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Section 199A Frequently Asked Questions
By Jason Watson, CPA
Posted Wednesday, November 1, 2023
Here are some common questions and answers that have come up during recent consultations with clients. Some of these might be repetitive if you’ve been paying attention.
Do I have to create an LLC to get the Section 199A deduction?
No. It is available to sole proprietors (no entity formation), rental property owners (as far as the activity rises to the level of a Section 162 trade or business or meets the safe harbor test), S corporation shareholders and partnerships (multi-member LLCs, LLPs, and all the other goofy variants). Having an LLC is a good idea for other reasons, but the Section 199A deduction is not one of them.
Is the Section 199A deduction a business deduction?
No. It is a deduction taken on the owner’s individual tax return on page 1 of your individual tax return (Form 1040) on line 13 for the 2020 tax year. Don’t look at your 2017 tax returns for line 13… the IRS decided to chop up Form 1040 into multiple parts and relabeled them Schedules for the sake of everyone’s desire to have a postcard tax return. No one seems to complain about state tax returns which can easily exceed 3 pages (California).
Back to the IRS and Form 1040 being chopped up… For example, Schedule 1 is titled Additional Income and Adjustments to Income which is essentially page 1 of old school Form 1040.
Is the Section 199A deduction available to rental property owners?
Yes, but there are rules outlined in IRS Notice 2019-7 including safe harbor requirements.
Why did they make the Section 199A deduction on the individual tax return of the owner?
Simple. The way Section 199A is written, there are limitations based on household income so it would be difficult for the business entity tax return to have visibility into each owners’ individual tax situation (not to mention privacy concerns).
What is the specified service trade or business nonsense I hear about?
Section 199A defines certain professions where the deduction is limited when certain income thresholds are exceeded. The list is health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing services and securities trading services. Plus any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.
I am a CRNA operating an S Corp. Am I considered a specified service trade or business?
Yes. The proposed regulations 1.199A expanded the definitions of SSTBs and the final regulations offered some more insight. Specifically for health, the regs state that anyone who provides medical services is considered a specified service trade or business. This means that nurses, nurse anesthetists, chiropractors, physical therapists, massage therapists, etc. Don’t forget pharmacists and veterinarians.
I am a realtor operating an S Corp. Am I considered an SSTB?
No. The proposed regulations 1.199A specifically call out real estate agents as not being a specified service trade or business and this was not altered in the final regulations. Yes, the political lobby must be very good.
I am an insurance agent operating an S Corp. Am I considered an SSTB?
No. The Section 199A final regulations have lumped insurance agents and brokers in this real estate agents and brokers, even if commissions are earned in connection with wealth management (such as life insurance).
Where is the specified service trade or business determined?
SSTB is determined at the entity level. So, if an entity is designated a specified service trade or business, all owners are subject to this possible limitation regardless of their individual title or contribution to the business. For example, let’s say Fred Flintstone and Mr. Slate are owners together. And Mr. Slate’s reputation or skill is known all over the world and it is the primary catalyst for the success of the business. Fred will also be deemed an owner of a specified service trade and business, and could further be limited on his Section 199A deduction. Guilty by association. Yabba dabba doo!
If the business is deemed to be an SSTB, do I lose my Section 199A deduction?
Maybe. Perhaps. You might. Yes and No. This is one of the biggest confusions out there. If you are a married doctor making $300,000 as a household you do not lose your Section 199A deduction, but if you make $500,000 you do. Read that again. Being labeled as a specified service trade or business isn’t bad until you meet income thresholds, which are $157,500 for singles and $315,000 for married filing joint. These numbers represent the end of the 24% marginal tax bracket, and the next tax bracket is 32%. This means the 32%, 35% and 37% represent the wealthier taxpayers and as such the Section 199A deduction becomes limited.
What if I file married filing separately? Can I get around the SSTB limitations?
Nice try. The IRS is smart. Congress is smart. The Joint Committee on Taxation is smart. Stop laughing… really, they are! And they saw you coming a mile away… probably heard you too.
All kidding aside, the tax code is very, very careful to prevent simple tax arbitrage based on tax filing status. If you are married filing separately, your $315,000 becomes $157,500 anyway. And… if you are in a community property state it might not make a difference since the K-1 will be the tax document coded with the specified service trade or business designation and splitting your income 50-50 (like in California) doesn’t appear to help.
Does capital gains income affect my Section 199A limitation?
Yes. If you are considering the basics where the Section 199A is available on the lessor of 20% of net business income or 20% of taxable income. For your business income, capital gains, dividends and interest income are excluded. For your individual income, capital gains are also excluded from the Section 199A deduction calculation.
How does Section 199A affect expats or expatriates?
Similar to other areas of the tax code involving foreign earned income exclusions, income that is already excluded does not count towards a Section 199A deduction. In other words, you cannot double-dip. If your earned income exceeds the foreign earned income exclusion, then there is a proration that is available.
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