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 determinant 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 (Dentistry). You are single with a 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

  • 20 percent of your taxable income over your net capital gains, or
  • 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 (Dentistry), 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.