The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, by President Donald Trump. The TCJA made major changes to the United States Tax Code by lowering corporate and individual tax rates, increasing the standard deduction, limiting certain itemized deductions, eliminating personal exemptions, and vastly expanding the child tax credit.
Perhaps the most profound change in the TCJA is a section of law that will benefit the vast majority of small business owners in the United States, including Real Estate Agents. This is the creation of Internal Revenue Code Section 199A, and, with it, a twenty-percent income deduction for qualifying businesses.
IRC §199A allows qualifying business owners to deduct 20% of qualified business income before calculating income tax due on their individual income tax return, Form 1040. Although referred to as a pass-through deduction for entities such as partnerships and S Corporations, sole proprietorships (including commission-paid real estate agents) may also qualify for the deduction.
Qualified Business Income
All business owners whose taxable income (in italics because it involves some adjustments to calculate for purposes of §199A) falls below certain thresholds (discussed below) qualify for the 20% deduction. For owners whose taxable income exceeds these thresholds, however, the source of business income becomes important. For these taxpayers, qualifying income is income derived from any U.S. business other than a specified service trade or business. A specified service trade or business is a for-profit activity whose main asset is the reputation or skill of its employees or owners. As a result, service businesses such as those practicing law, accounting, healthcare, consulting, and financial services do not qualify for the 20% deduction when the owner’s taxable income exceeds the thresholds discussed below.
Real Estate Agents were originally considered a specified service trade. After all, what is a real estate agent’s main asset if not his or her skill or reputation? Tax professionals considered real estate sales a specified service trade or business until a heavily lobbied carve-out inserted in the §199A Proposed Regulations (pg. 62) excluded real estate agents and brokers from the specified service definition.
Small Business Windfall
The good news for all business owners regarding the 20% income deduction is that any year taxable income on the owner’s tax return falls below certain thresholds, they qualify for the deduction. For 2018, these thresholds are $157,500 for single taxpayers (and married individuals filing separately) and $315,000 for married taxpayers who file jointly. Taxable income fall below this threshold? Congratulations! You qualify for the 20% business income deduction!
Over ninety-five percent of small business owners earn less than the thresholds listed above, making the Qualified Business Income Deduction a massive, albeit poorly communicated, middle-class tax cut. As a bonus for future years, the thresholds listed above will be adjusted for inflation on an annual basis - a rarity for income-based tax calculations.
Owners whose businesses are not specified service trades of business (including real estate agents) who have taxable income above the phase-out range can still qualify for the deduction. The computation, however, becomes a bit more complex.
Deduction Phase-Out (No Wages Paid)
Once taxable income passes the threshold listed above, several additional limits come into play. Two of these limits involve an income phase-out that will impact owners and real estate agents who do not pay wages to employees. For these owners the 20% deduction begins to phases out, allowing a partial deduction for those whose taxable income falls within the phase-out range. For single taxpayers, the 20% deduction is reduced by 2% for every $2,500 their taxable income exceeds $157,500 (2018). Once taxable income exceeds $207,500 ($50,000 over the threshold), the deduction vanishes. For married taxpayers filing jointly, the 20% deduction is reduced by 2% for every $5,000 taxable income exceeds $315,000 (2018). Once taxable income exceeds $415,000 ($100,000 over the threshold), the deduction vanishes.
Deduction Limit (Wage-Paying Real Estate Agents)
For owners and real estate agents who pay W2 wages to employees (even themselves) calculating the deduction limit becomes even more complex. For those whose taxable income exceeds $157,500 (single/MFS) and $315,000 (MFJ), the §199A deduction is limited to the greater of 1) The phase-out limits listed above, 2) Fifty-percent of Medicare wages (basically, Box 3 on form W3) paid to employees during the tax year, and 3) Twenty-Five percent of Medicare wages plus 2.5% of the unadjusted basis of depreciable property owned by the business entity.
For real estate agents and real estate brokers earning less than the phase-out limits calculating the deduction is relatively simple. Congratulations! You get the deduction!
For real estate agents and brokers in higher-earning households, however, planning-complexities abound. Those interested in maximizing this time-limited deduction need to make some serious decisions - decisions whose consequences may extend far beyond deduction’s 2025 sunset date.
We hope this article has helped you better understand the new 20% Business Income Deduction. If you’re a real estate agent interested in minimizing your largest expense – TAXES - we invite you to browse our course listing. For a thorough understanding of how to legally keep more of your hard-earned money, our Comprehensive Real Estate Agent Tax-Cut Library is for you! Are you a Real Estate Broker? Our Brokers Edition allows you to share the Library with up to twenty agents!
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Brett Hersh is an instructor and author for Overnight Accountant. He is also the owner of HBS Tax and a tax professional who specializes in helping real estate agents, brokers, professionals, investors, and businesses in related industries navigate the complexity of the ever-changing tax code. If you would like to schedule a consult with Brett or inquire about his services, please feel free to email him.