Tax Reform Toolkit: Pass-Thru Deduction Rules for High Income Taxpayers

    Eye on Housing’s first Tax Reform Toolkit post explained the basics of the new 20% deduction for pass-thru income (i.e. the 199A deduction). That article focused on how the deduction works for a taxpayer who has less than $315,000 of taxable income if married and filing jointly ($157,500 if single). In general, these taxpayers may deduct 20 percent of their pass-thru income from their adjusted gross income before calculating their tax liability.

    Individuals and families above these thresholds, however, must calculate their deduction using the W-2 wages paid to employees of, and the depreciable property held by, their business.

    These wage and property rules are phased in between $315,000 and $415,000 in taxable income for married couples filing jointly (one-half those amounts for single taxpayers).

    This article examines cases in which the limitations are fully phased in (i.e. taxable income is greater than $415,000/$207,500). The next post will explain how everything discussed to this point comes together in the case of a taxpayer whose income lies within the phase-out range.

    “Need-to-know” numbers

    These taxpayers must know three amounts before they can calculate their allowable deduction:

    1. W-2 wages paid to employees

    2. The prices paid for all depreciable assets owned by the pass-thru

    3. Taxable income—defined as income less deductions except for 199A

    Determining the potential 199A deduction amount

    With these in hand, calculate the maximum allowable deduction using the following two methods:

    Method 1: Multiply the amount of W-2 wages paid to employees (or your share of wages paid if you are one of multiple shareholders or partners) by 50%. Call this maximum allowable deduction ‘A’.

    Method 2: Multiply W-2 wages paid by 25%. Call this amount (i). Add up the prices paid for all assets currently being depreciated (note this is done on a cost basis rather than using the value of assets after depreciation). Multiply the cost of depreciable assets by 2.5%. Call this amount (ii). Add (i) and (ii) and call the sum “maximum allowable deduction ‘B’.”

    Now apply the “lesser of” rule which states that your maximum allowable deduction is equal to the lesser of:

    – The greater of A or B, or

    – Taxable income multiplied by 20%.


    Randy has $600,000 in qualified business income (QBI)—representing all of his household’s income—and would ideally like to take a deduction equal to 20% of that, or $120,000. He also plans on taking $100,000 in itemized deductions.

    In 2018, Randy’s pass-thru business:

    – Pays $200,000 in W-2 wages

    – Owns $1 million of qualified depreciable property

    Because he is above the income threshold, he must use methods 1 and 2 to calculate his maximum allowable deduction before applying the “lesser of” rule.

    Now Randy applies the “lesser of” rule using 20% of his taxable income.

    As he has $600,000 of income and takes $100,000 of deductions, Randy’s taxable income for these purposes is $500,000. Thus, his 199A deduction may not exceed 20% of $500,000, or $100,000. Fortunately, this does not further limit his allowable deduction, as his maximum 199A deduction allowed (A) is also $100,000.

    In the end, Randy may deduct a total of $200,000 (itemized deductions plus 199A) from his adjusted gross income before calculating his tax liability. Therefore, rather than paying tax on $500,000 as he would have under prior law, he will pay tax on only $400,000.

    The next Tax Reform Toolkit post will explain how to calculate the 199A deduction of a taxpayer whose annual taxable income falls within the phase-in range.


    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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    One thought on “Tax Reform Toolkit: Pass-Thru Deduction Rules for High Income Taxpayers

    1. David: Do your computations change if the recipient of the $200,000 salary is Randy, versus a non-Randy employee? The verbiage that I have read, about Section 199a QBI, says that “shareholder salaries are not included in QBI.” I wish they would not use the verb “include” with respect to expenses/deductions, because I cannot tell if it means that you arrive at QBI after having deducted the s-corp shareholder’s salary, or if it means that, in the process of computing QBI, you do not take a deduction for the s-corp shareholder’s salary. Thanks…–Dan Drew

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