The Tax Cuts and Jobs Act of 2017 created a lucrative new tax incentive for certain business owners: the ability to deduct up to 20% of their qualified business income. Thus, a business owner who qualified for the deduction could earn a taxable income of $500,000 but pay tax on as little as $400,000, resulting in tax savings of nearly $40,000.
Like nearly all provisions of the tax code, however, the deduction is subject to a myriad of exceptions, limitations, and special rules. Among other things, the deduction is reduced or even eliminated depending on the owner’s income, the nature of the business, how the business is organized (the deduction is only available to pass-through businesses such as partnerships, S corporations, and sole proprietorships), how much the business pays in wages, and how much property it uses.
When the deduction was added to the tax code, construction business owners, in particular, faced uncertainty about whether they qualified for the deduction if their income exceeded a specified amount, whether they could combine multiple trades or businesses into a single business (or separate a single business into multiple businesses), and whether income from rental activities qualified for the deduction. Recent IRS regulations have clarified these and other issues, generally in taxpayer-friendly ways.