On Dec. 22, 2017, the Tax Cuts and Jobs Act (the TCJA) was signed into law, providing the first major overhaul of the tax system since 1986. The law created many significant changes, including a reduction in corporate and individual rates, the repeal of the domestic production activities deduction (DPAD or section 199) and the creation of the new section 199A deduction (i.e., flow-through deduction).
The new deduction allows a deduction of up to 20 percent on income from food and beverage companies that are taxed as partnerships, S corporations or sole proprietorships, known as flow-through entities, for U.S. tax purposes. These entities don’t pay federal tax directly, but instead pass through items of income and loss to their shareholders or partners who pay the tax at the individual level. The purpose of 199A was to keep tax rates on flow-through entities competitive with the new corporate rate, which dropped to 21 percent from 35 percent. The new 199A deduction results in a significant drop in the top rate to 29.6 percent from 37 percent.
Previously, food and beverage companies that manufactured in part or whole were able to take advantage of section 199 (not to be confused with 199A), which provided for a 9 percent deduction from their qualified production activities income (QPAI). Section 199 or DPAD, was narrowly constructed to apply only to manufacturers of tangible property and there were limitations on contract processing/manufacturing and distribution being qualified activities.
Section 199A provides a larger base of qualified companies that qualify for the deduction, while specifically excluding certain “specified trade or businesses.” A specified service trade or business is any trade or business activity involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and any trade or business the principal asset of which is the reputation or skill of one or more of its owners or employees, or any business that involves the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities. While the TCJA did not provide guidance as to the “skill and reputation” of owners, it is not expected that food and beverage companies would fall under this limitation.
The basic section 199A qualified business income pass-through deduction is 20 percent of net qualified business income (QBI). However, there are limitations to this deduction based upon the wages paid by the business.
A taxpayer’s QBI for a tax year is generally the lesser of:
A few examples to highlight some of the differences and applicability under the new tax law:
As many businesses are structured to include subsidiaries or related entities (trucking or rentals), the new deductions provide planning opportunities to analyze overall structures and maximize the benefits across the entire group.
It is also important to note that this deduction expires after eight years, unlike the corporate rate reduction which is permanent.
Overall, even though the provisions are complicated, section 199A provides an opportunity for all companies involved in the food and beverage supply chain to reduce their tax liability.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.