Section 199A Frequently Asked Questions
Posted October 13, 2018
The Tax Cuts and Jobs Act of 2017 created a new tax deduction for business owners (and others) called the Section 199A Qualified Business Income Deduction. Later in August 2018, the IRS and the Joint Committee on Taxation released Proposed Regulations 1.199A to offer some additional insight to Section 199A. However, some of it reads well and some of it doesn’t, and we continue to field questions from clients and other small business owners all the time. As such we created a blog post titled Section 199A Frequently Asked Questions.
Before we get into Section 199A questions and answers, here are some additional resources for your review-
Ok, here we go-
Do I have to create an LLC to get the Section 199A deduction?
No. It is available to sole proprietors (no entity formation), rental property owners (as far as we know and the proposed regulations do not state otherwise), S corporation shareholders and partnerships (multi-member LLCs, LLPs, and all the other goofy variants). Having an LLC is a good idea for other reasons, but the Section 199A deduction is not one of them.
Is the Section 199A deduction a business deduction?
No. It is a deduction taken on the owner’s individual tax return on page 2 of Form 1040 on line 9. Don’t look at your 2017 tax returns for line 9… the IRS decided to chop up Form 1040 into multiple parts and relabeled them Schedules for the sake of everyone’s desire to have a postcard tax return. No one seems to complain about state tax returns which can easily exceed 3 pages (California).
Back to the IRS and Form 1040 being chopped up… For example, Schedule 1 is titled Additional Income and Adjustments to Income which is essentially page 1 of old school Form 1040. Here is a draft Form 1040 with the numbered schedules. As of October 13, 2018, the IRS was still tinkering with these. These numbered schedules plus the traditional lettered ones (A, B, C, D, E, F, etc.) is absolutely silly… have a 3 page Form 1040 with lettered schedules as necessary. Much simpler, yet we digress.
Is the Section 199A deduction available to rental property owners?
Defining a trade or business is easy for the most part, however certain activities are murky and one of them is rental properties. On one hand an argument that rental property income is already tax advantaged can be made since it is not subject to self-employment taxes (Social Security and Medicare). However, if it were subject to SE tax, people would simply create management entities, elect S Corp status, ding the rental a management fee and achieve a Section 199A deduction that way. This is perhaps one reason the IRS isn’t raising a big stink on rental properties.
Also, in Commissioner v. Groetzinger, 480 U.S. 23 (107 S.Ct. 980, 94 L.Ed.2d 25), the United States Supreme Court in 1987 held that for an activity to meet the definition of a trade or business it must have profit motive and operate with some regularity and continuity. This is also most rental property owners, even if it is just one house.
Why did they make the Section 199A deduction on the individual tax return of the owner?
Simple. The way Section 199A is written, there are limitations based on household income so it would be difficult for the business entity tax return to have visibility into each owners’ individual tax situation (not to mention privacy concerns).
What is the specified service trade or business nonsense I hear about?
Section 199A defines certain professions where the deduction is limited when certain income thresholds are exceeded. The list is health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing services and securities trading services. Plus any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.
I am a CRNA operating an S Corp. Am I considered a specified service trade or business?
Yes. The Proposed Regulations 1.199A expanded definitions of SSTBs. Specifically for health, the regs state that anyone who provides medical services is considered a specified service trade or business. This means that nurses, nurse anesthetists, chiropractors, physical therapists, massage therapists, etc.
Law includes attorneys, paralegals, mediators and arbiters. Accounting includes CPAs, Enrolled Agents, bookkeepers, tax professionals, financial auditors, etc. Credentials do not make or break this definition.
Where is the specified service trade or business determined?
SSTB is determined at the entity level. So, if an entity is designated a specified service trade or business, all owners are subject to this possible limitation regardless of their individual title or contribution to the business. For example, let’s say Fred Flintstone and Mr. Slate are owners together. And Mr. Slate’s reputation or skill is known all over the world and it is the primary catalyst for the success of the business. Fred will also be deemed an owner of a specified service trade and business, and could further be limited on his Section 199A deduction. Guilty by association.
If the business is deemed to be a SSTB, do I lose my Section 199A deduction?
Maybe. Perhaps. You might. Yes and No. This is one of the biggest confusions out there. If you are a married doctor making $300,000 as a household you do not lose your Section 199A deduction, but if you make $500,000 you do. Read that again. Being labeled as a specified service trade or business isn’t bad until you meet income thresholds, which are $157,500 for singles and $315,000 for married filing joint. These numbers represent the end of the 24% marginal tax bracket, and the next tax bracket is 32%. This means the 32%, 35% and 37% represent the wealthier taxpayers and as such the Section 199A deduction becomes limited.
What if I file married filing separately? Can I get around the SSTB limitations?
Nice try. The IRS is smart. Congress is smart. The Joint Committee on Taxation is smart. Stop laughing… really, they are! And they saw you coming a mile a way… probably heard you too. All kidding aside, the tax code is very, very careful to prevent simple tax arbitrage based on tax filing status. If you are married filing separately, your $315,000 becomes $157,500 anyway. And… if you are in a community property state it might not make a difference since the K-1 will be the tax document coded with the specified service trade or business designation and splitting your income 50-50 (like in California) doesn’t appear to help.
Jason Watson is the Managing Partner of the Watson CPA Group, a business consultation and tax preparation firm, and is the author of Taxpayer’s Comprehensive Guide on LLC’s and S Corps which is available online.