Manufacturers: If You Qualify, Be Sure You’re Taking Maximum Advantage of the Section 199A Deduction
Manufacturing company owners who value personal asset protection from creditors typically operate their businesses as C corporations. However, in recent years, some owners have switched their companies’ form of business ownership to one of the pass-through entities, such as an S corporation, partnership or limited liability company (LLC). Some even operate as sole proprietorships.
The primary motive often is to avoid the double taxation of C corporation owners. However, the Tax Cuts and Jobs Act (TCJA) complicated matters by installing a relatively low flat tax rate (21%) for C corporations beginning in 2018. The TCJA also created the Section 199A deduction, sometimes called the qualified business income (QBI) deduction, for owners of pass-through entities, because they wouldn’t benefit from the corporate rate cut.
If your manufacturing company is organized under one of the pass-through entities, now is a good time to review the 199A deduction to make sure you’re taking maximum advantage of it to the extent you’re eligible.
199A Deduction Details
The TCJA provides, through 2025, the 199A deduction specifically for sole proprietorships and owners of pass-through business entities. The deduction generally is equal to 20% of QBI, as defined below, subject to certain restrictions. It’s claimed on an owner’s individual tax return and the owner doesn’t have to itemize deductions to claim it.
QBI represents the owner’s share of items of taxable income and loss passed through from a qualified business, without alternative minimum tax (AMT) adjustments. However, it doesn’t include investment-related items (such as capital gains, interest income or dividends), reasonable compensation or guaranteed payments passed through from the entity.
The deduction is subject to certain limits, based on the owner’s income. If your total taxable income is below the applicable threshold (adjusted annually), you’re entitled to the full 20% deduction. For 2023, the threshold is $182,100 for single filers and $364,200 for joint filers. The limits phase in as income exceeds the threshold, and they fully apply when 2023 taxable income exceeds $232,100 and $464,200, respectively.
One such limit that could apply to owners of manufacturing businesses is that the 199A deduction can’t exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
For this purpose, “qualified property” is tangible property (including real estate) owned and used by the business for production of QBI during the tax year.
For simplicity, let’s say you earned $100,000 from your manufacturing company in 2023. You’re a single filer with no other income and plan to claim the $13,850 standard deduction. In this case, your taxable income for 2023 is $86,150. Your 199A deduction is $17,230 (20% of $86,150).
Seek Professional Advice
The Sec. 199A deduction is a potentially valuable tax break if your manufacturing company operates under one of the applicable entity types. Contact us for help in determining the size of your deduction and, as always, for assistance in completing and filing your tax return.