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The Support programs provided a dialog to enter a party’s net
income from sole proprietorships, partnerships or s-corporations. The entries in
this dialog are needed in order to accurately calculate the potential Section
199A business income deduction that can applied to reduce the business owner's
federal taxes. As the business deduction can be taken from the income of
multiple business entities and then combined, the dialog provides entries for
the income of up to 4 businesses. Additionally, income from a real estate
investment trust (REIT) can also be used as a Section 199A business deduction.
Before any income phase-outs, the business income deduction is 20% of
the business owner's Qualified Business Income (QBI) or 20% of the business
owner's Taxable Income, whichever is less. Taxable Income, for example, would be
the business owner's Total Income minus the federal standard deduction, minus
(1/2 of any SE tax) and minus any tax-free income like the portion of tips
received by the business owner that may be tax-free.
When an individual’s
Taxable Income exceeds certain inflation adjusted thresholds, then the business
deduction can be reduced. The Taxable Income thresholds for 2026 are $201,750
for a single, head of household or married separate filers, but double that to
$403,500 for an individual filing married jointly. If the business owner’s
Taxable Income does not exceed these thresholds, then there is no limitation or
phase-out of the Business Deduction.
In this dialog, you will need to
check whether or not the business is a specified service trade. This is
important as the phase-out of the business deduction is applied differently and
can occur much quicker if the business can be characterized as a specified
service trade. A "specified service trade" would include businesses involving
the performance of services in the fields of health, law, consulting, athletics,
financial or brokerage services, accounting, or commodity or security trading.
It would not include though engineering or architectural services. As long the
business owner's Taxable Income does not exceed the income phase-out thresholds,
then there is no difference in the Business Deduction whether the business is a
Specified Service Trade or not.
Business A or Business B on this dialog
would be for income from a sole proprietorship or from a partnership where the
individual’s income would be subject to the payment of self-employment taxes by
the individual.
For an individual’s income from a sole proprietorship or
partnership (Business A or B), there are two entry boxes. One entry box is for
business income that would qualify for the business deduction and another entry
box for income that would not qualify. We believe that most all net income taken
by a sole proprietor or by a partner in a partnership should be available for
the business deduction. An additional data entry box is provided for a sole
proprietor’s or partner’s income from that business that may not otherwise
qualify for the deduction but where the individual is still paying self
employment taxes on that income.
Business C or Business D would be for an
individual’s income taken from a s-corporation where the income is either W-2
wages subject to FICA paid at the corporate level or pass-thru income not
considered wages or subject to payroll tax. Only the pass-thru income taken
would be available for the business deduction, but the calculation needs to know
the owner’s W-2 wages paid by the s-corporation to accurately determine any
potential phase-out of the business deduction once the business owner's taxable
income exceeds the inflation-adjusted income thresholds.
If a business
owner's taxable income exceeds the phase-out limits, that amount of the business
deduction can be dependent on the W-2 wages paid to employees of the business
(and to the owner or a s-corporation) and also dependent on the original cost to
the owner of business capital assets not yet fully depreciated. The dialog
provides for two entry boxes for those amounts. These boxes are provided for
both the sole proprietorships and partnership businesses (Business A an B) and
for S-Corporations (Business C or Business D). If you are using a version of the
program that provides for a tax calculation of a married filing jointly party,
then this dialog will also show additional data entries to account for the
businesses owned by the spouse. Note that for a partner where there are multiple
partners or for a s-corporation with multiple owners this will only be the
allocable share, to the individual owner or partner, of those employee wages or
assets and not necessarily the full amount incurred by the business.
If
a business owner's taxable income does not exceed the inflation adjusted income
thresholds, then these additional data entries for employee wages and capital
assets are not relevant.
This dialog also includes entry boxes for any
tips received by the business owner in the course of the business activity. The
maximum amount of tips that can used as federal tax-free income is $25K unless
Total Income (without adjustments) exceeds $150,000 (Single, HH) or $300,000
(MFJ). Then the maximum amount of tips that can be used as tax-free income is
$100 less for every $1000 that Total Income exceeds the phase-out threshold.
Once a business owner's Taxable Income exceeds the income thresholds, three
initial calculations need to be made and the individual amounts compared to each
other to determine the potential phase-out of the Business Deduction. At this
point in the initial calculation, it does not matter whether or not the business
is characterized as a Specified Service Trade or not.
The three amounts
that need to be calculated are as follows:
1) 20% of the Qualified
Business Income (QBI): QBI constitutes the reasonable compensation to the
business owner that was entered in the dialog.
