Are you out-of-favor for the 20 percent deduction?

The 20 percent tax deduction under new 2018 tax code Section 199A is a very nice tax break for business owners, except for owners with high income who also fall into the out-of-favor group.

In general, the out-of-favor group includes lawyers, doctors, accountants, tax professionals, consultants, athletes, authors, security traders, actors, singers, musicians, entertainers, and others.

Getting just a little more technical, the out-of-favor “specified service trade or business” group includes any trade or business

  • involving the performance of services in the fields of health, law, consulting, athletics, financial services, and brokerage services; or
  • where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or
  • that involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (Sections 475(c)(2) and 475(e)(2), respectively).

Escapees. Notably, engineers and architects who had previously been in the out-of-favor professionals group somehow escaped the group with passage of this new law.

To qualify for the full 20 percent tax deduction under new tax code Section 199A when you operate a business that falls in the out-of-favor group, you need two things. First, you need qualified business income from one of the sources above, to which you can apply the 20 percent. Second, you need defined taxable income of

  • $315,000 or less if married filing a joint return, or
  • $157,500 or less if filing as a single taxpayer.

Example. You are single and operate your dental practice as a proprietorship. The practice produces $150,000 of qualified business income. Your other income and deductions result in defined taxable income of $153,000. You qualify for a deduction of $30,000 ($150,000 x 20 percent).

But when you are a member of the out-of-favor group, your Section 199A deduction on your out-of-favor business is zero when you have taxable income of more than

  • $415,000 if married filing a joint return, or
  • $207,500 filing as a single taxpayer.

If you think your 2018 taxable income will exceed the thresholds, we should spend time together working on a plan for you to realize the benefits of this tax reform, whether it be the new 20 percent deduction or an alternate plan.

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