It’s tax time, and for many New Hampshire business owners, the annual 20% federal income tax deduction potentially available to them under Internal Revenue Code Section 199A will be hugely important. Hence this third of three consecutive columns on the section.
For non-tax people: For the reasonably foreseeable future, I promise no more tax! However, I do hope this column will be useful to federal tax professionals, if only as a review of what they already know about Section 199A.
For clarity, and in case anyone wants to discuss this column with me or with others, I’ll number its paragraphs.
1) If the taxable income you report for 2022 is less than your Section 199A “threshold amount,” your Section 199A deduction will be determined under section 199A(b)(2)(A) as 20% of your “qualified business income” — an easy computation. (The term “high earner” is my term, not Section 199A’s.) For most businesses, “qualified business income” simply means their net business income — that is, their gross income less all federal tax deductions. The Section 199A threshold amount for individuals who file jointly is $340,100; for separate filers, it is $170,050. (The above “20%” is subject to a rather technical general deduction for all taxpayers that I won’t discuss here.)
2) If you are a high earner — i.e., if, your taxable income is at or above your Section 199A threshold amount — your Section 199A deduction from your share of your business’s income will be determined under Sections 199A(b)(2)(A) and (B). Under these provisions, and if your business doesn’t own “qualified property,” your deduction will be the lesser of: a) 20% of your net business income; and b) 50% of the aggregate wages your business pays to its employees.
3) Under Section 199A(b)(6), “qualified property” means, in essence, real estate, equipment and other tangible property owned by a trade or business, used by it in its business, and deductible under IRC Section 167.
4) If your LLC elects to be an S corporation for federal tax purposes, the above aggregate compensation will include its compensation to you yourself if you are an employee of your business. For any LLC in which one or more owners are also employees, an election under Subchapter S will sometimes make a lot of sense.
5) To compute your “high earner” deduction under Sections 199A(b)(2)(A) and (B), start with the following simple algebraic formula: 0.2(X-Y) = 0.5Y, where X equals your business gross income and Y equals the above aggregate wages.
6) Once you’ve done that math, if the left side of your computation exceeds the right side, you will need to increase the amount on the right side so that the right side will equal or exceed the left side. This is because, under Section 199A(b)(3)(B), if the left side exceeds the right, you will have to reduce your Section 199A deduction under the complex statutory formula in Section 199A(b)(3)(B)(ii). Under this formula, you must multiply the excess of the left side over the right side by a fraction of which the numerator is your taxable income and the denominator is your threshold amount, and then you must subtract the resulting number from your deduction under the left side.
7) What if your business does own Section 167 property? If this is the case, then, for 2022, your deduction will be the lesser of 20% of your net business income and the greater of (i) 50% of your business wages and (ii) 25% of your business’s aggregate wages plus 2.5% of the “unadjusted basis immediately after acquisition” of all qualified property owned and used by your business in 2022 (before, of course, any required application of Section 199A(b)(3)(B)). To compute your Section 199A deduction in this situation, you’ll have to adjust the above algebraic formula; but anyone who has a basic knowledge of algebra and of Section 199A will find the adjustment to be easy.
8) If your business is a Section 199A(d)(2) “specified service trade or business” (an “SSTB”), you may have to reduce your “high earner” Section 199A deduction under the formula set forth in Section 199A(d)(3). SSTBs consist of all of types of businesses normally described as professional businesses — e.g., accountants, attorneys, and physicians — plus certain types of investment businesses, but with the exception of architects and engineers.
9) In addition, you must use special rules to compute your Section 199A deduction if your business consists of farming or horticulture.
10) A final point: Tax scholars have described Section 199A as the most complex of all of the dozens of major amendments to the Internal Revenue Code in 2017. Thus, while I’m confident that the above discussion of the section is accurate, your own Section 199A deduction may have to take into account exceptions not noted above. So don’t just rely on this column to compute this deduction; rely on your Section 199A deduction as computed by a tax preparer with substantial Section 199A expertise.
If any readers would like a version of this column and of the other two columns I’ve published recently about Section 199A in a single Word document, let me know and I’ll email you that document.
John Cunningham is a lawyer licensed to practice law in New Hampshire and Massachusetts. He is of counsel to the law firm of McLane Middleton, P.A. Contact him at 856-7172 or [email protected]. His website is llc199a.com. For access to all of his Law in the Marketplace columns, visit concordmonitor.com.