How Capital Gains Can Destroy the New 199A 20 Percent Tax Deduction

Will you qualify for the new tax code Section 199A 20 percent tax deduction? 

When looking at the possibilities, don’t overlook your capital gains, because they add to your taxable income, which is the primary determinate of your qualification for some, all, or none of the 199A deduction. 

Example.  You operate a proprietorship that’s in one of those out-of-favor specified service businesses. You are single with taxable income of $210,000. You don’t qualify for the 199A deduction, because your taxable income is greater than $207,500. 

To determine your qualification for the Section 199A tax deduction, you look at your taxable income only. You do not consider capital gains at this point. 

Capital gains reduce your taxable income when you calculate your 199A deduction, which is the lesser of 

1.   20 percent of your taxable income over your net capital gains, or 

2.   20 percent of qualified business income or, if applicable because of your   income, the amount determined under the wage and/or wage and property calculation. 

Example.  You are married with taxable income of $300,000, of which $100,000 is from capital gains. You have qualified business income of $250,000. Your Section 199A deduction is the lesser of: 

• $40,000 (20 percent of $300,000 - $100,000), or
• $50,000 (20 percent of $250,000). 

Thus, you deduct $40,000.

Takeaways

Taxable income is the sole starting point for your Section 199A deduction. When your taxable income is equal to or less than the threshold of $157,500 (single) or $315,000 (married, filing jointly), your 199A deduction is the lesser of:

• 20 percent of your taxable income reduced by net capital gains, or
• 20 percent of your qualified business income plus 20 percent of your combined REIT dividends and qualified publicly traded partnership income. 

You are in the wage and/or wage and property phase-in range when your taxable income is above the threshold of $157,500 (single) or $315,000 (married, filing jointly) but equal to or below $207,500 (single) or $415,000 (married, filing jointly).  

If your taxable income is greater than $207,500 (single) or $415,000 (married, filing jointly), pay attention to the following: 

• If you are in an out-of-favor specified service business, your Section 199A deduction is zero.
• If you are in an in-favor business, you need wages and/or wages and property to qualify for   any Section 199A deduction.  Please reach out to me,  if needed, to clarify difference between in-favor and out-of-favor businesses.

Note how taxable income creates the trigger point in every case described above. For Section 199A, taxable income is just that—taxable income. It’s adjusted for nothing.

Please contact me with any questions and/or if you would like to model some scenarios out to see where you stand.  Best to prepare now to avoid any potential, unwanted surprises at tax time!  I can be reached at:  (805) 603-2992 or richard@griswoldcapital.net

Any tax advice from Rich Griswold comes from his capacity as an Enrolled Agent. Investment advisory services offered through Regal Investment Advisors, LLC an SEC registered investment advisor. Griswold Capital is independent of Regal Investment Advisors. Regal Investment Advisors LLC is not a law firm or an accounting firmIRS Enrolled Agent (EA)– An EA is a federally authorized tax practitioner who has technical expertise in the field of taxation and who is empowered by the U.S. Department of the Treasury to represent taxpayers before all administrative levels of the IRS for audits, collections, and appeals. “Enrolled” means to be licensed to practice by the federal government and “Agent” means authorized to appear in the place of the taxpayer at the IRS. Only Enrolled Agents, attorneys, and CPAs may represent any taxpayer before the IRS. The license is earned in one of two ways: (1) passing a comprehensive examination which covers all aspects of the tax code, or (2) having worked at the IRS for five years in a position which regularly interpreted and applied the tax code and its regulations. All candidates are subjected to a rigorous background check conducted by the IRS. In addition to the stringent testing and application process, the IRS requires Enrolled Agents to complete 72 hours of continuing professional education, reported every three years, to maintain their Enrolled Agent status. Enrolled Agents are required to abide by the provisions of the Department of Treasury’s Circular 230, which provides the regulations governing the practice of Enrolled Agents before the IRS.