Section 199A – 20% Deduction for Pass Through Entities

The Tax Cuts and Jobs Act of 2017 legislation passed into law on 12-22-17 has a provision in it that allows for a reduction in taxable income for self-employed individuals who are sole proprietors or who have incorporated themselves as LLC’s, subchapter S-Corp’s or partnerships. It is contained in “Section 199A”.

This was included because during the legislative process there were complaints that the corporate tax rate cut from 35% to 21% would only benefit companies organized as “C” corporations and this was unfair to small business owners who make up a larger share of the economy.

The Section 199A deduction is designed to help businesses that provide a product through the use of labor as opposed to a company that provides a service through the use of capital, generally speaking. These types of companies are categorized as “qualified trade or business” (product/labor) or “specified service trade or business” (doctors, lawyers, accountants, consultants, financial services, brokerage to name a few).

A key definition in determining if a business is a “specified service trade” is whether or not “the principal asset of such trade or business is the representation or skill of 1 or more of its employees”.

The deduction is equal to 20% of the net income (qualified business income) from the business. W-2 wages paid to an S-Corp. shareholder as “reasonable compensation” don’t get this deduction.

This deduction does not reduce adjusted gross income (AGI).

That being said, a specified service trade, such as an accounting and tax practice may qualify for the deduction if the taxable income of the business owner/taxpayer does not exceed certain “thresholds”.

For a single taxpayer, that threshold is $157,500 with a “phase out” range up to $207,500.

For a married business owner filing jointly, the threshold is $315,000 with a “phase out” range up to $415,000.

So, a married filing jointly sole proprietor doctor, lawyer or CPA would get the 20% deduction (unless the business operated at a loss) as long as the taxable income is < $315,000 and would get a reduced deduction between $315,000 and $415,000. For a “qualified trade or business” not in the service area, the 20% deduction is available even if the taxable income exceeds $415,000 for a married couple filing jointly. The deduction may be reduced by a feature called the “W-2/QP limitation” which takes into account the wages paid to employees in the business and the cost basis of “qualified property”. I’ll write more about that as more details become available.

Deceased Spouse Unused Exemption (DSUE)

The Deceased Spouse Unused Exemption (DSUE) is a little known and often overlooked provision in the tax code in the Estates and Trusts area.

Each taxpayer (in a marriage) is allowed the current tax year (for 2017) estate tax exclusion of $5.49MM, so if the proper tax planning has been done, a total of $10.98MM could be excluded from estate tax.

Here are two examples using the same facts that have very different outcomes.
 

Scenario A:

Spouse A and B each have been married before they married each other. As a result, they keep their assets separately in their own names. Spouse A has $2MM of assets and Spouse B has $4MM of assets.

Spouse A passes in 2016. He leaves all his assets to Spouse B. Because of the marital deduction, there is no estate tax on Spouse A’s estate, but now Spouse B had $6MM of assets.

Spouse B passes in 2017 with a $6MM estate, over the estate tax exclusion of $5.49MM. Her estate will have a taxable value of $510,000.
 

Scenario B:

Upon the death of Spouse A, Spouse B files federal tax Form 706 within nine months of the decedent’s death electing “portability” of Spouse A’s “unused exemption”.

At Spouse A’s date of death, his assets were $2MM. He had an “unused exemption” of $3.49MM. Form 706 should be filed to claim this even if the deceased spouse’s assets are below the estate exclusion minimum.

Spouse A’s “unused exemption” of $3.49MM is added to Spouse B’s estate tax exclusion of $5.49 MM and now Spouse B has an estate tax exclusion of $8.98MM.

When she passes in 2017 with $6MM in assets but an

$8.98 million exclusion, her estate is not taxable.

 

Medical Expense Deduction

Medical Expense Deduction

Most of the provisions of the recent tax legislation passed by Congress called the “Tax Cuts and Jobs Act 2017” go into effect beginning on January 1st of 2018 (tax year 2018).

 

There are others, like the tax treatment of alimony for divorce or separation agreements executed after December 31, 2018 that won’t go into effect until tax year 2019.

 

There is one important provision which is effective for tax year 2017 which may impact the tax return you file this spring.

 

This provision regards the percentage of gross income used to exclude out of pocket medical expense deductions on Schedule A of your individual (1040) tax return, should you itemize your deductions.

 

Beginning in tax year 2013, with the passage of the Affordable Care Act (ACA), also known as “Obamacare”, an exclusion, equal to 10% of your adjusted gross income, which appears on line 37 of page 1 of your 1040, is used to reduce the dollar amount of your eligible medical deductions.

 

Prior to the passage of the ACA, the exclusion percentage was 7.5%.  With the passage of the “Tax Cuts and Jobs Act of 2017”, the 7.5% exclusion is reinstated for tax years 2017 and 2018.

 

Without additional legislation, this provision will expire on January 1st, 2019.