Can a statutory agent qualify for the Section 199A deduction on his W-2 statutory net income? How about on his net income from his 1099 commissions?
Let’s look at an example
Say our statutory agent taxpayer files two Schedule C’s each year. First, he files a Schedule C for his statutory W-2 income. Second, he files a Schedule C for his 1099 income, which he earns based on his security license sales.
On his statutory W-2 income, he pays FICA and Medicare taxes on his gross income. He deducts his business expenses on Schedule C against that gross income. On his 1099 income, he pays the self-employment tax on his net income, after he deducts his business expenses on his Schedule C.
Our taxpayer is married, and his income for purposes of the Section 199A tax deduction will look like this:
- $140,000 in net Schedule C income from his W-2 statutory employee business
- $130,000 in net Schedule C income from his 1099 annuity and mutual fund sales business
- $300,000 in 1040 taxable income (the client has no capital gains)
Answer – So, what does it look like for our taxpayer?
Statutory Income IRS Notice 2018-64 states that monies paid to statutory agent employees are not wages for Section 199A. This is in spite of the fact that those monies go on the W-2 because they are subject to FICA. This is good news!
In tax law, the statutory employee is an independent contractor under the common law rules. But, is treated as an employee for FICA purposes. In this special category, the life insurance agent statutory employee operates a trade or business.
1099 Income In our example, a $130,000 in net Schedule C income from his 1099 security sales business creates a $26,000 qualified business income tax deduction ($130,000 x 20 percent). He is also subject to the taxable income limit.
Taxable Income Our statutory agent taxpayer’s taxable income creates the overall limitation on the Section 199A deduction of $60,000 ($300,000 x 20 percent). This does not reduce the $54,000 total Section 199A deduction earned with his qualified business income from his two businesses ($28,000 + $26,000). Thus, the Section 199A tax deduction is $54,000.
Thresholds Remember, gross taxable income triggers the beginning of possible trouble when joint 1040 taxable income exceeds $315,000.
And for the out-of-favor specified trade or business, there’s no Section 199A deduction on that business income once the 1040 taxable income for a joint return exceeds $415,000 ($207,500 on an unmarried return).
Is This Insurance Professional in an Out-of-Favor Business?
Before answering, remember that when joint taxable income is $315,000 or less, there’s no difference in the Section 199A deduction between the out-of-favor specified service trade or business or the in-favor business. In this situation, the deduction is based on the lesser of taxable income or net qualified business income.
Now, on to our answer.
The statutory agent insurance professional we’ve described is in the in-favor business category for his statutory W-2 life insurance sales (no question).
As to his 1099 annuity and mutual fund sales, we see two possibilities. The 1099 for insurance-based annuity products, such as variable annuities and variable life insurance. They should fall into the insurance-based in-favor business category and should qualify for the Section 199A deduction.
If that single 1099 includes more than 10 percent of its income from mutual fund sales it could mean trouble. There’s a possibility that the IRS (in its final regulations) would classify that 1099 business as an out-of-favor specified service trade or business under the de minimis exception.
Here are the takeaways
The W-2 statutory agent employee is an independent contractor. That means it is a trade or business that reports income and deductions on Schedule C of Form 1040.
Statutory income on the W-2 produces trade or business net income that qualifies for the Section 199A tax deduction.
When taxable income is $315,000 or less (married, filing jointly) or $157,500 or less (filing as other than married) it’s easy. Both in-favor and out-of-favor business income qualifies for the Section199A tax deduction based on the lesser of business or taxable income.
The insurance agent who receives 1099 income may have income that’s in-favor or out-of-favor for the Section 199A tax deduction.
Please contact our office if you would like to review your tax plan with us before the end of the year shoot us an email or call us to schedule a chat at (480) 517-0988.Tags: Tax, Tax Planning