Does the new 2020 Section 199A calculator make the Section 199A calculation easy? Yes, you can big-picture your Section 199A deduction in seconds.
Use the calculator to take a variety of looks at this great tax deduction. The calculator lets you consider the phase-in and phase-out zones for in-favor and out-of-favor trades and businesses, and you can do this in seconds.
You will find that the calculator saves you time and gives you focus.
As you likely know by now, the Tax Cuts and Jobs Act created a 20 percent tax deduction under new tax code Section 199A.
The question for you: will you reap benefits from this new deduction?
And the second question: if things look bleak as to your qualifying for the 20 percent tax deduction, what can you do in the following eight months to create some hope for the deduction?
This article and the calculator are here to help you realize this tax deduction.
Brief 199A Review
If you operate your business as a pass-through entity, such as a proprietorship, a partnership, or an S corporation, the profits of that business can generate the Section 199A tax deduction.
You qualify for the Section 199A deduction—period, regardless of pass-through business type— when you have
pass-through qualified business income (QBI), and 2020 Form 1040 taxable income equal to or less than $163,300 (single and head of household) or
$326,600 (married, filing jointly)
With Form 1040 taxable income equal to or less than the thresholds above, doctors, lawyers, accountants, financial planners, stockbrokers, manufacturers, retailers, consultants, and all other businesses with pass-through income qualify for the deduction.
In other words, regardless of type of pass-through business (doctor or retailer), your pass-through
income faces no phase-out impediments.
And the calculation is easy.
With taxable income equal to or less than the thresholds, you qualify for the Section 199A deduction. Your deduction will equal the lesser of
1. 20 percent of your Form 1040 taxable income less net capital gains and dividends, or
2. 20 percent of your QBI.
Note that qualification for the deduction starts with your Form 1040 taxable income.
Example. You are married with joint taxable income of $325,000 and QBI of $350,000. Your Section
199A deduction is $65,000.
As you can see, no issues. Here’s how this looks in the 2020 Section 199A calculator:
Remember, the taxable income is your Form 1040 taxable income before the Section 199A deduction.
For what QBI is, see IRS Issues Final Section 199A Regulations and Defines QBI.
Capital Gains and Dividends
When computing the Section 199A deduction, the ceiling on the deduction is 20 percent of your taxable income after excluding net capital gains and dividends. You can see how the IRS defines this in IRS Clarifies Net Capital Gains in Final 199A Regulations.
To see the impact, let’s say you had (a) taxable income of $320,000, (b) QBI of $350,000, and (c) capital gains and dividends of $40,000.
Note how the capital gains and dividends reduce your 199A deduction from $65,000 in the first example to the $56,000 shown above.
Wages and Property
When your 2020 Form 1040 taxable income is equal to or less than $163,300 (single and head of household) or $326,600 (married, filing jointly), wages and property are not considered for the Section 199A deduction.
For example, say that your business had $100,000 of wages and $1 million of qualified property and that your taxable income, net capital gains and dividends, and QBI were the same as above. Your Section 199A deduction is unchanged, as you see below:
Key point. When your Form 1040 taxable income is less than the thresholds, your Section 199A calculation is straightforward. You consider only taxable income, net capital gains and dividends, and QBI. Wages and property have no effect.
When your Form 1040 taxable income is above the threshold but does not exceed the sum of the threshold plus $50,000 ($100,000 for a joint return), you are in what the tax code calls a “phase-in limit.”
To clarify, at this level, the tax code is phasing in the need for wages and/or property for you to qualify for the deduction.
For example, with taxable income greater than $213,300 (single, including head of household) or $426,600 (married, filing jointly), and no wages and/or property, your Section 199A deduction is zero.
So, wages and/or property start to become important when you are above the thresholds and in the phase-in range. At that point, the following happens:
In-favor business. You need wages and/or property to qualify for the Section 199A deduction.
Out-of-favor specified service trade or business. You do not qualify for the Section 199A deduction when your Form 1040 taxable income exceeds the threshold plus the phase-in amount.
When your taxable income puts you inside the phase-in range, with wages and/or property or without, you will find the calculator very handy indeed.
The phase-in applies to all taxpayers, both the in-favor businesses and the out-of-favor specified service trades or businesses.3 But the out-of-favor business suffers a phase-out of the phase-in (think double phase-out).
The numbers tell the story. We’ll start with an in-favor business.
Example 1. You have taxable income of $386,600 and $200,000 of QBI from an in-favor business. Your deduction is as follows:
What happened? You have $60,000 of taxable income in the phase-in range of $100,000; accordingly, you lost 60 percent of your QBI deduction because your taxable income is 60 percent above the threshold.
Example 2. You have the same facts as in Example 1 above, but this time you operate an out-of- favor specified service trade or business, such as a dental or accounting practice. Your results
are as follows:
Because your QBI is from an out-of-favor business and your taxable income is 60 percent above the threshold, you suffer a second phase-out, leaving you with 40 percent of what the in-favor business would qualify for as a Section 199A deduction ($16,000 x 40 percent = $6,400).
