The Section 199A deduction is set to expire in 2025. That means independent contractors and small business owners will need to brace for a 25% tax increase.
What’s the Section 199A deduction?
The Section 199A deduction is more commonly called the qualified business income deduction. It applies to everything from gig workers, like Uber drivers and Instacart shoppers, to larger businesses like partnerships and S-corporations.
For most people, the qualified business income deduction reduces your trade or business income by 20%. You effectively only pay income taxes on 80% of your net profit instead of 100% of your net profit.
You’ll almost always get the full deduction if your income is up to $182,100 ($364,200 for joint filers). If your income is over that amount, you may get a full deduction, partial deduction, or no deduction depending on what type of business you have.
Why is the Section 199A deduction expiring?
The qualified business income deduction was a temporary provision of the Tax Cuts and Jobs Act.
The Tax Cuts and Jobs Act made major changes to the tax code starting with tax years beginning in 2018. Many of those changes only last through 2025.
So your 2025 tax return is safe, but when you file your 2026 taxes, you currently won’t have the qualified business income deduction.
Because the new tax law increased the federal deficit, most of it had to be made temporary. Otherwise, it would have needed more votes in the Senate than the Republicans had.
Most of the expiring changes affect individuals and small businesses. By contrast, changes for corporations, such as the lower tax rate on C-corporation income, are permanent.
How is this a 25% tax increase?
The QBI deduction is a 25% tax increase not a 20% tax increase even though it’s a 20% deduction. Remember your grade school math classes.
If you started at $100 and deducted 20%, that’s $100 x 20% = $20, and then $100 – $20 = $80.
If the deduction goes away, you’re adding back $20. $20 is 25% of $80 ($20/$80 = 2/8 = 1/4).
What can you do to avoid losing the QBI deduction?
Unfortunately, as the tax law stands, the QBI deduction is all or nothing. Currently, businesses that are on the edge of whether or not they qualify can sometimes make tax planning moves to make sure they do qualify.
If the Section 199A deduction expires, it goes away for everyone. It won’t be like now where there are different rules depending on whether you’re a specified service trade or business.
One thing you might want to consider is deferring expenses. Instead of taking tax deductions now, you might want to save those deductions for when your effective tax rate is higher.
Some current pass-through entities might benefit from converting to C-corporations. However, because of double taxation, that usually won’t make sense for independent contractors and sole proprietors.
Will Congress extend the QBI deduction?
There’s really no telling what Congress will do especially in today’s political climate. Taxes will probably play a huge role in the 2024 election.
The current options seem to be:
- Let the QBI deduction expire (this automatically happens if Congress does nothing or can’t agree on changes)
- Make the QBI deduction permanent
- Extend the QBI deduction for another few years
- Reduce the QBI deduction over time by extending it at a lower rate until it goes away
- Change the rules for qualifying for the deduction
And don’t forget that the current individual income tax levels will also expire and go back to higher rates in 2026.
This creates a major tax planning challenge since there’s no telling what your effective tax rate will be and what changes you can make to lower it.
My current guess is:
- Most likely: Tax increase
- Somewhat likely: Taxes stay the same
- Not very likely: Tax decrease
So for now, I would say plan for a 25% tax increase in 2026 and hope it doesn’t end up being that high.