2) 50% of the W-2 Wages
Paid: This can be W-2 wages paid to the owner of an S-Corp, or W-2 wages paid to
an employee of the business (for any type of business entity). It does not
appear to include the business income taken by a sole proprietor or partner
which instead would be characterized as income subject to self-employment tax
and not by the IRS as W-2 wages. For a partnership, it would include the
allocable share of W-2 wages paid to employees. In other words, for a 50/50
partnership, each partner would be able to allocate 50% of the employee W-2 wage
paid for purposes of the Business Deduction. It all depends on the partnership
agreement. Same goes for an S-Corp as it would likely depend on the ownership
agreement. But for an S-Corp, the business owner would certainly add his own W-2
wages received along with any allocable share of W-2 wages paid to employees.
For an S-Corp, the owner’s individual W-2 wages would not be included in the QBI
that is passed thru to the owner. For a sole proprietorship, this would include
all of the W-2 wages paid to employees but not to independent contractors
performing services for which no W-2 wages were reported to the IRS by the
business.
3) 25% of W-2 Wages Paid plus 2.5% of percent of the unadjusted
basis, immediately after acquisition, of all qualified property: OK, perhaps
time to talk to your tax accountant. But again for an S-Corp or Partnership,
this would be the partner’s or owner’s allocable share of the cost of all
accumulated depreciable capital assets. For a sole proprietorship, it would
simply be the sole business owner’s original cost of all acquired capital assets
for that business that have not yet been fully depreciated.
Once these
three items listed above are determined, then take the greater of 2) or 3)
above, and then compare to 1), taking the lesser amount. This lesser amount will
be the Lower Limit of the Business Deduction and 1) from above will be the Upper
Limit of the Business Deduction.
The phase-out calculation for a business
that is not a specified service trade is:
Business Deduction = UpperLimit
– (UpperLimit – LowerLimit) X %Factor
Where for the 2026 Tax Filing Year:
UpperLimit = Always 20% of QBI
LowerLimit = Either 1), 2) or 3) from above
%Factor = (Taxable Income – 201,750)/75,000 for a Single filer; or
(Taxable
Income – 403,500/150,000) for married filing jointly;
Note that the
%Factor will range from 0 to 1 depending on how much the individual’s taxable
income exceeds the income threshold. Therefore for a business that is not
specified service trade, once a business owner’s Taxable Income fully exceeds
the end of the phase-out bracket, the Business Deduction will be the Lower Limit
of the Business Deduction as described above.
For a business that is not
specified service trade, when a business owner’s Taxable Income falls between
the phase-out threshold and the end of the phase-out bracket, the Business
Deduction will proportionally fall between these upper and lower Business
Deduction limits based on the where the individual’s Taxable Income
proportionally falls within the phase-out bracket.
Note that for a
business that not a specified service trade, if 20% of QBI is less than either
2) or 3) above), then the Lower and Upper Limits of the Business Deduction will
be the same and there will be no phase-out or reduction of the Business
Deduction. On the other hand, if that business has no W-2 employee wages to
declare or no depreciable assets, then the Lower Limit of the Business Deduction
will be zero resulting in a complete phase-out of the Business Deduction once
the individual’s Taxable Income exceeds the end of the phase-out bracket
($276,750 for single and $553,500 for married jointly).
Now for a
Specified Service Trade business, the Upper and Lower Limits of the Business
Deduction are determined as above, but the formula is different. Again for the
mathematically inclined, the phase-out calculation would look like this:
BusinessDeduction = UpperLimit X %RFactor - ((UpperLimit X %RFactor) -
(LowerLimit X %RFactor)) X (1 - %RFactor)
Where for the 2026 Tax Filing
Year:
UpperLimit = Always 20% of QBI
LowerLimit = Either 1), 2) or 3)
above
%RFactor = 1 - (TaxableIncome – 201,750)/75,000 for a Single filer; or
1 - (TaxableIncome – 403,500/150,000) for MFJ;
Note that the %RFactor
will now range from 1 to 0 depending on how much the individual’s taxable income
exceeds the threshold. This is just the reverse as how the %Factor worked above
for a business that is not specified service trade.
Therefore for
Specified Service Trade Business, the Business Deduction will always be reduced
to zero once the individual’s Taxable Income fully exceeds the end of the
phase-out bracket. If 20% of QBI is less than either 2) or 3) above), then the
Lower Limit and Upper Limit of the Business Deduction will be the same and the
Business Deduction will be phased out in the same proportion as the individual’s
Taxable Income that exceeds the range of phase out threshold.
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