Section 199 of the US Tax Code defined the requirements for a business to take a tax deduction for certain production activities. This part of the tax code was designed to encourage business to start or expand manufacturing businesses in the United States. This was usually called the Domestic Production Activities Deduction (DPAD).
Before 2018, the deduction was limited to 9% of the production income of the business. With the enactment of the Tax Cuts and Jobs Act on December 22, 2017 this was eliminated and replaced. Sole proprietorships, S corporations and partnerships are now permitted to deduct 20% of the qualified business income earned by the business (QBI). This deduction can apply to almost all types of businesses. But, there are limitations on the deduction for certain specified service businesses.
Another restriction on this deduction is that it is limited to the greater of 50% of the salaries paid out on W-2s or the sum of 25% of the W-2 wages, plus 2.5% of certain items. The W-2 wage limitation does not apply to tax payers with taxable income of less than $157,500 for the year ($315,000 for married filing jointly) and is phased in for taxpayers with taxable income above those thresholds. So, besides having qualified business income, many companies must have paid out salaries to produce the income. This deduction currently expires in 2023 at the Federal level. Some states also offer this deduction to businesses as well.
While the purpose of Section 199A is clearly to reduce the tax burden on small business owners operating as pass through entities, its statutory construction and legislative text is anything but clear. The provision is rife with limitations, exceptions to limitations, phase-ins and phase-outs and critical but poorly defined terms. As a result, section 199A has created ample controversy since its enactment. Until the IRS provides further guidance the complexity will create countless challenges for business owners and tax professionals.
Clearly, this deduction can result in decreased income tax expense for the owners of many companies. For more information go here… to view the Internal Revenue guidelines. You should also contact Fricke and Associates, CPA for an analysis of how your business can benefit from Section 199A tax deduction.