Qualfied Business Income Deduction




Some business owners will get a deduction based on business income from for 2018 under the new Tax Cuts and Jobs Act (TCJA). Do you qualify? For Business Owners, I will help you get a general idea about the 20% Qualified Business Income Deduction. Keep in mind several of the words and concepts mentioned have not been clearly defined, so tax experts are seeking clarifications on many of the issues and definitions of various terms used. 

Qualified Business Income Deduction

It appears the intent with the 20% Qualified Business Income Deduction is to level the playing field for all business types. It seems that other business types were given this deduction due to the reduction in Income Tax Rates given to C Corporations. I will address some of the business types that could benefit from this deduction, including sole proprietors, partnerships, and S Corporations. The deduction is to give the owners, partners, and shareholders of these entity types a deduction on their personal tax returns.

Basic Deduction

Basically the deduction is the lesser of the following:

   a) 20% of your pass through "Qualified Business Income" (QBI) plus 20% of your qualified REIT dividends and qualified PTP income or

   b) 20% of your taxable income minus your net capital gains

What if you are limited by b) 20% of your taxable income minus your net capital gains, can you carry forward the portion you are not allowed to take this year? No, if you can't take all of your 20% of your pass through "Qualified Business Income" then you lose it.

However, there are qualifications and limitations to take into account.

Qualified Business Income

First, what is "Qualified Business Income" (QBI)? QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. This income must be connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded. QBI also does not include reasonable salaries paid to shareholders of an S Corporation or Guaranteed Payments to partners for services rendered to a business not dependent on the partnership's income level. 

Qualified Trade or Business

What businesses are not qualified? The IRS mentions, other than C Corporations, two types of businesses, Specified service trade or business (SSTB), and performing services as an employee.

However, income from a SSTB does not qualify only if the taxpayer has taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,000 for all other taxpayers. So for purposes of this article I am going to present this type of business as one that can qualify but with that limitation. It's just semantics. 😕😕😕

Domestic Business Qualification Question???

It is important to note that the deduction only applies to qualified income from a Qualified Trade or Business that is a domestic business. Here is how it is stated on IRS.gov:
Eligible taxpayers may be entitled to a deduction of up to 20 percent of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. 
Notice the reference to "a domestic business". What is that? I don't think that is clear yet. However, the IRS also indicates the following in regard to Qualified Business Income:
QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.
Notice the reference to "income effectively connected with a U.S. trade or business". This expression is used in the tax law to require foreign businesses in anyway doing business in the U.S. to report income on a U.S. tax return.

So look for clarification of this issue. Absent such clarification it should be important to carefully develop strategy and keep good documentation. I would also be ready to comply by tracking revenue according to these categories. This would involve some discussions about the specific situation for the business in question. 😀

Overall Limitation

The QBI deduction is limited to 20% if the taxpayer's taxable income in excess of any net capital gain. Again, there is no carryover of the used portion because of this limitation.

Other Limitations

Qualified Wage and Capital Limitations


The QBI deduction may also be limited by a qualified wage and capital limitation and/or a limitation for s SSTB. These limitations are calculated based on the taxpayer's taxable income. The taxable income thresholds for 2018 are outlined below:

Taxable Income MFJ/Single or other
Below $315,000/$157,500                                                           No Limit
Between $315,000-$415,000/$157,500-$207,500                      Partial Limitation
Above $415,000/$207,500                                                          Fully Applied Limitations

Taxpayers above the $415,000/$207,500 threshold are subject to another limit:
The lesser of:

  • 20% of QBI or 
  • The greater of 50% of the taxpayer's share of qualified W-2 wages for the business, or 25% of the qualified W-2 wages plus 2.5% of the business's unadjusted basis in all qualified property.
Taxpayers in the middle threshold are subject to a prorated portion of the limitations mentioned above. The prorated percentage is the amount of taxable income in excess of the threshold divided by $100,000/$50,000. This ratio is multiplied by the difference between the pre-limitation deductible QBI amount and the fully phased-in wage and capital limitation amount. This is the amount used to reduce the pre-limitation deductible QBI amount.

Just contact me for help.

Limitation for Specified service trade or business (SSTB)

There are limitations for what are called specified service trade or business (SSTB), which are trades or businesses involved in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. There is no limitation for QBI from an SSTB for taxpayers whose taxable income is less than $315,000 for a married couple filing a joint return, or $157,000 for all other taxpayers. However, there the deduction is limited for taxpayers whose income is between $315,000 and $415,000 for MFJ filers and $157,500 and $207,500 for all other taxpayers. The limitation is the same as the discussed for Qualified Wage and Capital Limitations. However, for taxpayers over the top threshold there is no deduction allowed for QBI from an SSTB.

More to Come

This post addresses just the basics of the Section 199A - Qualified Business Income Deduction. I have in mind additional posts about other specifics later. 

The Situation Now

This is a unique time with complicated aspects of the new tax law, the Tax Cuts and Jobs Act. There is much discussion among tax preparers about the definitions and issues and we will see that increase as we start preparing returns for 2018. I have been going through scenarios and having ongoing discussions with my business clients about their specific situations and we are working on strategies for this year and on into the future. I can help you too with your situations. Just contact me  by sending me a text or an email to setup a time for an initial phone conversation.

Jeff Haywood, CPA
The CPA Superhero
jeff.jhtaxes@gmail.com







The above information is general information, it is not all inclusive, and keep in mind, in your tax situation everything "depends on facts and circumstances." So call me to talk about your specific facts and circumstances.


References






Be careful when reading articles about your finances or the tax law and its application, including my articles, because the wording and definitions are such a challenge and the articles are influenced by the writers perspective, specifically his own clients situations that he is mindful of and other situations the writer is not thinking of . The point is talk to your CPA about your situation and don't draw conclusions based on articles, including from irs.gov, because concepts and definitions are not very clear and, of course, they are subject to change. Now is the time to be having discussions about your situation and developing strategies for you and your businesses. Again, please contact me using my information above to discuss your situation. I help business owners all over the U.S. and foreign countries with their U.S. tax returns and strategies to reach their goals.

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