whole or in part. If a taxpayer owns
nature of the trade or business generating the QBI, (3) the
more than one qualified business, then the QBI must be
taxpayer’s share of W-2 wages for the QBI, and (4) the
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2019 Tax Filing Season (2018 Tax Year): Section 199A Deduction for Passthrough Business Income
taxpayer’s share of the unadjusted basis of tangible,
ratio of the excess of a taxpayer’s taxable income above the
depreciable capital assets used to generate the QBI.
lower threshold amount to $50,000 for single and HOH
filers, and $100,000 for joint filers.
Taxable income denotes a passthrough business owner’s
AGI less all deductions, excluding the Section 199A
The third outcome begins when the taxable income of
deduction. All trades and businesses are eligible for the
taxpayers with QBI exceeds $207,500 for single and HOH
deduction, except for those deemed a “specified service
filers, and $415,000 for joint filers. In this case, no
trade or business (SSTB),” or those based on the
deduction is available for income from SSTBs. In addition,
performance of services as an employee. W-2 wages are the
the deduction is subject to the W-2 wages/qualified
total wages attributable to a taxpayer’s QBI during a tax
property limit. This means that the deduction for a qualified
year that are subject to withholding, elective deferrals, and
business is the smaller of 20% of a taxpayer’s QBI for such
deferred compensation. The unadjusted basis of tangible,
a business, or the larger of (1) 50% of a taxpayer’s share of
depreciable assets refers to the acquisition cost of such
W-2 wages for a qualified business or (2) 25% of those
property attributable to a taxpayer’s QBI.
wages plus 2.5% of her/his share of the unadjusted basis of
qualified property used in the business.
The definition of a SSTB merits close attention because it
sets the boundaries between businesses that qualify for the
Comparison with Previous Law
deduction and those that do not for upper-income owners.
Federal tax law immediately preceding P.L. 115-97 offered
Basically, an SSTB owned by such individuals does not
no deduction for passthrough business income. But
qualify for the deduction. According to Section 199A, an
passthrough businesses (and C corporations) engaged in
SSTB is any trade or business involved in the performance
qualified production activities (e.g., mining and
of services in health, law, accounting, actuarial science, the
manufacturing) were generally eligible for a deduction
performing arts, consulting, athletics, financial services,
equal to 9% of their income from such activities. The
brokerage services, investing and investment management,
deduction could not exceed a taxpayer’s share of W-2
trading or dealing in securities, commodities, or partnership
wages attributable to domestic production income.
interests. Unlike Section 1202, which provides a capital
gains tax exclusion for qualified small business stock and
Selected Filing Issues
has a similar provision regarding eligible businesses,
According to one expert’s estimate, over 90% of
architecture and engineering do qualify for the deduction.
passthrough entities could qualify for a full or partial
Section 199A deduction for the 2018 tax year.
An SSTB also encompasses businesses whose principal
asset is the reputation or skills of one or more of its
But fewer firms may claim the deduction than are eligible
employees or owners. For example, an independent
for it. For many small passthrough business owners, two
contractor who has contracts with several unrelated
likely deterrents to benefiting from the deduction are the
companies and has minimal tangible and intangible
complexity of the provision and the recordkeeping required
property is considered an SSTB if the business’s main asset
to claim it. Among the challenges for eligible taxpayers is
is the reputation or skill set of the owner.
determining whether a firm’s business activities qualify for
the deduction and to what extent. The final regulations
There are three basic outcomes for claiming the Section
(T.D. 9847) for Section 199A issued by the IRS in January
199A deduction.
2019 provide some guidelines for identifying qualifying
businesses, but eligibility ultimately hinges on the “facts
In the first outcome, taxpayers with QBI who have taxable
and circumstances” for specific firms.
incomes in 2018 up to threshold amounts of $157,500 for
single and head-of-household (HOH) filers, and $315,000
For example, consulting does not qualify for the deduction
for joint filers, should be able to take a Section 199A
for upper-income taxpayers, whereas training does. So what
deduction equal to 20% of their QBI. This assumes that
would be the status of a firm’s business income under the
such an amount is less than 20% of any excess of the
rules for the deduction if it were to provide training along
taxpayer’s taxable income over the sum of any net capital
with advice and counsel (which the IRS considers a form of
gain and qualified cooperative dividends. Such an outcome
consulting) related to the training?
is the least complicated of the three.
Claiming the deduction for rental real estate businesses is
The second outcome is the most complicated of the three,
also a challenge, since owners of such property must pass a
as it includes a phase-in of the two limits. It applies to
three-part “safe harbor” test in order to qualify under IRS
taxpayers with QBI and taxable incomes in 2018 between
Notice 2019-7. The test requires a taxpayer to maintain
the threshold amounts of $157,500 and $207,500 for single
separate books and records for each real estate business;
and HOH filers, and between $315,000 and $415,000 for
demonstrate adequate recent active involvement in each
joint filers. For a taxpayer in this income range, the
business; and keep detailed records of the amount of time
calculation of QBI takes into account the “applicable
spent on this activity.
percentage” of all items of income, loss, gain, and
deduction for the taxpayer, and of W-2 wages or W-2
Gary Guenther, Analyst in Public Finance
wages plus qualified property allocable to the taxpayer’s
QBI. This percentage is 100% less the percentage that is the
IF11122
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2019 Tax Filing Season (2018 Tax Year): Section 199A Deduction for Passthrough Business Income
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