Tax changes Donald Trump signed into law late last year include a major new rule—Section 199A.
This section changes tax compliance requirements for businesses and creates a special 20-percent deduction for some kinds of small businesses, says Daniel J. Pilla, a tax consultant who explains Section 199A’s rules and quirks in a conference for Eli Financial titled “The Tax Cuts & Jobs Act: Choosing a Business Entity and Understanding Section 199A.”
This new business entity tax means you need to understand compliance requirements for the five common business entities defined in the law and know the positive and negative sides of each.
Pass-Through Income Could Benefit Qualified Businesses
As explained by business consultants BDO, the new law, which went into effect on Jan. 1, allows taxpayers other than corporations to get an annual deduction equal to the sum of:
- The lesser of the taxpayer’s combined qualified business income amount or 20 percent of the excess of the taxpayer’s taxable income over any net capital gains plus the aggregate of any cooperative dividends—plus
- The lesser of 20 percent of the aggregate amount of the qualified coop dividends or the taxpayer’s taxable income reduced by the next capital gain.
The term “qualified business income” warrants its own definition here. Such income is, explained a Forbes article, “best thought of as the ordinary, non-investment income of the business. Stated in another way, this is the revenue the business was designed to generate, less the applicable expenses. So we ignore things like interest or dividend income or capital gains from the sale of property.”
Congress to Address Section 199A Snafu
As January rolled into February, lawmakers in Washington, D.C. were already at work modifying Section 199A. Why? The final version of the bill passed in December included a snafu which complicated matters for entities in the agriculture industry: Farmers could deduct 20 percent of their gross sales to co-ops but only 20 percent of their net income if they sell elsewhere.
“Whether any changes would be made retroactive to Jan. 1 is still unclear,” noted an AgWeb article.
Deduction Is ‘Complicated, Convoluted’ and Caution Is Advised
Before Trump signed the new tax law, it was common for tax pros to recommend forming a limited liability corporation and being taxed as an S-Corporation, explained Craig Smalley in an article titled “The Complicated, Convoluted Section 199A Deduction” for CPA Practice Advisor. Things are a lot more complicated now, he said.
“I’m not here to tell you that a C-Corporation is the best choice for every client,” Smalley wrote. “However, I am saying that instead of giving blanket advice … you need to analyze each client’s particular situation. In fact, I have come to believe that blanket advice to a client, is borderline malpractice.”
Why the change in advice? The best course of action depends on the owner’s personal tax bracket, how they fund their retirement, how they received a salary, and what they did with their monthly or quarterly distributions. Each case entails careful deliberation and a lot of tax math.
This new section and the changes it ushers in have real-world ramifications for businesses, says Pilla. Becoming educated on the rules can keep your business legal—and possibly cut down on your tax obligations.
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