Section 199A: Tax reform’s gift to PMPs

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Section 199A, passed as part of U.S. tax reform efforts in December 2017, gives many small business owners a 20 percent qualified business income (QBI) deduction. Generally, QBI is income from a trade or business received by an individual from a “flow-through” business: a sole proprietorship, a partnership, a limited liability company (LLC) or an S corporation. Pest management professionals (PMPs) with positive income qualify for the deduction.

Why would you get a tax deduction for a certain type of income? The short answer is that the Section 199A deduction was needed to help level the playing field for small businesses that are privately owned. Tax reform cut taxes for C corporations; the highest rates went from 35 percent to 21 percent. Many small businesses are taxed on individual tax returns at federal rates of up to 37 percent. To keep small businesses competitive with larger corporations, the U.S. Congress enacted a partial deduction for QBI. The deduction has the effect of lowering the federal income tax rate on that income.

Section 199A is complex for high-income earners and professional services companies such as doctors, lawyers or accountants. However, for most of us, it’s pretty straightforward.
 

HOW IT WORKS

How much taxable income is on your personal tax return? Is it $160,725 or less? Is it $321,400 or less if you are married filing jointly?

If you answered “yes,” your Section 199A deduction is computed based on a relatively
simple calculation. Your Section 199A deduction is the lesser of:

• 20 percent of your taxable income less your net capital gain, which generally is your capital gains plus dividend income, or
• 20 percent of your QBI.

If you answered “no” and you have QBI, you’ll probably need help from a tax professional. The rules get complicated quickly. For those with taxable income of more than $160,750 ($321,400 for married filing jointly), their Section 199A deduction is subject to the following limitation:

All QBI for firms such as pest control companies is subject to a limitation on the Section 199A deduction based on W-2 wages paid by the business and the unadjusted asset basis in the business. The higher these attributes, the greater the Section 199A deduction. Note that the unadjusted asset basis generally is the acquisition cost of property on your balance sheet. It includes tangible property, including buildings, but does not include land.
 

FOUR CAVEATS

Before taking the Section 199A deduction, consider:

1. QBI does not include wage (W-2) income.
2. It is important to maintain documentation supporting that the activity is a trade or business.
3. It is important that the activity not be considered
   a hobby.
4. Rental income from the active conduct of a rental real estate trade or business is QBI. Income from the renting out of buildings where the owner is not engaged in a real estate trade or business is not QBI.

The Section 199A deduction can be a huge deduction that can lower a PMP’s taxes immensely. But at higher income levels, the rules and calculation can become extremely confusing and complicated.