May 20th 2025.
The United States Congress is currently working on passing a new tax bill that includes changes to the popular Section 199A deduction. It's still uncertain whether the House's version of the bill, which has been tweaked and dubbed the Big Beautiful Section 199A deduction, will become law. But for those wondering how this new deduction will affect them, this blog post will explain the mechanics.
To start off, there are two main features of the new formula for the deduction. First, the tax savings will be slightly larger. And second, for business owners who have limited deductions due to W-2 wages or being classified as a specified service trade or business, the limitations will phase out at a slower rate.
So, what does this mean for you? If the bill is passed, it's important to make sure that your Section 199A deductions are optimized to take advantage of the new and improved formula.
It's important to note that the new formula won't take effect until tax years beginning after December 31, 2025. Additionally, this new Section 199A deduction is permanent, so it won't expire like some other tax laws.
The deduction percentage will also increase from 20% to 23%. For example, under the old formula, a taxpayer with $1,000,000 of qualified business income would receive a $200,000 deduction. With the new formula, they would receive a $230,000 deduction. However, there is still a limitation on both versions of the deduction. Taxpayers can only claim the deduction on the lesser of their qualified business income or their ordinary taxable income.
Both the old and new versions of the deduction have limitations for taxpayers with higher incomes. These limitations are based on factors such as W-2 wages, the cost of depreciable property, and whether the business falls under a specified service trade or business category. However, the new law changes the speed at which these limitations occur, resulting in a lower marginal tax rate for those whose deductions are limited. While the mechanics of this calculation may be confusing, there is a simple calculator available for use.
The first step in determining the Section 199A deduction is to calculate the deduction for non-specified service trade or business income. This is the lesser of 23% of the qualified business income or a limited amount based on W-2 wages and depreciable property. Let's look at an example: Thomas is a single taxpayer who owns a farm and a law firm, each earning $1,000,000 a year. The farm pays $300,000 in wages and has $400,000 in depreciable machinery. Since the law firm is a specified service trade or business, it is not included in this calculation. The non-specified service trade or business deduction would be $150,000, the lesser of 23% of $1,000,000 or a calculated amount based on wages and depreciable property.
The second step in the calculation involves adding in any specified service trade or business income and then applying a limitation based on the taxpayer's income. For example, if Thomas' taxable income is $1,000,000, he would be subject to a threshold amount of $200,000. This means that 75% of the amount his income exceeds the threshold would be subtracted from the deduction. In the end, the deduction would be the greater of $150,000 or $0.
One final change to note is that dividends from electing Section 851 qualified business development companies will now be considered qualified business income, just like REIT dividends. This means that they will also be eligible for the Section 199A deduction.
And as a postscript, it's worth mentioning that the new law resets the base year for inflation adjustments to 2025 to ensure that taxpayers don't miss out on any increases due to inflation.
In conclusion, the Big Beautiful Tax Bill may bring some changes to the Section 199A deduction, but with a better formula and larger tax savings, it's important to make sure you understand how it will affect your business. Use this information and the available calculator to optimize your deductions and take advantage of this new law.
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