The former Section 199 Domestic Production Activities Deduction is repealed (Iowa is keeping it for 2018).
The new tax law established the Section 199A Qualified Business Income Deduction. Corporations (C-corps) may not take this deduction. Other taxpayers are allowed a 20% deduction of Qualified Business Income (QBI) from their taxable income, subject to a variety of limitations. S-Corporations and Partnerships will need to provide their shareholders and partners the information required to determine the deduction at the shareholder or partner level. The 199A deduction only relates to the computation of taxable income–it has no effect on the computation of self-employment tax for sole proprietors and partners. It also has no effect on determining Adjusted Gross Income. Note: Iowa will not allow this deduction in 2018, and will phase it in from 2019 through 2021.
What is Qualified Business Income (QBI)? As of this writing, it’s not completely certain precisely what qualifies as QBI. In its broadest sense, business income is the net income from a trade or business operating in the United States. A qualified trade or business is any trade or business other than a specified service trade or business (but see below for the income threshold for SSTBs), or the trade or business of performing services as an employee. Excluded from QBI are the reasonable W-2 wages paid to shareholder-employees and guaranteed payments made to partners (on their own tax returns). All QBI from all of a taxpayer’s trades or businesses are summed for the tax year. If the result is a loss, the loss is carried forward to the subsequent year to offset QBI that may be eligible for the 20% deduction that year.
See this page for further discussion on what may qualify as QBI.
In all cases, the 20% 199A deduction is limited by the 20% of taxable income limit. Taxable income for this purpose doesn’t include long-term capital gains or qualified dividends, which are subject to preferential tax treatment in their own right. So, if a taxpayer’s QBI is $100,000, there is a potential $20,000 199A deduction from income subject to tax. However, that deduction is limited to 20% of the taxpayer’s taxable income. If, after other income, deductions and credits are considered, and the taxpayer’s taxable income before the 199A deduction is $80,000, the 199A deduction will be limited to $16,000, or 20% of the taxpayer’s taxable income before the 199A deduction. If part of the $80,000 above was $10,000 in long-term capital gains and qualified dividends, the taxable income limit would be $70,000, and the 199A deduction would be $14,000. The remaining potential deduction is not carried forward.
The deduction is also potentially limited by a taxable income threshold, which begins at $315,000 taxable income for married filing joint (MFJ) taxpayers, and at $157,500 for all other taxpayers. For taxpayers below these thresholds, the only limitation for the 199A deduction is the taxable income limitation above (farmers–see next paragraph). This includes those in a specified service trade or business (SSTB). For taxpayers above the thresholds, there is a W-2 wage limit that is beyond the scope of these pages to describe. For SSTBs, their 199A deduction is phased out totally at the top of threshold range, even if they have employees. These thresholds fully phase in at $415,000 for MFJ taxpayers, and $207,500 for all others.
For farmers who sold commodities to cooperatives, a complex bifurcated calculation is required at all income ranges. They will need to be prepared to allocate their farming expenses among sales to cooperatives and sales to other buyers. See the discussion from Iowa State’s Center for Agricultural Law and Taxation blog for more information on this complex calculation.
In addition, a taxpayer may claim 20% deduction of certain qualified REIT dividends and Publicly Traded Partnership income, subject to limitations.
IRS has a Q&A on the new Section 199A deduction here.
The bottom line–many taxpayers with trade or business income from sole proprietorships, farming operations, and income from S-Corporations and partnerships will be able to deduct 20% of the net business income from their taxable income.