New tax law permits 20 percent deduction for ag business owners—but limits apply

Recognizing that C corporations make up less than 5 percent of agricultural business entities, creators of the tax-reform law included a new provision to level the playing field for the other 95 percent of business structures, such as sole proprietorships, S corporations and partnerships.

This new Section 199A, or business income tax provision, allows non-C corporation entities to take advantage of a significant tax deduction in the updated tax law. The new calculation is based on business income—but it comes with several limitations, exceptions, new terms and other complexities.

Simply put, the business income tax provision allows taxpayers—other than C corporation owners—to deduct 20 percent of their “qualified business income” earned in a “qualified trade or business” from their tax bill. In the previous tax code, business income was considered either active or passive. And those measurements remain in place. But a new term has been added to the code: “trade or business income.” The IRS, however, hasn’t yet clarified the definition for trade or business income. Generally, any active business income is considered trade or business income. Some passive business income, however, may also be considered trade or business income.

Be cautious in making significant structural changes to optimize this deduction as this provision is scheduled to sunset after Dec. 31, 2025.

The taxable income threshold

As the IRS and tax experts navigate the new and complicated path of the Section 199A provision, I can offer you these key points:

1. Under the new provision, QBI is calculated at the entity or business level and reported on your individual tax return, just as it has always been. The Section 199A deduction of 20 percent is calculated for each separate business, with several limitations that should be considered. If you are married filing jointly and your taxable income is below $315,000, then the limitation is easier to calculate. The deduction is the lesser of 20 percent of QBI or 20 percent of taxable income. If you’re filing as single or married filing separately, the income threshold is $157,500.

2. If your taxable income exceeds $315,000, you still qualify for the 20-percent deduction, but you are subject to additional limitations. The additional limitations for income above $315,000 is described below. You may take the 20-percent deduction from No. 1 (above) as long as that amount is less than:

a. 50 percent of the W-2 wages paid by that business, or

b. 25 percent of the W-2 wages paid by that business, plus 2.5 percent of the business’s depreciable real or personal property. 

Examples by the numbers

In 2018, Jordan, a married taxpayer, has $350,000 of qualified business income from the farming operation, $100,000 of qualifying wages, and $315,000 of taxable income. Jordan’s taxable income is right at the threshold so the Section 199A deduction is limited to the lesser of $70,000 (20 percent of QBI of $350,000) or $63,000 (20 percent of taxable income of $315,000). In this example, Jordan will take a $63,000 Section 199A deduction for 2018.

Using this same example but changing the numbers, now assume Jordan has $500,000 of QBI from the farming operation, $100,000 of qualifying wages, and $475,000 of taxable income. Jordan’s taxable income is over the threshold, so the Section 199A deduction is now limited to the lesser of $100,000 (20 percent of QBI of $500,000) or $95,000 (20 percent of taxable income of $475,000) or $50,000 (50 percent of qualifying wages). In this example, Jordan is only able to take a $50,000 Section 199A deduction for 2018.

These are somewhat simplified calculations for QBI and the limitations. The new Section 199A provision is far from simple. There are many more complexities in this Section 199A deduction as it relates to capital gain income, the cooperative provisions, phased-in limitations, multiple entities and specified service businesses. Because confusion still surrounds it, visit with your accountant before the end of your tax year to see if the tax deduction applies to you and how you can take advantage of it.