815 / How is the income from a partnership taxed under the 2017 tax reform legislation?
Partners in a partnership may generally deduct 20 percent of “qualified business income (QBI)”2 (which generally excludes “specified service business” income (see below)).
Partnerships that are categorized as service businesses and have income below the applicable threshold level plus $50,000 ($100,000 for joint returns) also qualify for the deduction.
The applicable threshold levels for 2025 are $394,600 (joint returns), and $197,300 (single returns), so service business owners with income that exceeds $494,600 (joint returns) or $247,300 (single) will not receive the benefit of the deduction.
The applicable threshold levels for 2024 are $383,900 (joint returns) and $191,950 (single returns), so service business owners with income that exceeds $483,900 (joint returns) and $241,950 (single) will not receive the benefit of the deduction.
The entirety of the taxpayer’s income must be taken into account (not only the business’ income).3
The deduction is available regardless of whether the taxpayer itemizes, and is applied based on ownership interest (i.e., a partner who owns 25 percent of a partnership is entitled to apply the deduction to 25 percent of his or her QBI). The calculation is made on an entity-specific basis, meaning that the deduction must be applied separately to each entity rather than based upon the cumulative income of all entities owned by the taxpayer.
Qualified business income is generally the net amount of qualified items of income, gain, deduction and loss with respect to qualified trades or businesses of the taxpayer, excluding qualified REIT dividends, qualified cooperative dividends and qualified publicly traded partnership income (but see Q ).4 Income, gain, deduction and loss items are generally qualified if they are connected with a U.S. trade or business and are included or allowed in calculating taxable income. Amounts related to the following investment items are excluded: capital gains, qualified dividend income (or equivalent), non-business interest income, foreign base company income taken into account under IRC Section 954(c), non-business annuity distributions.5
For alternative minimum tax purposes, qualified business income is calculated without regard to otherwise allowable adjustments.6
When the pass-through entity’s income exceeds the 2025 threshold ($394,600/$197,300), the deduction is capped at the greater of (1) 50 percent of W-2 wage income or (2) the sum of 25 percent of the W-2 wages of the business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all “qualified property” (but see Q for a discussion of the “phase-in” for certain taxpayers whose income only exceeds the threshold by $50,000 ($100,000 for joint returns)).7
Planning Point:
IRS guidance provides that the term “W-2 wages” includes only income properly reported to the Social Security Administration on Form W-2 within 60 days of the deadline for filing the form, including extensions. The filing deadline is generally January 31, giving most businesses until April 1 to file the form in order to count the wages for Section 199A purposes.8
“Qualified property” generally includes depreciable property that is used in the taxpayer’s trade or business for the production of income as of the end of the tax year, as long as the depreciation period has not expired before the end of that year. The depreciation period is a period that begins on the first day that the taxpayer places the property in service and ends the later of (1) 10 years after that date or (2) the last day of the last full year in the applicable recovery period that would apply to the property under IRC Section 168 (without regard to Section 168(g)).9
A “specified service business” is a trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of the business is the reputation or skill of one or more employees or workers, or one which involves the performance of services consisting of investing and investment management trading or dealing in securities, partnership interests or commodities.
To determine the “qualified business income” with respect to a specified service trade or business, the taxpayer takes into account only the applicable percentage of qualified items of income, gain, deduction, or loss, and of allocable W-2 wages.10 With respect to S corporations, qualified business income does not include any amounts that are treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include guaranteed payments or amounts paid or incurred by a partnership to a partner, when the partner is providing services and is not acting in his or her capacity as a partner.11
Planning Point:
Qualified business income (QBI) excludes pass-through income that is categorized as “compensation” or a “guaranteed payment”. The 20 percent deduction applies only to QBI.
It remains to be seen whether safeguards will be put into place to discourage partnerships from categorizing more business income as partnership profits (i.e., reduce guaranteed payments that would be treated in the same manner as excluded compensation in order to increase QBI and take advantage of the 20 percent deduction with respect to those funds). Currently existing “reasonable compensation” rules apply only to S corporations and C corporations, and have not been specifically extended into the partnership arena.
If the qualified business income for the year is a loss, it is carried forward as a loss for the next tax year. Any deduction allowed for that subsequent tax year is reduced by 20 percent of any carried forward business loss from the previous year.12
The deduction is allowed as a reduction reducing taxable income, rather than as a deduction in computing adjusted gross income (i.e., the deduction does not impact limitations based on adjusted gross income). Further, trusts and estates are also eligible for the 20 percent deduction.
For partnerships and S corporations, these rules apply at the partner or shareholder level (each partner is treated as having W-2 wages for the year equal to that partner’s allocable share of the partnership).
See Q for a detailed discussion of how a pass-through entity’s deduction for qualified business income is determined.
1. Under IRC § 199A.
2. IRC § 199A(a).
3. IRC §§ 199A(b)(3), 199A(d)(2).
4. IRC § 199A(c).
5. IRC §§ 199A(c)(3), 199A(d)(3).
6. IRC § 199A(f)(2).
7. IRC § 199A(b)(2). In the case of a short taxable year, only those W-2 wages paid during the short taxable year count under Treasury Regulation § 1.199A-2(b)(iv)(C).
8. Rev. Proc. 2019-11.
9. IRC § 199A(b)(6). IRC Section 168 provides accelerated cost recovery system rules. IRC Section 168(g) provides an alternate depreciation system that may be used with respect to certain property, including tangible property used predominantly outside the U.S., tax-exempt use property and tax-exempt bond financed property.
10. As defined in IRC § 199A(b)(4).
11. IRC § 199A(c)(4).
12. IRC § 199A(c)(2).