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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
199A, a new deduction for passthrough business income. In
design, the deduction is relatively simple: it is equal to as
much as 20% of qualified business income in a tax year.
Available evidence suggests that Congress created the
deduction mainly to give noncorporate businesses a tax cut
comparable to the reduction in the corporate income tax
rate under P.L. 115-97 from a top rate of 35% to a single
rate of 21%.
A passthrough business falls into one of three legal
categories: a sole proprietorship, a subchapter S
corporation, or a partnership (including a limited liability
company [LLC] electing to be taxed as a partnership). In
each case, the items of income, loss, gain, deduction, and
credit for the business are passed through to the owners
(whether distributed or not in the cases of S corporations
and partnerships), and any profits are taxed at the owners'
individual income tax rate. By contrast, the profits of a
subchapter C corporation are taxed twice: once at the entity
level, and a second time at the owners' level when the
profits are distributed to them in the form of dividends and
long-term capital gains. A sole proprietor reports her
business profit or loss on Schedule C of Form 1040, while a
partner and an S corporation shareholder report their share
of their business's profit or loss on Schedule E.
Most U.S. businesses are organized as a passthrough
business. According to the Internal Revenue Service,
passthrough firms filed 95% of the 33.4 million business
tax returns for the 2013 tax year; sole proprietors filed 72%
of the returns, followed by S corporations (13%),
partnerships (10%), and C corporations (5%).
Summary of Current Law
Section 199A allows individuals, estates, and trusts with
passthrough business income to deduct up to 20% of their
qualified business income (QBI) in determining their
taxable income from 2018 to 2025. Owners of agricultural
and horticultural cooperatives may also claim the
deduction. The deduction does not affect a taxpayer's
adjusted gross income (AGI), as it is claimed below the
line. Nor can a taxpayer claim the deduction as an itemized
deduction. Nonetheless, the Section 199A deduction may
be claimed by taxpayers who take the standard deduction
and those who itemize their deduction.
A taxpayer's QBI is defined as the net amount of items of
qualified income, loss, gain, and deduction for each
qualified domestic trade or business he or she actively or
passively owns, in whole or in part. If a taxpayer owns
more than one qualified business, then the QBI must be
determined separately for each of them; those amounts are
combined to determine her or his total QBI in a tax year.
QBI does not include short-term and long-term capital
gains, dividends, interest income and annuity unrelated to a
qualified trade or business, certain income items described
in Section 954, reasonable compensation paid to S
corporation shareholders for services they performed for the
business, and guaranteed payments to partners under
Section 707(c) for services rendered to a partnership. Nor
does it include income from the performance of services as
an employee.
In general, the deduction for QBI in a tax year is equal to
the sum of
* the smaller of (1) a taxpayer's combined qualified
income amount for the year, or (2) an amount equal to
20% of taxable income computed without the Section
199A deduction, reduced by any net capital gain and
qualified cooperative dividends, plus
* the smaller of (1) 20% of qualified cooperative
dividends, or (2) taxable income, reduced by any net
capital gain.
A taxpayer's combined qualified income amount is the
sum of
* the deductible amounts of QBI from all qualified
businesses she/he owns, and
* 20% of any qualified real estate investment trust
(REIT) dividends and qualified income from publicly
traded partnerships she/he receives.
The deductible amount from a qualified trade or business is
generally the smaller of
* 20% of a taxpayer's QBI from all qualified trades or
businesses, or
* a W-2 wages/qualified property limit, which is the larger
of (1) 50% of a taxpayer's share of total W-2 wages
attributable to each qualified business in a tax year, or
(2) the sum of 25% of a taxpayer's share of W-2 wages
plus 2.5% of her/his share of the unadjusted basis of all
qualified property attributable to each business.
The deduction cannot exceed a taxpayer's taxable income
from all sources in a tax year, reduced by any net capital
gain. Use of the deduction hinges on four considerations:
(1) the taxable income of a taxpayer with QBI, (2) the
nature of the trade or business generating the QBI, (3) the
taxpayer's share of W-2 wages for the QBI, and (4) the
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