The Tax Cut and Jobs Act creates a new deduction under code section 199A for Qualified Business Income.
Through December 31, 2017
Prior to the new law, income from pass-through and sole proprietorship businesses was taxed using ordinary income tax rates applicable to all individual income.
Effective for tax years beginning after December 31, 2017
The deduction under the new law is generally 20% of income, gain, deduction and loss relating to qualified trade or business income of a taxpayer. There are limits to the deduction for most taxpayers based on W-2 wages of the applicable trade or businesses and/or the basis of the qualified property of the business. The deduction is also not allowed for certain types of businesses (such as personal service businesses), although exceptions apply if income is below certain thresholds. The deduction reduces taxable income as opposed to adjusted gross income (AGI), which is relevant to various phase-out limits of other deductions often based on AGI.
This deduction is a mechanism to pass additional tax rate reductions to businesses taxed on individual tax returns. Many small businesses have their income taxed on individual returns subject to individual tax rates and were therefore receiving a much smaller tax reduction than C corporations which had most rates cut from 35% to 21%. The basic deduction is straightforward but the limitations add a level of complexity to the process.