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October 25, 2018

Understanding the 20% Passthrough Deduction

Mark Sullivan- Per Diem Plus
Mark W. Sullivan, EA
Mark is our transportation industry expert and has over a decade of experience advising clients on IRS accountable per diem programs. 

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The 20% Passthrough Deduction for Qualified Business Income

Internal Revenue Code Section 199A generally provides a 20% passthrough deduction for qualified business income (QBI) derived from a sole proprietorship, partnership or S corporation that is a qualified trade or business, like a trucking business.

  • The Sec 199A deduction is taken from adjusted gross income (AGI) in determining taxable income and therefore does not reduce self-employment income.
  • Most eligible taxpayers will be able to claim it for the first time when they file their 2018 federal income tax return in 2019.
  • The deduction is available, regardless of whether an individual itemizes their deductions on Schedule A or takes the standard deduction.

The 199A deduction is complicated!  The estimated average annual burden hours per taxpayer is 2.5 hours, thus taxpayers are advised to seek professional tax guidance when calculating the deduction for their business. 

Internal Revenue Code Section 199A

The section 199A deduction is the lesser of:

  1. The combined qualified business income (QBI), or
  2. 20% of the excess (if any) of
    • Taxpayer’s taxable income for the year over
    • Taxpayer’s net capital gain

WARNING: Section 199A deduction:

  • Is not available for wage income or business income earned through a C corporation.
  • Qualified business loss from a separate business reduces QBI by 20% as well.

Qualified Business Income (QBI) is defined at Sec 199A(c) as the net amount of qualified items of income, gain, deduction, and loss for a tax year with respect to any qualified trade or business of the taxpayer.

Example 1

  • Harvey Trucker, is single
  • Sole Proprietor
  • Has Schedule C business income of $150,000
  • Income below $157,500 threshold
  • $150,000 from Sch. C is QBI
  • $150,000 x 20% = $30,000 pass-through deduction

Example 2

  • Harvey Trucker, is single
  • Sole shareholder and employee of S corporation
  • Pays himself $80,000 of wages
  • Has K-1 business income of $50,000
  • Income below $157,500 threshold
  • Wages are not qualified business income
  • $50,000 from K-1 is QBI
  • $50,000 x 20% = $10,000 pass-through deduction

Example 3 - Disparities from Entity Choice

  • Assume Harvey’s taxable income is $150,000, all from the business
  • S-Corp: He pays himself $100,000 of wages
  • As a sole proprietor Harvey has $150,000 of QBI and a QBID of $30,000 ($150,000 x 20%)
  • With the S corporation, however, Harvey has only $50,000 of QBI and a QBID of $10,000 ($50,000 x 20%)

What line on Form 1040 do you report the deduction on?

Line 9 of the Form 1040 for 2018 (draft). IRS will be issuing new tax returns, worksheets and other tools to assist individuals and businesses with their deduction calculation and tax preparation. DOWNLOAD 2018 DRAFT F1040 101718

Who is eligible for the deduction

Small businesses with qualified income below:

  • $315,000 for married couples filing jointly
  • $157,500 for single filers

When is the deduction modified?

Small business qualified income exceeds:

  • $315,000 - $415,000 for married couples filing jointly
  • $157,500 - $207,500 for single filers

How do S-Corporations and partnerships handle the deduction?

S-corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI and W-2 wages on Schedule K-1 so the shareholders or partners may determine their deduction.

Questions? Contact Mark W. Sullivan, EA


About: Per Diem Plus is a proprietary mobile software application that was designed by truckers and built by tax pros. It is the only IRS-compliant mobile app that automatically tracks each qualifying day of travel in the USA & Canada and replaces ELD backups (logbooks) to substantiate away-from-home travel.


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Reference: 2017 Tax Cut & Job Act, Kenneth K. Wright (2018)

Disclaimer

This article includes information is not included in the Internal Revenue Bulletin 2018-64, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.

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