Does Your Service-Based Business Qualify for the Qualified Business Income Deduction?
August 11, 2020
One of the most talked about corporate tax perks of the Tax Cuts and Jobs Act (TCJA) has been the Section 199A deduction. And rightfully so—it generally gives owners, shareholders, or partners of pass-through entities a 20% deduction on qualified business income (QBI) on their personal tax returns. But despite its more than two-year existence, the 199A deduction is still widely misunderstood. Much of the confusion surrounding it can be traced to this media-driven myth: service-based businesses do not qualify for the deduction.
If you own a service-based business and have wondered about your eligibility, here’s what you should know.
1. Pay attention to taxable income thresholds.
In general, if your total taxable income in 2019 was under $160,700 (or $321,400 if married filing jointly), you may qualify for the deduction. In 2020, the limits are $163,300 for single filers and $326,600 for joint filers. If your income exceeds the threshold, you must reference complicated IRS rules to determine if your business income qualifies for a full or partial deduction.
2. What is a Specified Service Trade or Business?
Part of these complicated rules involve what the IRS calls “Specified Service Trade or Businesses” (SSTBs). If you own an SSTB and your taxable income exceeds the applicable threshold, you won’t qualify for the 199A deduction. However, you may still qualify for the 199A deduction, despite your SSTB ownership, if your taxable income falls below the threshold.
To be clear, there’s a difference between a service-based business and an SSTB. The IRS defines SSTBs as certain businesses that operate in the following industries. (This is a simplified list; the IRS guidelines denote subcategories within each industry.)
• Actuarial Science
• Performing Arts
• Consulting (services within the architecture and engineering fields are not included)
• Financial Services
• Brokerage Services
• Investing and Investing Management
• Reputation or skill of one of more employees or owners (e.g., an Instagram influencer)
3. Does the de minimis rule apply to you?
If your trade or business has several lines of business and one happens to be an SSTB, consider the de minimis rule. This rule allows taxpayers with $25 million or less in annual gross receipts from SSTB activities to avoid the SSTB classification if less than 10% of these receipts are generated by the SSTB activity. If a taxpayer has more than $25 million in annual gross receipts from SSTB activities, less than 5% of the receipts must by generated by the SSTB activity to avoid the SSTB classification.
You also may be able to treat SSTB activities as a separate trade or business, which could allow your non-SSTB business activities to qualify for the 199A deduction. You would be more likely to qualify for this type of treatment if you:
• Separately invoiced customers for these activities
• Maintained separate books for these activities
• Had employees who worked only on these activities
Don’t miss out on this valuable deduction.
Despite the IRS’ efforts to clarify the 199A deduction, it can be difficult to gauge your eligibility. If there’s even a chance you might qualify, consult with your tax advisor as soon as possible. The deduction is 20% of your qualified business income, which could translate to a significant tax savings. And you don’t want to miss out on that. If you have questions about the 199A deduction, businesses included in the SSTB definitions, or would like to confirm your eligibility, contact us today.