First things first.
Your Section 199A tax deduction will benefit from your business’s W-2 wages paid to you and your employees if you
- are married and filing jointly and your taxable income is over $315,000 and less than $415,000;
- are filing as single or head of household and your taxable income is over $157,500 and less than $207,500; or
have an in-favor business and your taxable income is greater than $415,000 (married, filing jointly) or $207,500 (filing as single or head of household).
If you are above the $415,000/$207,500 threshold with no wages and no property, your Section 199A tax deduction is zero regardless of your type of business.
Example 1. You have an in-favor business with $400,000 of qualified business income (QBI) with no wages or property. Your Form 1040 shows $500,000 of taxable income. Your Section 199A tax deduction is zero.
Note. Your $500,000 in taxable income is above the threshold. Without wages or property, the deduction is zero regardless of the type of business.
Example 2. Your in-favor business has $400,000 of QBI after wages of $300,000. Your Form 1040 shows $500,000 of taxable income. Your Section 199A tax deduction is $80,000.
For Section 199A purposes, W-2 wages include
- cash wages and benefits,
- elective deferrals,
- deferred compensation, and
- designated Roth contributions.
For Section 199A purposes, you must use one of the three following IRS-created methods to find your Section 199A wages:
- Unmodified box method. Under this effortless method, your W-2 wages are the lesser of Box 1 or Box 5.
- Modified Box 1 method. Under this more accurate method, your W-2 wages are the total of Box 1 plus amounts in Box 12 that are coded D, E, F, G, and S minus amounts in Box 1 that are not wages for federal income tax withholding purposes.
- Tracking wages method. Under this most accurate method, you track the W-2 wages subject to federal income tax withholding and add the amounts in Box 12 that are coded D, E, F, G, and S.
If you operate as an S corporation, you should use the modified Box 1 method (method 2) or the tracking changes method (method 3) to ensure your S corporation includes your elected deferrals and health insurance in its W-2 wage calculation.