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Understanding The 20% Passthrough Deduction

Updated: Nov 29, 2023

The 20% Passthrough Deduction for Qualified Business Income


Internal Revenue Code Section 199A generally provides a 20% passthrough deduction for qualified business income (QBI) derived from a sole proprietorship, partnership or S corporation that is a qualified trade or business, like a trucking business.

  • The Sec 199A deduction is taken from adjusted gross income (AGI) in determining taxable income and therefore does not reduce self-employment income.

  • Most eligible taxpayers were able to claim it for the first time when they filed their 2018 federal income tax return in 2019.

  • The deduction is available, regardless of whether an individual itemizes their deductions on Schedule A or takes the standard deduction.


 


 

Internal Revenue Code Section 199A


The section 199A deduction is the lesser of:

  1. The combined qualified business income (QBI), or

  2. 20% of the excess (if any) of

    • Taxpayer’s taxable income for the year over

    • Taxpayer’s net capital gain


WARNING: Section 199A deduction:

  • Is not available for wage income or business income earned through a C-corporation.

  • Qualified business loss from a separate business reduces QBI by 20% as well.

Qualified Business Income (QBI) is defined at Sec 199A(c) as the net amount of qualified items of income, gain, deduction, and loss for a tax year with respect to any qualified trade or business of the taxpayer.


Example 1

  • Harvey Trucker, is single

  • Sole Proprietor

  • Has Schedule C business income of $150,000

  • Income below $170,050 threshold

  • $150,000 from Sch. C is QBI

  • $150,000 x 20% = $30,000 pass-through deduction

Example 2

  • Harvey Trucker, is single

  • Sole shareholder and employee of S corporation

  • Pays himself $80,000 of wages

  • Has K-1 business income of $50,000

  • Income below $170,050 threshold

  • Wages are not qualified business income

  • $50,000 from K-1 is QBI

  • $50,000 x 20% = $10,000 pass-through deduction

Example 3 - Disparities from Entity Choice

  • Assume Harvey’s taxable income is $150,000, all from the business

  • S-Corp: He pays himself $100,000 of wages

  • As a sole proprietor Harvey has $150,000 of QBI and a QBID of $30,000 ($150,000 x 20%)

  • With the S corporation, however, Harvey has only $50,000 of QBI and a QBID of $10,000 ($50,000 x 20%


 

Who is eligible for the deduction?


Small businesses with qualified income below:

  • $340,000 for married couples filing jointly

  • $170,050 for single filers

How do S-Corporations and partnerships handle the deduction?


S-corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI and W-2 wages on Schedule K-1 so the shareholders or partners may determine their deduction.


The estimated average annual burden hours per taxpayer is 2.5 hours, thus taxpayers are advised to seek professional tax guidance when calculating the deduction for their business. Have an IRS issue or tax question? Request a free consultation with Mark Sullivan, EA HERE




 

Copyright 2022 Mark Sullivan Consulting, PLLC. Per Diem Plus proprietary software is the trademark of Per Diem Plus, LLC.®


Disclaimer: This article is for information purposes only and cannot be cited as precedent or relied upon in a tax dispute before the IRS.




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