Graphics by Anna Gray.
The 2017 Tax Cuts and Jobs Act added a provision for the Qualified Business Income deduction under Section 199A of the Code. The language of the statute itself can be unpacked a bit. The very first subsection (a) of the law sets out the general formula:
“(a) IN GENERAL.—In the case of a taxpayer other than a
corporation, there shall be allowed as a deduction for any taxable
year an amount equal to the sum of—
(1) the lesser of—
(A) the combined qualified business income amount of the taxpayer, or
(B) an amount equal to 20 percent of the excess (if any) of—
(i) the taxable income of the taxpayer for the taxable year, over
(ii) the sum of any net capital gain (as defined in section 1(h)), plus the aggregate amount of the qualified cooperative dividends, of the taxpayer for the taxable year, plus
(2) the lesser of—
(A) 20 percent of the aggregate amount of the qualified cooperative dividends of the taxpayer for the taxable year, or
(B) taxable income (reduced by the net capital gain (as so defined)) of the taxpayer for the taxable year.
The amount determined under the preceding sentence shall not exceed the taxable income (reduced by the net capital gain (as so defined)) of the taxpayer for the taxable year.”
A few features of the law are worth notice. First, it creates a deduction. Second, that deduction is calculated with a formula. Third, the formula requires a deeper dive into four concepts:
(1)(A) combined qualified business income amount;
(1)(B) 20% of {taxable income – (net capital gain + the aggregate amount of qualified cooperative dividends)};
(2)(A) 20% of the aggregate qualified cooperative dividends; and
(2)(B) taxable income – net capital gain.
These concepts (call them 1A, 1B, 2A, and 2B for now) are defined further by the statutory language, explained a bit in congressional reports, and will be further clarified by the IRS. ALFI will continue to unpack these concepts in future posts. For now, the IRC Section 199A Qualified Business Income law boils down to the following:
If 1A > 1B and 2A > 2B, then 199A Deduction = 1B + 2B
If 1A < 1B and 2A > 2B, then 199A Deduction = 1A + 2B
If 1A < 1B and 2A < 2B, then 199A Deduction = 1A + 2A
If 1A > 1B and 2A < 2B, then 199A Deduction = 1B + 2A
All of this is limited, of course, by the amount of a taxpayer’s taxable income minus net capital gain.