In-favor businesses are those that are not out-of-favor. For what to know about the out-of-favor groups, see the following articles:
· New IRS 199A Regulations Benefit Out-of-Favor Service Businesses
· IRS Section 199A Final Regs Shed New Light on Service Businesses
Once taxable income is above the threshold, the in-favor business benefits greatly from wages. Say you add $100,000 of wages to Example 2. Your result is as follows:
With no wages as shown above, your deduction was $16,000. The $100,000 of wages increased your deduction to $40,000 (20 percent of QBI).
Once income is above the threshold plus $50,000 ($100,000 on a joint return), you need wages and/or property to qualify for any Section 199A deduction if you operate an in-favor business.
And when you operate an in-favor business and are in the phase-in limit range, wages can eliminate the ill effects. That’s what happened with the $100,000 in wages in the calculator example above.
Important: Wages eliminate the phase-in problem, but they do not cure the phase-out problem for the out-of-favor specified service trade or business, as you can see in the out-of-favor specified service business calculation below:
With the same facts as an in-favor business, your out-of-favor business suffers a 40 percent reduction ($40,000 x 40 percent = $16,000) because your taxable income has you at 60 percent of your upcoming zero deduction.
Yes, it’s sad but true. When your taxable income exceeds the threshold plus phase-in, your out-of- favor business creates a zero Section 199A deduction regardless of wages and/or property. You can see how the law makes this complicated, but the calculator makes it easy to understand. To access the 2020 calculator, click here.
Wage and Property Calculation Rules
The wage and property calculations come into play when taxable income is
in the phase-in and phase-out ranges (regardless of whether it’s an in-favor or out-of- favor business); or
above the thresholds plus $50,000 ($100,000 married, filing jointly) when you operate an in-favor business.
When you operate an in-favor business and you are above the threshold, your Section 199A deduction
is the lesser of
1. 20 percent of your taxable income minus net capital gains and dividends; or
2. the lesser of
· 20 percent of your QBI, or
50 percent of the W-2 wages with respect to the qualified trade or business OR the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property—whichever is greater.
For what makes up the wages, see IRS Updates Defined Wages for New Section 199A Tax Deductions.
“Qualified property” means the unadjusted basis (generally, the original cost) of property that is (a) on hand at the end of the year that the business depreciated during the year and (b) is either
· 10 years or less in age from the date you first placed it in service, or
· not yet past the last day of its recovery period.
Key point. If your taxable income exceeds the thresholds by $50,000 ($100,000 married, filing jointly), any out-of-favor specified service trade or business produces no Section 199A deduction, regardless of wages or property.
You can see why the Section 199A calculator is a super handy tool when your 2020 taxable income is greater than $163,300 (single and head of household) or $326,600 (married, filing jointly).
Now that you see how the 2020 calculator works, you can see how it can help with tax planning ideas.
Let’s look at Harry. He is self-employed; in the in-favor group; and single, with taxable income of $400,000 and QBI of $370,000. With no wages or property, Harry’s Section 199A deduction is zero.
What can Harry do to give himself a raise in pay?
Solution. Harry changes his business structure to become an S corporation and has his S corporation pay him $100,000 in wages.
With the wages, Henry’s taxable income is still $400,000; his QBI is now $270,000, the wages are $100,000, and his Section 199A deduction is $50,000 (50 percent x $100,000).
Bonus money. Harry also saves $10,834 in self-employment taxes.7
Note how important tax planning is to Harry. With no tax planning, Harry gets a zero Section 199A deduction and pays a lot of self-employment taxes.
By getting his S corporation in place, Harry deducts $50,000 under Section 199A and also saves $10,834 on his self-employment taxes.
You have to guess that Harry will have a good use for this newly created cash windfall. And with no changes in his income, he will reap this windfall each year from now through tax year 2025, as the law now allows.
For additional strategies to consider when you want to increase your Section 199A tax deduction, see the following articles:
· 2018 Last-Minute Section 199A Strategies
· Use a Conservation Easement Donation to Create a $63,000 199A Deduction
If your 2020 taxable income will be $326,600 or less (married, filing jointly) or $163,300 or less (single or head of household), you can relax. You have no Section 199A tax planning to do. You qualify for the 20 percent deduction on your QBI—period.
Once your taxable income is above the thresholds, you need to consider tax planning—now. Why now? Because some strategies require that you have time on your side.
For example, if you switch from a proprietorship to an S corporation to benefit from the W-2 wage strategy, your switch does not begin until you have the S corporation in place.
If you are looking at a retirement plan strategy, you want time to consider your options and get that tax-saving plan in place.
If you are above the thresholds, make sure you take some time to review the strategies and do some calculations with the calculator.