Do Doctors Qualify for the Section 199a Deduction?

The Tax Cuts and Jobs Act of 2017 wrote into law Internal Revenue Code Section 199a, the Qualified Business Income Deduction. This 20% deduction is available to owners of certain pass-through entities and has the potential to reduce a business’s effective tax rate by a significant amount. Unfortunately, the deduction is not available to all taxpayers. Not only is the deduction limited for high earners, but owners in certain service industries are phased out of the benefit completely. Some doctors will be able to benefit from this new tax deduction, but others will not be so lucky.

Section 199a Limitations

The Qualified Business Income Deduction (QBI Deduction) has quite a few limitations doctors need to consider. First, the deduction is not available to owners of C corporations. Only owners of pass-through entities, like partnerships and S corporations, can receive the deduction.

Second, the 20% deduction can never exceed the taxpayer’s taxable income for the year reduced by their net capital gain.

Third, the deduction is subject to a taxable income limitation. As taxpayers report more taxable income, the less of the deduction they can take. Section 199a bifurcates high earners into three different categories, and each category is subject to a different limitation. The following thresholds are for taxpayers who are married and filing a joint return with their spouse.

1. Taxpayers whose taxable incomes do not exceed $315,000 ($157,500 for non-married filers). These taxpayers can rest easy; they will be eligible for the full 20% deduction.
2. Taxpayers whose taxable incomes exceed $415,000 ($207,500 for non-married filers). These taxpayers will face a wage limitation. Their deduction will be limited to the greater of (1) 50% of their allocated portion of the business’s W-2 wages, and (2) the sum of 25% of those same W-2 wages plus 2.5% of the basis they hold in qualified business property.
3. Taxpayers whose taxable incomes are greater than $315,000 but do not exceed $415,000 ($157,500 and $207,500 for non-married filers, respectively). These taxpayers must gradually apply the wage limitation as their taxable incomes approach the upper threshold.

The limitations don’t stop there, though. Taxpayers in certain specified service trades or businesses (SSTBs) have another to consider. SSTBs are businesses that perform services in the following fields:

• Health
• Law
• Accounting
• Consulting
• Athletics
• Performing arts
• Actuarial science
• Financial services
• Investment management

Owners in SSTBs, including physicians, whose taxable incomes are above the lower taxable income limitation thresholds ($315,000 married / $157,500 single) will begin to lose their deduction, and the 20% deduction will fully phase out when their taxable incomes reach the upper thresholds ($415,000 married / $207,500 single).

Physician Considerations

The SSTB limitation will hit physicians especially hard. Until recently, they had a workaround; they thought they could separate their medical activities from their non-SSTB activities. For example, it is quite common for doctors to be owners in a rental company that leases a building to their own medical practice. By formally separating the medical service business from the rental business, doctors hoped they could apply the 20% deduction to their rental business. Unfortunately, in August of 2018, the IRS released a set of proposed regulations that disallowed this approach. The proposed regulations state that a business’s income that is at least 80% attributed to the activities of an SSTB will be considered an SSTB for this income limitation.

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The 199a deduction was Congress’s attempt to make flow-through entity taxation more equitable to that of C corporations. The tax rate for C corporations has been reduced to an all-time low of 21% while the highest individual tax rate remains at 37%. This 20% deduction didn’t completely close the gap, but it helped. If you have questions about the Section 199a deduction or the benefit you can receive, Wilson Lewis can help! For additional information please call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.