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IRS Updates Defined Wages for New Section 199A Tax Deductions

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:

  1. Unmodified box method. Under this effortless method, your W-2 wages are the lesser of Box 1 or Box 5.
  2. 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.
  3. 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.

 

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