Tax Reform Toolkit:  199A for Incomes within the Phase-In Range

The prior two Tax Reform Toolkit posts have explained the new 20 percent pass-thru deduction (i.e. 199A) as it applies to pass-thru owners with:

  1. Less than $315,000 (married filer) or $157,500 (single) of taxable income, or
  2. More than $415,000 (married) or $207,500 (single) of taxable income.

In the case of (1), the pass-thru deduction (A) is generally equal to 20 percent of the taxpayer’s qualified business income (QBI).  W-2 wages paid and depreciable assets limit the upper-income pass-thru deduction (B), but the basics are relatively straightforward.

Then there is the case of someone whose taxable income lies within the $100,000 phase-in range between $315,000 and $415,000 (half of those amounts in the case of single filers).  Taxpayers in this range can be separated into two groups:

  1. Taxpayers who would not qualify for the deduction if they had made more than $415,000 ($207,500), and
  2. Everybody else

The first group includes taxpayers whose businesses do not pay any W-2 wages or have any depreciable assets as well as those in the business of a “specified service” (e.g. attorneys and accountants).  Both groups of business owners use (A) to begin calculating their allowable deduction, but the formula is simpler for the first.

Example: Group 1

Consider Paul, a joint filer with $365,000 in taxable income and $300,000 of qualified business income (QBI).  Had Paul’s taxable income been $310,000, he would have been eligible for the full deduction, equal to 20 percent of QBI, or $60,000 (A).  Had Paul claimed over $415,000 of taxable income, he would not have qualified for any 199A deduction as his business did not pay W-2 wages or have depreciable property.

However, Paul made $50,000 less than the phase-out threshold, equal to 50 percent of the $100,000 phase-in range for joint filers.  To calculate his allowable deduction, he must subtract this percentage from 100%, yielding 50%.  He then multiplies (A) by 50% and sees that he is entitled to a 199A deduction equal to $30,000.

In general, this type of taxpayer can calculate their limited deduction by multiplying their full 20% deduction (QBI x 20%) by the percentages associated with their taxable income as shown below.

 

Example: Group 2

Now take the case of Mary.  Her circumstance is identical to Paul’s except that her business pays out $100,000 in W-2 wages and owns $500,000 of depreciable assets.  Therefore, unlike Paul, her 199A deduction would not fully phase out if her taxable income exceeded $415,000.

To determine her maximum allowable deduction, she needs to know the dollar amounts of:

  • (A), which is $60,000 just like Paul’s, and
  • (B), her deduction as limited by the wages and depreciable property tests for high-income earners

As noted in the last blog post, (B) is limited to the greater of 1) One-half of W-2 wages paid, or 2) One-quarter of W-2 wages paid, plus 2.5% of depreciable property.  For Mary, (B) equals $50,000 because the former ($50,000 = 0.5 x $100,000) is greater than the latter ($37,500 = (0.25 x $100,000) + (0.025 x $500,000)).

The final step uses the amount by which (A) exceeds (B) and the amount by which taxable income exceeds the phase-in threshold as a percentage of $100,000 (or $50,000 for single filers).  These two numbers are known as the “excess amount” and “applicable percentage,” respectively, and are used to calculate the amount by which Mary must reduce (A).  The step-by-step is shown below.

Income after deductions ($365,000) minus $55,000 equals $310,000.  Under the new tax brackets, this $55,000 reduction saves Mary $17,200 in taxes.

The next Tax Reform Toolkit post will examine changes to the business interest deduction and its dynamic with the new depreciation rules.

DISCLAIMER

This article is for informational purposes only. It should not be considered tax advice. Before making any tax decisions, work with a tax professional. For more detail, please see the full disclaimer.



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