Should my business pay more wages or have qualified property to have a full 20% of profits Section 199A deduction, if you are a high earner taxpayer?
Internal Revenue Code Section 199A was enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA), and slightly modified in 2018. This provision provides a tax deduction of up to 20% of the net income that a taxpayer receives from an active trade or business, which may include rental real estate and professional practice income other than wages.
Individuals who earn more than $210,700, and married couples filing jointly who earn more than $421,400 in 2019, will not be able to take Section 199A deductions on trade or business income, or will have their deduction limited to the greater of 50% of wage expenses paid by the applicable entity, or the sum of (a) 25% of wage expenses, plus (b) 2.5% of the cost of qualified property.
Wages will include pension contributions, wage taxes, medical insurance for employees, and other items. The cost of qualified property that can be multiplied by 2.5% can be complicated by the history of the property, which includes furniture and equipment that has not been in service more than ten years, but excludes forms of land, buildings that have been completely depreciated and have been in service for more than ten years, and certain other items. Some taxpayers will convert independent contractor arrangements into employment arrangements to pay more wages, and may acquire new assets that qualify for the 2.5% test described above in order to maximize Section 199A deductions.
This is a complicated area of tax law. It is strongly recommended that a tax lawyer be consulted who is familiar with these rules.